Bitcoin: A Wise Investment?

Bitcoin Brief: A Wise Investment?

Joseph Doudt

Cryptocurrency has taken developed nations by storm in the last decade. Just eight years ago, one bitcoin could be acquired for a mere $450. At the time of writing this, an investment at that time would have, so far, brought in a return of 157 times the initial outlay. This kind of return is nothing to scoff at. There are, of course, plausible arguments that cryptocurrencies are just a momentary trend, sure to die off. The chart from 2020-2022, viewed in isolation, would lend credence to that mindset. In fact, that chart is what created that mindset in many investors. Typically, a spike with such a monstrous correction afterwards signifies a short-term bubble. However, when that correction reverses, and over a few years, trends upwards to new all-time highs, the fad argument begins to dissolve.

Firstly, investment fads are typically over a short or medium term. It has been three and a half years since Bitcoin’s entry into the limelight, during which time the currency has spiked, corrected, and again pushed to new highs. It of course remains to be seen whether bitcoin will push continually higher, or crash again; but the multi-year trend, as well as society’s growing digitalization, seems to point towards continued growth. Still, technological advancement alone will not prop up bitcoin–an expected rise in use cases and financial practicality, which remains largely speculative at this time, will have to carry that weight.

Regardless of its true value, cryptocurrency has long been a rising tide, lifting net worths across the world. At this time, bitcoin is above $71 thousand per coin. The market capitalization of cryptocurrency as a whole was $2.8 trillion a few months ago–while it was only $10 billion in June 2016. $1.5 trillion of that is now in bitcoin alone. That figure is higher than the market cap of all but seven companies worldwide. A significant amount of that stems from the ability of investors to buy fractional cryptocurrency as well as crypto ETFs. Those have opened the floodgates of retail trading into the sector. Some of these retail traders have, in a matter of years, earned the ability to never work again. I recall an article that displayed a roster of event prizes from the early 2010s, where the third-place prize was 100 bitcoins. Back then, that was worth a few dollars. Today, those would be worth $7.1 million. Retail gains notwithstanding, large companies have become increasingly exposed to the asset. The well-known Tesla, for example, holds 9,720 bitcoins. Another firm, MicroStrategy, which focuses on AI-powered analytics and data visualization, has long used their positive cash flows and financing proceeds to accumulate bitcoin; as of 2024, their hoarding is to the tune of $16.65 billion (CoinGecko). Many companies and individuals have gained from the upward motion. Certainly, many losses have been had as well–but those have been a matter of entry/exit timing, rather than the overall soundness of the investment. Looking at price history alone, bitcoin would have proven a sound investment at most points over the past decade.

Now, we must delve into the realm of whether, fundamentally, bitcoin offers $1.5 trillion worth of value to society today or set to offer that and more soon. To begin with, we ought to conduct an analysis of what cryptocurrency is, and how it functions. Understanding a company, currency, or commodity, is the first step of informed investment. Most cryptocurrency is decentralized–hence, the appeal. This means that no one entity controls everything in any form of central account. Rather, users hold their own copies of the historical ledger of transactions. By “mining” cryptocurrency, individuals are providing their computing power to process and validate global transactions on the currency (NerdWallet). Different networks essentially validate one another’s information and secure it. Roughly every ten minutes, a ‘block’ is created. This is a set of transactions that are cryptographically encoded and immutable, storing historical transaction data securely. Whichever user’s processor successfully completes a block and enters it into the record gets the reward, which currently stands at 3.125 bitcoin. This number halves approximately every four years. To complete said block, your computer must generate a cryptographic formula that falls within an immensely narrow range. To put this in perspective, the global rate of solution attempts was about 600 quintillion times per second in June this year (Compass Mining). The first computer to solve for the right code gains the right to submit a block to the ledger. As mentioned earlier, this block simply verifies and packages past transactions in an unchangeable way, to maximize security and prevent fraud. Other computers must cross-check this block before the reward is gained, but this is more a formality than anything. Only a miniscule percentage of mined blocks will not be rewarded–when they are not, it is due to simultaneous solutions found by multiple miners, and the subsequent process of how the network decides which miner to reward.

Bitcoin was founded in 2009, making it the first cryptocurrency to grace the market. A pseudonymous, still unknown creator, who goes by Satoshi Nakamoto, published a whitepaper called “Bitcoin: A Peer-to-Peer Electronic Cash System” (Kriptomat). This paper presented the concept of bitcoin, and launched the creation of its software. Nakamoto inaugurated the currency by mining the first block of 50 bitcoin. The last public communique from Nakamoto was in April 2011. Early on, only a few developers and programmers participated in the technology. Slowly, however, it began to see success, undergoing gradual growth and regular software updates. Four years after its creation, the price per unit exceeded $1,000. Soon thereafter, it tanked and stagnated for a few years.

In 2014, the largest cryptocurrency exchange was hacked, and 850,000 bitcoin were stolen. That same year, the founder of Silk Road, a major website for crypto transactions, was sentenced to life in prison. It had been discovered that illegal drugs made up more than two-thirds of the products sold through the store that specialized in the anonymous, encrypted payment platform–big surprise. It is clear that 2014 was a year of negative press for cryptocurrency.

What about 2024–where does the currency stand now? As of today’s date, it stands at all-time highs. A single bitcoin in today’s market will set you back by over $71,000. This value is highly volatile–but despite the rollercoaster ride of the last decade, the price continues to rise. Based on this fact, investor sentiment is generally positive. Whether or not retail and institutional investors believe in the longevity or usefulness of bitcoin in general, they seem to believe the price will continue rising.

Undoubtedly, demand for bitcoin continues to exceed supply. However, it may certainly be argued that investors are acting foolishly in this regard, rather than basing their portfolio on fundamentals. While cryptocurrencies are popular in the moment, it is possible that the growth prospects are limited. One downside of bitcoin, for example, is that it is not backed by anything. Thus, price is entirely a product of supply and demand. Should demand suddenly drop, for any reason whatsoever, capital may quickly be lost.

Most popular cryptocurrencies are decentralized, which is a two-edged sword. On one hand, this is a major appeal of crypto, due to the user anonymity, immunity from seizure, and freely available, yet anonymous data regarding transactions and money supply. However, there is no serious regulation of these assets. The Commodity Futures Trading Commission seeks to prevent market manipulators from defrauding consumers–the anonymity in crypto, and the irreversibility of transactions, make scams far simpler for the perpetrator. These scams can be fairly easily avoided by the commonsense user, by avoiding niche, relatively unknown currencies, as well as by only making transactions with trusted vendors.

The DOJ’s National Cryptocurrency Enforcement Team seeks to combat the currency’s use as an illegal tool in terrorism financing and cybercrime, and the IRS works with cryptocurrency brokers (a challenging-to-define term) to receive digital asset reports for tax purposes (Plural Policy). Beyond these initiatives, there is shockingly little government oversight. Quite evidently, the existing initiatives are solely to prevent illegal acts–fraud, terrorism, cyberattacks, and tax evasion. When it comes to consumer protection, such as the FDIC and CFPB are involved in, or general regulation, there is next to nothing. This is by design.

So far, we have addressed bitcoin’s lack of backing, which is not any different to many fiat currencies. We have also gone over decentralization, which is in some ways negative. However, this decentralized nature of crypto is also its primary selling point. Many entirely lawful consumers enjoy the prospect of fully anonymous transactions, which cannot be easily scrutinized by the government. Control is in the hands of many, through the peer-to-peer system, rather than a small group of elites. Additionally, the malfunction of a server or portion of the network will not have a widespread impact, due to crypto servers being dispersed across the world.

In August of this year, during one of the biggest stock market sell offs as of late, online brokerage firms such as Charles Schwab, Fidelity, and Vanguard were down for multiple hours due to server issues, affecting thousands of users (AP News). This has happened various times in the past, even recently as July 19, 2024, the date of the infamous Crowdstrike outage–multiple brokerages were also affected then. Network decentralization alleviates that risk. To shut down bitcoin, for example, every instance of the bitcoin client software would need to be deactivated, which is near impossible, due to the decentralization of the currency, and the massive size of the network today. Thus, Bitcoin users need not worry about an inability to trade.

I will reference one more important facet of decentralization: immutability. I briefly touched on this earlier; it is the unchangeable nature of the transaction record. Chargebacks cannot be done, and transactional data (account numbers, amounts) cannot be altered post-transaction. The bitcoin ledger confirms each transaction through a vast network, in each step along the blockchain, which, simply put, means that there is enhanced security for its users (TechTarget). The cryptographic encryption endemic to cryptocurrency also helps there.

So, given the facts of how cryptocurrency works, is the price for a single bitcoin worth it? Given the fact that its price is determined by supply and demand, we should look at those two factors to find an answer. Regarding demand, we should analyze the daily volume of bitcoin trades over time. Over the past decade, this statistic has increased, albeit in a highly volatile manner (Y-Charts). Since April 2023, the measure has increased at a much more rapid pace. On October 28, 2024, 702,824 bitcoin changed hands. This, in dollars, equates to a one-day volume of $50.9 billion. For the purposes of this analysis, we will presume that fair weather continues for cryptocurrency and usage continues to increase, driving up demand.

Consider a basic supply-demand graph in economics. When demand shifts to the right (goes up), the equilibrium price increases. Thus, the factor of increased transactions in isolation would increase the price of bitcoin, ceteris paribus. Of course, if supply increased alongside demand, price would remain stable despite an increase in quantity. This reality brings rise to an important fact: bitcoin supply was fundamentally designed to decrease over time.

This planned reduction is called halving. To recap from earlier: roughly every four years, since bitcoin’s inception, this has occurred, lowering the supply of new bitcoin on the market. Eventually, bitcoin supply will hit a cap of 21 million coins, after which no additional units will be minted. There are two sources of bitcoin supply: those putting their coins up for sale, as well as newly mined coins. The number of coins up for sale will likely remain in its own pattern, or even decrease as halving occurs, due to the expectation of a resultant increase in value. That expectation stems from the reality that a halving would cut the rate of bitcoin minting significantly enough to hit supply levels, which will draw back the supply curve. Naturally, according to that same simple graph used in economics, a leftward movement of the supply curve (a reduction) increases unit prices. Overall, these planned reductions in supply, when paired with a rising use rate of crypto, seem to signal continued price gains. Of course, a notable downfall in crypto usage could offset the upward price pressure of crypto halving, if public sentiment deteriorates.

Based on these factors, Bitcoin in particular appears to be a wise investment, so long as its use cases abound. Other coins have their own minting methods, as well as unique caps or lack thereof, which all factor into their respective supply and demand levels. Whether or not one believes bitcoin usage will continue to trend upwards is up to personal discretion. I lean towards the optimist case, despite being uninvested in the currency. Previously, I was skeptical, seeing it as a fad. However, it has continually grown and reached new all-time highs over time, proving robust demand.

Additionally, online transactions have become so much more commonplace over recent years. I, for one, have carried no cash in my wallet for years, and have had only one, maybe two, instances of inconvenience as a result. Cards, Apple Pay, PayPal, and many other forms of payment dominate. In fact, bitcoin can be used as a payment method in PayPal. As bitcoin becomes more common, with more investing in it, I predict that an increasing number of major retailers will accept it. Already, Microsoft, AT&T, Starbucks, Home Depot, and Shopify accept it, among others (99 Bitcoins).

It is a simple matter of corporate sentiment toward the currency. Just as an individual will buy bitcoin if they expect it to appreciate it, a company will accept the payment method if they expect the currency to appreciate post-purchase or at least remain stable for long enough to be sold. Due to its existence as a currency, crypto can be immediately spent out of a wallet, despite being “invested.” I put the word in quotes because bitcoin merely seems akin to an equity investment, due to its rapid growth and immense volatility. Yet, it is indeed a currency, like a dollar bill. Due to the convenience of use, as well as the perks such as anonymity, irreversibility, and currency appreciation, I will likely allocate part of my portfolio to bitcoin if it corrects again and offers a tempting entry point. I don’t expect it to correct due to a dire outlook, but simply due to the oft-overblown volatility of an emotional, irrational market. Each investor should conduct their own research, of course–that is just my plan.

Assuming one is interested in adding cryptocurrency exposure to their portfolio, it is important to correctly classify the asset. Would this be similar to a currency investment, such as a certificate of deposit or forex? Or might it take the place of a commodity investment in, say, oil or gold? According to the Commodity Futures Trading Commission, cryptocurrency is a commodity, due to the reliance of its price on market forces (CFTC). On top of those two potential classifications, the SEC reasons that most cryptocurrencies (except bitcoin) should be seen as a security, for the sake of additional regulatory opportunities to “protect investors.” Likely story, SEC. I expect they’re more interested in overcoming the frustrating fact that most crypto is decentralized, outside of their purview.

So, currency, commodity, or security? Classification is important, as it directly contributes to a properly organized portfolio. We can safely say that bitcoin, at least, should not be called a security, since even the SEC treats bitcoin as an exception. And, most crypto is far more volatile than currencies. In the end, bitcoin most resembles a commodity, but other, less volatile crypto, may be classified as a currency. It is helpful to consider bitcoin similarly to how one might look at gold, back when it was a primary unit of trade. Bitcoin can quite literally be mined and then spent or held through a period of appreciation.

When it comes to making a decision of how to classify cryptocurrency within one’s own portfolio, volatility and historical returns are helpful. If I invest in something as volatile as bitcoin, for example, I will not want to label that a currency investment–most currency investments will have a lower yield and less risk overall. So, I personally would consider a high-volatility crypto investment as a commodity. Now, if I acquire a cryptocurrency with low volatility and less, but safer, yearly returns historically, I might label that a currency investment, taking the place of a CD or forex position.

Even with these rules, the inherent difficulty in labeling these investments is plainly visible. A popular commodity, gold, yielded a total of 72.2% over the previous 5 years. Bitcoin, on the other hand, returned 677.34%. This monumental discrepancy is largely due to the buzz around bitcoin–it may level off over time. Yet, it remains clear that any classification, even ones that make a relative amount of sense, must be taken with a grain of salt. In the end, a very sensible perspective is to treat cryptocurrency as an entirely new kind of investment, until the hype dies down and it better parallels another asset class–if it ever does. Of course, the downside is that there are no long-established allocation formulas that incorporate cryptocurrency.

Most financial experts recommend limiting crypto exposure to 5% (Investing in Crypto). Yet, a portfolio in bitcoin alone would have outperformed the market over the last five years by many times over. Ultimately, the recommended exposure has to do with uncertainty and high volatility, as well as portfolio diversity. We are treading new ground. In the end, I hope this research has provided you with a better conception of cryptocurrencies in general. Ideally, you feel more confident in whether or not to place them in your portfolio and have an idea of how you might include them.

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Works Cited

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