Bullish or Bearish: Bitcoin
Make sure you understand the real risk before you invest.
As of this writing, Bitcoin (BTC) is currently valued at just over $27,000, or almost 6x greater than its 2020 low point. So, now is an opportune time to discuss whether to be optimistic about Bitcoin’s skyrocketing price, or fearful of a swift demise.
What is Bitcoin?
First, some background. Bitcoin is the world’s most popular cryptocurrency, pioneered by the mysterious Satoshi Nakamoto in the early 2000s. No one knows exactly who Satoshi is, or even whether this pseudonym refers to a single person or a larger collective, but a white paper published under this name in 2008 introduced the idea of an unregulated, decentralized digital currency.
This novel cash system promised to replace banks and governments by having members of the Bitcoin network approve transactions anonymously and ensure security via a distributed ledger shared across the community, known as the blockchain.
Satoshi’s elegant solution ensured that fraudulent behavior would be rejected by the rest of the network before it was published to the blockchain, thereby providing confidence to Bitcoin users that all of their anonymous transactions would be safeguarded from malicious actors.
Early users of Bitcoin were mostly highly technical computer experts, who understood the underlying protocols and calculations well enough to determine that they could depend on the network’s security.
This created one of Bitcoin’s most compelling features: users did not have to trust one another; they only had to trust in the blockchain and the integrity of the Bitcoin network to know that their transactions would be secure.
Price History
Though fully fielded in 2009, Bitcoin did not start to gain popularity for several years. In the early days, there simply weren’t enough computers contributing to the network to ensure that transactions would be published to the blockchain in an expeditious manner, so some peer-to-peer exchanges would linger in limbo for weeks.
The value of Bitcoin remained so low that one early adopter famously paid 10,000 BTC for 2 pizzas in 2010, marking the first known occasion that Bitcoin was ever exchanged for a physical good or service (the value of those pizzas is now $270,000,000, for those counting).
In 2013, the price of Bitcoin saw its first monumental increase. It began the year valued at around $13, but by December the price had spiked to over $1,000, garnering substantial international attention.
Bitcoin’s price would then fluctuate for several years until 2017, when it saw its second meteoric rise and reached a maximum value of over $19,000. This surge was followed by a several-year lull, during which BTC would fall as low as $3,500, but 2020 proved to be a blockbuster year for the cryptocurrency.
Today, Bitcoin is trading at an all-time high of $27,000, and investors across the world are wondering whether the next phase will prove to be another boom, or a bubble.
The Good News
The good news for Bitcoin supporters is that institutional investors are pouring billions of dollars into the currency right now, which most economists suggest has been the source of the surging price.
Hedge funds, venture capitalists, bankers and fund managers of all types are clamoring to ensure that they do not miss out on the massive returns that cryptocurrencies can offer. As a result, many are investing millions in Bitcoin, which for the time being has been a great bet.
In addition, there are scores of brilliant computer scientists dedicated to defending the integrity of the Bitcoin network. They design software updates as a community and confer about their visions for the future of the currency, so Bitcoin has the best and brightest working to protect it.
The Bad News
Unfortunately, Bitcoin is not being used as it was intended. Satoshi had envisioned a world in which all users of Bitcoin contribute to the blockchain and use his currency in everyday life. Distributing the computational burden across millions of users was supposed to increase security and make the blockchain unhackable.
Instead, most users of Bitcoin have no intention of using it as an actual currency, and given its volatility, it really doesn’t make sense to do so. Some online stores accept Bitcoin, and there are some who do use it in lieu of credit cards, but most users of Bitcoin have purchased it speculatively, as an investment in its future price rather than an investment in its future utility as everyday currency.
As a result, Bitcoin’s original architecture is not designed to support the manner in which it’s being utilized today.
Users who download wallets apps like Coinbase or Binance do not contribute to the computational burden of maintaining the blockchain. This means that they play no role in deterring fraudulent behavior, which leaves the task of ensuring the integrity of Bitcoin to a relatively small group of advanced users.
Much to Satoshi’s chagrin, there are now massive corporations and consortia (called pools) around the world that exist only to mine Bitcoin, a process in which a user solves a complex equation and then is allowed to publish new information on the blockchain, receiving free Bitcoin in the process.
The ASIC (Application Specific Integrated Circuit) computers that these miners use are millions of times more effective than an ordinary PC or MacBook, and mining companies utilize ‘farms’ that can operate tens of thousands of these ASICs at the same time.
This means that a very small group of users control a massive percentage of the computational power in the Bitcoin network, which gives them an equivalent level of control over the approval process for transactions. If a syndicate of users were to combine resources and gain control of over 50% of the network, they would be able to conduct a ‘51% attack,’ which would allow them to modify the blockchain fraudulently.
Today, 65% of the Bitcoin ‘hashrate’ is distributed across only 6 pools.
The Worse News
There are many attacks, like the 51% attack, that could undermine the Bitcoin network, so I won’t list them all here. However, what makes them truly dangerous is not the prospect of a large-scale heist, but instead the effect that such a breach would have on Bitcoin’s price.
As a cryptocurrency, Bitcoin’s value is entirely subject to the ‘animal spirits’ that govern how investors perceive it. A large-scale attack would subvert the entire foundation of the Bitcoin network, indicating that its very integrity could no longer be trusted.
Such a revelation could cause panic across the network, and as investors liquidated their BTC to ensure that their funds were not hijacked, the price of Bitcoin could plummet. Hard. To zero.
A cryptocurrency whose users cannot have confidence in its transactions is worthless, so all who invest heavily in Bitcoin need to understand the gamble that they are making. The consolidation of network nodes into a few powerful players should be a troubling sign for all in the Bitcoin community.
However, it should be noted that attacks on the Bitcoin network are considered unlikely due to the simple fact that stealing Bitcoin is useless if the price will fall to nothing. Malicious actors know that a single hack could doom the network, so they’re incentivized not to act in a way that will lessen the value of their own BTC.
Nonetheless, with a market cap of $500B, some clever users may deem it worthwhile to compromise Bitcoin’s price if they can steal even 1% of the outstanding BTC and liquidate their position before the network catches on.
Conclusion
In all, I am bullish on Bitcoin in the short-term as an investment. There is substantial institutional capital flowing into the ecosystem, and this kind of attention from the finance world is generally believed to be the driver of Bitcoin’s huge spikes.
However, I am bearish on Bitcoin’s future as a true cryptocurrency. Most members of the network use Bitcoin for speculative trading, rather than everyday currency, and it seems unlikely that people will decide to replace cash with BTC if its price continues to fluctuate wildly from month-to-month.
This use case, and the rise of Bitcoin farms and mining pools, reduces the security of the network, and makes Satoshi’s dream of Bitcoin as a global cryptocurrency fit for everyday use seem increasingly out-of-reach.
