When bitcoin prices gain about 10% on a single trading day, as they did during both Wednesday’s and Thursday’s sessions, the corresponding price increase is now more than $1,000. In one day! (However, prices then fell by more than $2,000 overnight on Friday.) The cryptocurrency sensation has clearly reached a fever pitch.
For those unacquainted, bitcoin is the oldest, most popular, and most trusted among the variety of cryptocurrencies (or altcoins) that now exist. Its dramatic price swings are earning it increasing attention from Wall St, and certainly from speculators.
Bitcoin is often abbreviated BTC, as if it were a security, but it’s not a share of equity or a bond. It lacks some of the fundamental properties of a currency, so it’s not that either. (Anything whose price can change $1,000 in a day doesn’t make for a useful unit of account.) Financial regulators, in fact, have had a hard time classifying it altogether the past few years. It seems strange to label something intangible a commodity, but that’s the categorization that some have been settled on.
The price of bitcoin has nonetheless increased roughly 1,000x—that’s a thousandfold, or more than 100,000%—over the past five years, rising from about $15 to over $15,000 in that span. It began the 2017 calendar year at $1,000; that means it’s up more than 1,000% year-to-date.
But the question so many people still have is, What is it?
Is it “digital gold” or “gold for millennials” as is now becoming popular to say?
Even people who don’t participate in or watch the markets are starting to take notice. It’s telling that bitcoin’s price has skyrocketed when such confusion abounds and so much about its future is still unknown, even to the experts.
In short, bitcoins are digital tokens. They were invented around 2008 with a predetermined, fixed maximum supply in order to maintain their scarcity. The tokens are slowly released in small fractions of a bitcoin at a time to miners who basically lend some of their computing power to perform algorithmic calculations. Those calculations help verify transactions on the blockchain, a distributed ledger that records transactions securely and in a decentralized manner.
Blockchain technology is what’s really enticing and revolutionary about cryptocurrencies. It could form the backbone of a variety of other digital solutions in finance, monetary policy, voting, and the way transactions are carried out all around the globe. It has the advantages of being transparent, public, and unalterable.
But, as contrarian investor Vitaliy Katsenelson at MarketWatch correctly points out, you’re not “buying the blockchain” or necessarily investing in blockchains when you buy bitcoin. It doesn’t hold any exclusive rights to the emerging platform. Many of the other digital coins out there use the same concept, albeit for different applications. Bitcoin doesn’t give someone ownership of anything that can accurately be valued the way the share of a company or holding a real asset does.
Perhaps 17 million of the maximum supply of 21 million bitcoins are “in circulation,” amounting to a total market capitalization or “market capacity” for BTC in excess of $200 billion. That exceeds many prominent multinational corporations and even the annual economic output of entire countries. This means bitcoin accounts for more than half of the entire cryptocoin market, which consists of hundreds of different coins.
Yet nothing has fundamentally changed with bitcoin or how it functions between last year and now that would explain the rise in its price—except that large institutions are opening the doors for investors to speculate on it. In particular, bitcoin futures could begin trading on Wall St as soon as next week.
The risks and limitations of bitcoin in its current form are demonstrated by the murky story of a cryptocurrency called tether as well as more than one instance of various bitcoin exchanges and digital wallets being breached by hackers in the last several years. Moreover, it’s still not especially easy to exchange bitcoins for dollars, let alone all other currencies. Moreover, because these new innovations are still in their infancy, it’s unclear that they will be scalable (i.e. successful in large-scale applications).
It has been suggested by some in the crypto community that bitcoin could function as a sort of reserve currency for other digital tokens, not unlike the dollar does (and gold once did) in a world filled with competing currencies. However, this still requires one to trust an unregulated ecosystem of altcoins that is far from fully mature. Blockchain technology does have the potential fundamentally alter a number of society’s institutions—eventually.
As it stands, bitcoin could be in a bubble. Wild swings up and down have been part of its history. The bitcoin price spiked to over $900 late in 2013 only to drop back down to below $300 for much of the next three years. The right side of the chart above shows how the price increase begins to follow the path of a parabola around the middle of 2017, meaning it’s been rising at an exponential rate.
Such a volatile path is cause for some concern and is highly unlikely to be sustainable. The rapid price movements are also leading to other market dislocations: On Thursday, there were huge spreads (as high as $3,000) between bitcoin prices on different exchanges. Yet another of these exchanges was hacked this week, as well, causing some $64 million of bitcoin to vanish. Throw in the wild price swings up and down and you can begin to see that the market for cyrptocurrencies is still clearly working out the bugs.
Of course, past financial bubbles have led to great results after the failure and mania. Rampant speculation was behind the invention of such transformative 19th-century technologies as trains and telegraphs. We’ve seen it happen in our own time with the “dot-com bubble,” which matured into today’s thriving e-commerce environment.
Whatever bitcoin truly is or ends up becoming, what digital currencies of various stripes are not are stable stores of wealth like precious metals. Gold’s longtime status as a safe haven will always distinguish it from other risk assets, and there’s no denying that bitcoin carries considerable risk. No matter how successful bitcoin or some rival cryptocurrency ever becomes, they will never be a substitute for physical precious metals.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.