5 Questions You Need To Ask Yourself Before Investing In Bitcoin

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Bitcoin crossed the $40,000 mark on Jan 7, 2021. Also, juggernauts like Square, Microstrategy have been pouring money into bitcoins. Reading this might make you want to invest in them.

Bitcoin is a bubble? Can governments ban bitcoins? - pretty common questions that naturally mess with your brain, especially since there are two extremities. While on one the one hand, bitcoin is becoming more and more popular, on the other, there is a sense of uncertainty around the future of the asset.

This article answers five most frequently asked questions about bitcoin. At the end of this article, you will have most of your bitcoin-related doubts cleared.

πŸ€” Is Bitcoin A Bubble?

In late 2017, bitcoin peaked at almost $20,000, which seemed impossible to touch again. Looking at the linear price chart of bitcoin between 2018 - 2019, anyone would instantly label it a classic bubble.

On the other hand, bitcoin's long-term logarithmic chart speaks a different story. This chart looks a lot more rational as it gives you bitcoin's value in relation to bitcoin's four-year halving cycle.

A bitcoin halving event is an algorithmically pre-programmed occurrence that cuts the bitcoin (bitcoin block rewards) supply in half every four years (every 210,000 blocks).

Here's how the bitcoin performed during the halving cycle.

The table indicates that bitcoin witnessed a meteoric rise as the supply is limited, and the circulation becomes scarce every four years. The price is further catalyzed by HODL investors.

After the recent halving event on May 12, 2020, the supply rate is limited to 6.25 BTC per newly mined block, and with it, bitcoin is on the rise.

Bitcoin touched a new all-time high of above $40,000 on Jan 7, 2021. Currently, it is trading at around $39,000, according to CoinMarketCap.

If bitcoin follows a trajectory similar to its previous halving cycles (not guaranteed), bitcoin's relative price index will grow stronger in coming years.

πŸ’° Why does Bitcoin have value?

The major utility of bitcoin is that it allows people to store value outside the traditional, centralized currency system. Bitcoin is borderless; you can transfer and carry BTC units anywhere with a simple mobile application, hardware wallet. The fact that bitcoin is limited to 21 million units (out of which over 18 million are in circulation) makes it more valuable.

We are not comparing bitcoin with gold, but try bringing $250,000 worth of bitcoins and $250,000 worth of gold via an international airport. You know which option is simple and convenient.

Bitcoin enables everyone (even the unbanked) to buy, store, send, and receive value in a frictionless manner.

πŸ“ˆ Am I investing in a Non-Scalable Cryptocurrency?

Bitcoin can only process 4-7 transactions per minute, whereas payment behemoths like VISA can process tens of thousands of transactions per second. If you look at this with a new investor's eyes, you will not bet on bitcoin due to its inability to scale.

However, the blockchain trilemma states that a blockchain network cannot achieve maximum decentralization, security, and speed at the same time. This is also true for any payment protocol.

VISA, for example, processes countless transactions with moderate security. Bitcoin, on the other hand, prioritizes decentralization and security while compromising on speed.

The traditional banking system also faces scalability issues. Remember waiting for days for wire transfers to reach your friend aboard? To combat this, banks partner with settlement layers like Paypal, electronic transfers, checks, etc.

Similarly, the lightning network is a proposed solution to combat the bitcoin stability issue. The lightning network processes an arbitrary number of quick transactions per minute between counterparties outside the Bitcoin network and adds them to the bitcoin blockchain in one batch transaction. This reduces the burden on the bitcoin network, allowing more frequent transactions.

The fact that Lightning Labs, Bitcoin's Lightning infrastructure developer, has been listed in World Economic Forum's list of top 100 technology pioneers speaks volumes about the technology.

😱 Is Bitcoin Too Volatile?

Satoshi Nakamoto envisioned Bitcoin to emerge as a medium of exchange. The cryptocurrency is also promoted as a store of value. However, with its notorious volatility, it doesn't fit in any of these asset classes.

You will not invest in bitcoins for an emergency fund or for a down payment to be paid after 6 months from now. When you need a fixed amount of return in a near-time period, bitcoin will not be an asset of your choice.

Nevertheless, bitcoin is an 'emerging store of value'. With only 12 years since its launch, the asset has still room for growth. For bitcoin to become a reliable store of value in the future, it requires volatility, most importantly upward volatility, and with it comes associated downward falls. If bitcoin amasses a $2.5 trillion market cap one day with well-distributed holders, the volatility is likely to reduce significantly.

🏦 Will Governments Burst the Bitcoin Bubble?

Some governments have already β€œbanned” bitcoin. Well, gold was also illegal to hold in the U.S. from 1933 to 1975.

With bitcoin slowly going mainstream, it will become more difficult to ban it.

Here's why bitcoin can go mainstream:

  • Currently, bitcoin has over $700 billion in market capitalization.
  • The IRS labeled crypto as a 'commodity' for tax purposes.
  • Two publicly-traded companies Microstrategy (MTSR) and Square (SQ) own large sums of bitcoin. Several other public companies, private companies, and investment funds also own bitcoins.
  • Investing whales like Cathie Woods, Paul Tudor Jones, and Stanley Druckenmiller also possess bitcoins.
  • Fidelity and several large companies run institutional-grade custodian services involving bitcoins.
  • PayPal announced it would allow U.S. customers to buy, sell, and hold bitcoins and other major crypto units on its platform in 2021.
  • Federally regulated banks in the U.S. can legally keep crypto assets in custody.

It would be extremely difficult for major capital markets like the U.S., Europe, or Japan to ban bitcoin at this point, considering the level of bitcoin adoption among legal frameworks, institutions, and companies.

πŸ“ The Bottom Line

It would be best if you approached bitcoin like any other asset - with a proper analysis of risks, rewards, bullish, and bearish cycles. Also, you should bet on bitcoin only after measuring your risk tolerance and financial goals.

The rule of thumb for being less-affected by bitcoin's volatility is to manage your position rather than trading bitcoins more frequently.

Written by Dmitry Perepelkin