5 myths about bitcoin

Myth #1: Bitcoin is a bubble

While it is true that some people buy Bitcoin as a speculative investment in search of big returns, this does not mean that Bitcoin itself is a bubble. Bubbles are economic cycles characterised by unsustainable increases in market value. They eventually emerge when investors realise that prices are much higher than the fundamental value of the asset. Bitcoin is sometimes compared to an infamous early speculative bubble: the Dutch "tulip mania" of the 17th century. In 1637, speculators raised the price of some varieties of tulips 26 times. The bubble lasted six months, collapsed and never recovered.

The real story:

Bitcoin went through several price cycles for more than 12 years and each time recovered to make new highs. As with any new technology, up and down cycles are expected. For example, at the end of the dot-com era in the nineties, Amazon shares plummeted from $100 to $5, only to become one of the most valuable companies in the world in the following decades.

Some big Bitcoin investors believe that Bitcoin's fluctuations form a pattern typical of young markets. They say Bitcoin will rise and fall with smaller swings and longer gaps in between, until at some point in the future it will establish itself in relative stability. But only time will tell.

Myth #2: Bitcoin has no real use

Critics like to claim that Bitcoin is useless in the real world, and if it is used, it is mostly for illegal activities. None of these claims are true. Bitcoin has a long history as a means of making payments to anyone in the world, all without a bank or payment system as an intermediary. And it is increasingly being used by big investors as a gold-like hedge against inflation.

The real story:

Bitcoin has become increasingly popular in recent years as an inflation-resistant savings vehicle very similar to gold, leading to the nickname Bitcoin 'digital gold'. A growing number of large funds and public companies (Tesla, Square, MicroStrategy) are buying millions or even billions of dollars worth of Bitcoins to better manage their assets.

Like gold, bitcoins are scarce (there will never be more than 21 million bitcoins). Gold, of course, is heavy, bulky and difficult to transport and store. Bitcoin, on the other hand, can be sent digitally as easily as sending an email.

In the early years, Bitcoin attracted negative attention as a means of payment on the darknet. But when the first major darknet market closed, Bitcoin prices rose after just a few days and continued to rise.

Like any form of money, some will be misused. But compared to US dollars, the illegal use of bitcoins is a drop in the bucket. According to a recent report, 2.1% of bitcoin transactions in 2019 involved criminal enterprise.

And because all bitcoin transactions take place in an open blockchain, it is often easier for authorities to monitor illegal activity than in a traditional financial system.

Myth #3: Bitcoin has no real value

While Bitcoin cannot be backed by a physical asset such as gold, the US dollar or virtually any other modern fiat currency is not. Bitcoin is rigidly programmed to be in deficit, which makes it resistant to inflation. Inflation with fiat currencies can happen when they are created in large quantities, which increases the existing supply.

The real story:

There will only be 21 million bitcoins. This shortage is a major factor in its value.

Not only is supply limited, the number of new bitcoins mined decreases over time in a predictable way. Every four years, as part of an event called "halving", the rewards for blocks paid to miners on the network are halved.

This helps to ensure that supply is always reduced, which, in line with the basic economic principle of scarcity, has worked to ensure that the price of Bitcoin as a whole rises over the long term - from less than a penny at the start to more than $50,000 by the end of 2019.

Bitcoin also derives value from the work that computers on the network contribute through a process called mining. Powerful computers around the world provide huge amounts of processing power to verify and protect each transaction (in exchange, they are rewarded with new bitcoins).

Myth #4: Bitcoin will simply be replaced by a competitor

Bitcoin was the first truly successful digital money. And while new cryptocurrencies have long promised to overtake Bitcoin through new features or other benefits, none have come close.

The real story:

Although thousands of competing cryptocurrencies have been created over the past decade, Bitcoin has always been and remains the most valuable cryptocurrency by market capitalisation by a significant margin.

It is also the most popular, accounting for around 60% of the crypto market.

The reasons include Bitcoin's first-mover advantage and the purity of its mission as a decentralised and open currency.

That doesn't mean competitors can't give it a try. Bitcoin is decentralised, meaning it is run by a global community of miners and nodes rather than a central authority.

For example, if the basic architecture of Bitcoin needs to be changed to add new features, functions or to protect against a recently discovered bug, the community can initiate a fork to update the network.

For the update to be accepted, it must be supported by a majority of 51% of the community. This allows Bitcoin to adapt and evolve as needed, as seen in the Bitcoin Segregated Witness ('SegWit') update in 2017.

Because the software is open source, developers who cannot reach consensus in the community can even create a hard-fork of the Bitcoin blockchain and create an entirely new cryptocurrency. Bitcoin Cash, for example, was created this way, but so far no Bitcoin clone has come close to replacing the original.

Of course, there is a huge amount of innovation going on in the space, so it is entirely possible for a larger competitor to emerge. But given the current circumstances, most experts don't see Bitcoin's replacement as a likely outcome anytime soon.

Myth #5: Investing in bitcoin is a gamble

While it is true that Bitcoin has experienced significant price volatility over the past decade, this is to be expected from a young and growing market. Since Bitcoin's initial blockchain in 2010, it has steadily gained long-term value - with a market capitalisation in excess of $1 trillion (as of February 2021; see Current Market Capitalisation). And as Bitcoin continued to grow, a robust regulatory structure in countries around the world helped attract a wave of institutional investments (Tesla, hedge funds).

The whole story:

Bitcoin investors have a fundamental reason to believe that their asset values should rise, whereas in casinos, as you know, the odds are tilted in favour of the house. Of course, there are no guarantees about future performance or long-term results, but Bitcoin's long-term trend line over the past decade has been upward.

One popular investment strategy to reduce the impact of volatility is dollar-cost averaging, in which you invest a fixed amount each week or month, regardless of what happens in the market. This strategy usually leads to positive returns regardless of volatility in a positive trendline environment.

Bitcoin volatility seems to be declining. A recent Bloomberg analysis compared Bitcoin's recent bullish rise to the 2017 boom and found that this time the volatility is much lower. Why? The rise of institutional participants and the general stabilising effect of "becoming mainstream" cryptocurrencies.

Whether bitcoin or any other cryptocurrency has a place in your investment portfolio depends on your personal circumstances, risk tolerance and investment time horizon. And while bitcoin has risen steadily over the past decade, it has also had significant down cycles. Investors should be cautious in volatile markets (and consider working with a financial adviser before making a large investment)