How Bitcoin Is Edging Toward the Financial Mainstream: QuickTake
(Bloomberg) -- Bitcoin and other cryptocurrencies have become a global obsession, inspiring their own counterculture and attracting millions of converts. Once seen as the province of nerds, libertarians and drug dealers, Bitcoin and its less famous cousins have been embraced by rock-star investors and propelled by a belief that digital money is shaking up the financial world. Yet even after Bitcoin’s price exploded during the pandemic, it’s still on a roller-coaster ride, and there are few signs that cryptocurrencies will evolve into a useful way to pay for most transactions.
1. How did crypto become a craze?
By going up and up (with some major downs along the way), even in the face of skepticism from much of the financial establishment. In April, Bitcoin climbed to almost $65,000 before taking another tumble. Even after that crash, anyone who had bought it before November at least doubled their money, and probably much more. Its rise dwarfs all other boom cycles in financial assets over the past 50 years and pushed the theoretical market value of all cryptocurrencies — including Ether, Tether and other much smaller so-called tokens or coins — to as much as $2 trillion. Still, crypto investing remains risky and volatile, subject to evolving regulation and the whims of a fickle market dominated by a small number of anonymous investors.
2. How is it becoming more legit?
Fans argue that Bitcoin, now about 12 years old, has gained wider acceptance as a store of value and a haven asset like gold as institutional investors have bought in. Banks, brokerages and securities exchanges are gearing up to meet demand. There are also more safeguards, including new custody and trading services — with proper licenses and credentials — that cater specifically to the large regulated investors. In the U.S., profits on Bitcoin are subject to capital-gains taxes like other assets. A watershed moment came in April with the U.S. stock market debut of Coinbase Global Inc., a crypto trading venue that’s shooting to establish a digital money ecosystem. What’s more, a number of central banks are studying how to digitize sovereign currencies, a validation of the blockchain system brought closer to the mainstream by Bitcoin. The next big step would be for U.S. regulators to clear the first Bitcoin exchange-traded fund, possibly as soon as this year, giving retail investors a safer and cheaper way in.
3. Can I use Bitcoin to pay for things?
No, not really, not yet, even though big players such as Mastercard Inc. and PayPal Holdings Inc. have taken steps to embrace crypto transactions for shoppers and merchants. Elon Musk, the mercurial chief executive officer of Tesla Inc., sent Bitcoin rocketing when he unveiled an investment of more than $1 billion, and then plunging when he criticized its energy use. (Musk is also a fan of Dogecoin, a digital token that started as a joke featuring a picture of a Shiba Inu, a dog breed popular in internet memes.) But Bitcoin’s volatility means it’s really functioning more as a speculative investment than actual money. Transactions can be slow and expensive, occasionally costing more than $25 when the network is congested. Bitcoin uses a system of software protocols to generate and track tokens by using high-powered cryptography deployed by a volunteer army of so-called miners who are rewarded for their work.
4. What motivates investors?
Zero and negative yields on traditional assets such as government bonds have driven a reach for alternatives, and there’s been a fear of missing out as Bitcoin rallied to record after record. That spurred more talk that Bitcoin could be part of any portfolio, even though it’s not backed by any other asset or business and will never produce any dividends. True believers were energized during the pandemic because of the flood of money the world’s central banks have pumped into the financial system. There’s renewed fear that such moves could spark inflation — and more talk that Bitcoin could fill the traditional role of gold as a hedge against rising prices, since both have limited supply. Production of new Bitcoin is forecast to end around 2140.
5. What are the main dangers?
Cryptocurrencies have long been connected to cybercrime, ransomware, money laundering, tax evasion and thefts. Tales are still emerging of would-be millionaires thwarted by losing their password. Most pension funds still shy away. What really rattles crypto markets, though, is that financial regulators around the world are still trying to get a handle on it, including those in China. In Turkey, where crypto drew in citizens seeking shelter from inflation and a weakening currency this year, the central bank banned its use as a means of payment after two exchanges collapsed. In June, however, El Salvador became the first nation to embrace Bitcoin as legal tender.
6. Who buys and uses Bitcoin?
Prominent money managers such as Mike Novogratz and Alan Howard have invested hundreds of millions of dollars in Bitcoin and other cryptocurrencies. A survey Fidelity Investments conducted in 2020 found that 36% of institutional respondents held crypto in their portfolios. More than six out of 10 expressed interest in Bitcoin and other cryptocurrencies, up from fewer than half in 2019.
7. Why is Bitcoin compared with gold?
As a scarce resource, gold has traditionally been a hedge against inflation; it surged to a record high in August 2020. Governments can speed up their treasuries’ printing presses and thereby debase their currencies, but miners can’t flood markets with gold, goes the thinking. Part of Bitcoin’s appeal lies in the fact that it isn’t controlled by governments or their monetary policies, and that its supply is limited even more strictly than gold’s. If Bitcoin attracts the same amount of money now invested in gold, it could rise to a theoretical price of more than $146,000 in the long term, according to strategists at JPMorgan Chase & Co.
8. What exactly is Bitcoin, anyway?
It’s a form of money that’s remarkable for what it’s not: It’s not a currency you can hold in your hand. It’s not issued or backed by a national government. At their core, Bitcoin and its imitators are sets of software protocols for generating digital tokens and for tracking transactions in a way that makes it hard to counterfeit or re-use tokens. A Bitcoin has value only to the extent that its users agree that it does.
9. Where did the Bitcoin system come from?
The original software was laid out in a white paper in 2008 by a person or group of people using the pseudonym Satoshi Nakamoto, whose identity remains unknown, despite several efforts to assign or claim credit. Online fantasy games had long used virtual currencies. The key idea behind Bitcoin was the blockchain -- a publicly visible, largely anonymous online ledger that records Bitcoin transactions. Mania swept the market in 2017, when Bitcoin skyrocketed to $19,000 from $789 and thousands of fly-by-night outfits peddled their own copycat tokens in “initial coin offerings.” The bust left a lot of losses.
10. What’s the blockchain?
Think about what happens if you make an online transfer using a bank. It verifies that you have the funds, subtracts that amount from one spot in a giant database it maintains of accounts and balances, and credits it in another. You can see the result if you log on to your account but the transaction is under the bank’s control. You’re trusting the bank to remove the right amount of money, and the bank is also making sure you can’t spend that money again. The blockchain is a database that performs those tracking functions -- but without the bank or any other central authority.
11. Who performs the bank function for Bitcoin?
It’s done by consensus on a decentralized network. Bitcoin transactions can be made through sites offering electronic “wallets” that upload the data to the network. New transactions are bundled together into a batch and broadcast to the network for verification by so-called Bitcoin miners. Long-time Bitcoin fans point to the so-called halvening that happened in 2020, cutting in half the amount of new Bitcoin issued to miners for verifying transactions, as another reason for its resurgence. Halvenings happen every three to four years and they help slow down the mining of new coins. Production will cease entirely at 21 million coins; it’s estimated that won’t happen until 2140. The tally was more than 18.5 million at the end of 2020.
12. Who gets to be a miner?
Anybody, so long as you have really fast computers and a lot of electricity. The transaction data in each batch is encrypted by a formula that can be unlocked only through trial-and-error guessing on a massive scale. The miners put large-scale computing power to work as they compete to be the first to solve the puzzle. If a miner’s answer is verified by others, the data is added to a linked chain of blocks of data and the miner is rewarded with newly issued Bitcoin. Because every block contains data linking to earlier blocks, an attempt to spend the same Bitcoin twice would mean revising many links in the chain. Plus, as miners compete, they verify each other’s work each step of the way.
13. Could another cryptocurrency supplant Bitcoin?
As the number of cryptocurrencies and tokens continues to multiply -- they now reach into the thousands -- Bitcoin remains the best-known, time-tested and valuable. It’s also the one coin that’s considered to be a potential store of value. Others, such as Ethereum, are used for other things, such as issuing tokens for use in decentralized finance applications. So-called stablecoins such a Tether peg their price to the U.S. dollar or other fiat assets, and some back up the value by holding reserves.
14. How can I buy Bitcoin or invest in it?
There are a bunch of ways, all with different risks. People can buy the coins directly from exchanges like Coinbase. Accredited investors can also invest in vehicles like the Bitcoin Investment Trust, which tracks Bitcoin’s price. Now investors can buy or sell Bitcoin futures, and soon may be able to buy Bitcoin exchange-traded funds. But be warned: Even plenty of people who believe in Bitcoin’s future think some wild rides still lie ahead. The big runup in Bitcoin’s price back in 2017 was followed by an 83% rout that lasted a year.
The Reference Shelf
- A Bloomberg editorial on Crypto’s rise.
- A column by Joe Weisenthal on Ethereum as the future of finance and a podcast on the vision for DeFi.
- Bloomberg’s macro strategist Mark Cudmore explains how the cult of Bitcoin contributes to its volatility.
- A beginner’s guide to buying Bitcoin.
- A QuickTake explainer on the origin of Bitcoin and blockchain and on China’s regulation. More detailed Q&As cover ETFs, halving, new flavors of crypto, the difference between Bitcoin and Ethereum, Bitcoin lingo, security tokens, central bank digital currencies, China’s moves toward a digital currency, yield farming and decentralized finance applications.
- Economist Nouriel Roubini argues that Bitcoin’s rise is a bubble.
- An article on the concentration in Bitcoin ownership among so-called whales.
- Two explainers, one aimed at kindergartners and the other a you-too-can-mine-Bitcoin project, plus an exploration of the double-spending problem.
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