I think it’s fair to say that most people first hear about Bitcoin as a way of making money. The media loves dramatic headlines of the exchange rate soaring and then plummeting, it’s great for clicks. Many people have indeed done well from it (or not) in the past, but there is a lot more to the story than just that; there are other reasons to learn about it that might surprise you and which could eventually have a much bigger impact. Here’s the big picture.
Anarchy by design
Back in 2009, Bitcoin had an unusual beginning. It was invented by an anonymous individual (or group, we don’t know) called Satoshi Nakamoto who was part of a bunch of revolutionist/anarchist computer programmers who called themselves the ‘cypherpunks’. They wanted to create a replacement for national currencies (aka the ‘fiat’ currencies: the dollar, pound, euro, etc). As a result, Bitcoin isn’t controlled by any government, bank, company or other organisation and no one can dictate how much you’re allowed to have or how you use it. Sean Lennon, John Lennon’s son, said that Bitcoin “transcends the physical world” and it “empowers people in a way they’ve never been empowered before”.
Bitcoin was also designed from the outset to protect your privacy. Whenever you buy something today with a bank or credit card a whole chain of companies get involved in that transaction and use or sell the data they collect on you. Bitcoin transactions are purely between you and the person you’re sending it to, no bank or anyone else is involved.
New Money
Let’s start with the basics.
Like ordinary money, Bitcoin was designed to be used for buying things and for saving and investing. It’s the first ‘cryptocurrency’ (‘crypto’ for short. It uses heavy-duty mathematical cryptography in its security). In reality, however, not many places take crypto as payment yet (although that is starting to change – PayPal has recently begun accepting it in a limited way and Tesla says they will soon accept it in payment for cars. People have mostly profited because the exchange rate has jumped up dramatically over its lifetime. Back in 2009 when it was invented, you could buy Bitcoin for a few cents. By mid-March 2021 one Bitcoin will sell for over $55,000. Other cryptocurrencies have been developed since, but Bitcoin is still the most popular by a long way.
It’s been a bumpy ride though, to say the least. In late 2017 the price peaked at just under $20,000 before crashing back all the way to $3,000 in 2018. Many people were caught out and lost money. This highlights one of the main criticisms of Bitcoin – it is so volatile. That can also be where the opportunity lies though – many of the people who bought since 2018 are now in profit.
How far will it go up? Some say it may go over $100,000 or more in the next couple of years (big investment companies JP Morgan and Morgan Stanley included) and to $1,000,000 in the next decade. Others say it’s a big Ponzi scheme and it’s going to crash to nothing. Whoever is right, past behaviour indicates there will still be a lot of highs and lows on the way.
So, should you buy it? This isn’t financial advice (I’m not allowed to do that) but in general terms, it’s largely a question of how comfortable you are with the risk, how quickly you want to take any profits and if you can hold your nerve through the peaks and crashes. Whatever your motives, the standard financial warnings still apply: don’t invest more than you can afford to lose, never take out a loan to buy and do your research.
Money is most associated with making payments and you can certainly use cryptocurrencies for buying things, or you could if anyone accepted them. A few firms do and there are some crypto market places, but on the whole, this hasn’t taken off yet. Also, the UK and US governments, amongst others, tax many cryptocurrencies with Capital Gains Tax, meaning that every time you buy something with crypto you would have to pay tax on any profit you had made. That pretty much kills crypto for buying things, for now anyway.
A better use of crypto is for fast money transfers. Sending large amounts (eg a house deposit) takes a lot to organise and sending money internationally has always been very slow and expensive. With Bitcoin, the amount you send and where it goes is irrelevant – they don’t affect the small fee, and the transfer will be confirmed in a few minutes (10 to 60 minutes is common, depending on how busy the Bitcoin network is). Another option, to avoid any price volatility and perhaps tax liability is to use a ‘stablecoin’. Stablecoins, such as USDC or USDT, are cryptocurrencies that have a fixed price of US$1.00 (within a few per cent).
You might be thinking, if Bitcoin is now more than $55,000, that’s way more than I want to send or can afford to buy. Well, each Bitcoin is split into much smaller units, much like every pound is split into 100 pence. In fact, each Bitcoin is split into 100 million Satoshi, or ‘sats’ (named after the mythical creator, Satoshi Nakamoto). You can buy or send a few sats in the same way as a whole Bitcoin, for the same fee. Regularly buying and hodling them is known as ‘stacking sats’.
The reason most people hold crypto now is that they hope to make a profit, either by trading in and out to take advantage of the peaks and dips, or to hold long term. Did you notice the spelling mistake in the last paragraph? It was deliberate. In a play on words, people who buy Bitcoin to hold it for a very long time are known as ‘hodlers’. It was originally a spelling mistake early on in Bitcoin’s life but it stuck; hodlers hodl Bitcoin believing it will eventually go up in value by a very large amount. So far it has been a very successful strategy.
For this reason, some people are claiming it will become an alternative to gold as a store of wealth, especially in times of turmoil. Gold is known as the ‘safe haven’ when the world is getting uncertain because it holds its value due to its scarcity. Bars of gold are beyond the ability of most people, but Bitcoin isn’t. Bitcoin could even turn out to be even more scarce than gold. Only 21 million Bitcoins can ever be created, that’s written into the computer code that controls it, and over 18 million of those have already been distributed. The number of new Bitcoins being created each month is also slowing down, also controlled by the computer code. As the supply of new coins decreases and demand goes up, so in theory, the price should also go up. As a result, a few large companies have started buying large amounts of Bitcoin to protect their balance sheets, such as MicroStrategy in 2020, which have made a huge profit on their investment and are leading the way for others.
Bitcoin is also attracting attention as a way of avoiding some possible economic problems that might be on the way. Governments have dealt with the 2008 financial crisis and Covid pandemic largely by borrowing and printing large amounts of money (‘known as ‘Quantitative Easing’ or QE for short) to dig themselves out of the hole created by, amongst other things, stimulus cheques in the US and the furlough scheme in the UK. The US national debt is now at $28 trillion. Some businesses are now starting to worry that this will make inflation come back in a big way. Bitcoin should not be affected by inflation in the same way as fiat money as it has had no QE and the rate that new Bitcoins are created is strictly controlled by the computer code – no one can just create a million more at will. The theory is that it should increase in value while pounds, dollars, euros, etc lose value. We may find out if these fears are warranted in the next decade.
For all the reasons above, many governments are getting worried about the effect that Bitcoin could have on their national currencies. Some politicians and officials want to regulate it much more tightly (such as the European Central Bank) or to try to ban it (e.g. India and Nigeria), while others are more open to it (e.g. Switzerland and the US State of Wyoming). Even within the US government, there are opposing policies, although the new Biden administration seems to be more positive.
In the next article, I’ll look at some things you should aware of in crypto and some of the dangers.
The Big Picture continues in article 4 – Things to be aware of.
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