Is Bitcoin akin to 'digital gold'?
- In October, PayPal announced that it would begin allowing users to buy, sell, and hold cryptocurrencies.
- Other major fintech companies—Square, Fidelity, SoFi—have also recently begun investing heavily in cryptocurrencies.
- While prices are volatile, many investors believe cryptocurrencies are a relatively safe bet because blockchain technology will prove itself over the long term.
PayPal CEO Dan Schulman sees a silver lining amid the chaos of the COVID-19 pandemic: It's accelerating cryptocurrency adoption at a rapid clip, potentially by years.
Speaking in front of a digital audience at the 2020 Web Summit, Schulman added that he's optimistic about the future of cryptocurrencies:
"I think that if you can create a financial system, a new and modern technology that is faster, that is less expensive, more efficient, that's good for bringing more people into the system, for inclusion, to help drive down costs, to help drive financial health for so many people. [...] So, over the long run, I'm very bullish on digital currencies of all kinds."
His bullishness might be unsurprising, considering PayPal is among the latest fintech companies to move into the cryptocurrency space. In October, PayPal announced that users would soon be able to buy, sell, and hold cryptocurrencies "directly through PayPal using their Cash or Cash Plus account." That went into effect in November, and the company plans to extend it to Venmo users in 2021.
Presentation slide from Sanja Kon's presentation on the evolution of money at 2020 Web Summit
Credit: Sanja Kon
The move came shortly after the payments company Square invested $50 million into Bitcoin, and after Fidelity announced that it was opening a Bitcoin fund into which qualified purchasers could invest (minimum investment: $100,000). Together, this institutional backing might have something to do with Bitcoin's recent surge back to near its 2017 price peak of $19,783. (Bitcoin is listed at 19,384.30 as of Dec. 3.)
Presentation slide from Sanja Kon's presentation on the evolution of money at 2020 Web Summit
Credit: Sanja Kon
But more importantly, it suggests cryptocurrencies might soon have the opportunity to prove themselves in real-world use cases. After all, skeptics have long doubted the ability of cryptocurrencies to go mainstream as a form of everyday payment. But people seem increasingly comfortable with digital payment systems.
"The entire world is going to come into digital first," Schulman said at Web Summit, adding that PayPal's services already go hand-in-hand with cryptocurrencies. "As we thought about it, digital wallets are a natural complement to digital currencies. We've got over 360 million digital wallets and we need to embrace cryptocurrencies."
Sanja Kon, CEO of global partnerships at the cryptocurrency payments processor company UTRUST, also spoke at Web Summit about the increasing adoption of digital payments:
"Physical cash is becoming more and more obsolete. And the next step in the evolution is digital currency."
Kon noted some of the inherent advantages of cryptocurrencies, namely ownership.
"For many people, this is really the main benefit of cryptocurrency: Users owning cryptocurrencies are able to control how they spend their money without dealing with any intermediary authority like a bank or a government, for example," Kon said, adding that there are no bank fees associated with cryptocurrencies, and that international transaction fees are significantly lower than wire transfers of fiat currency.
Kon said cryptocurrencies have unique growth opportunities in areas where people aren't integrated into modern banking systems:
"With cryptocurrencies and blockchain, with the use of just a smartphone and access to internet, Bitcoin and cryptocurrencies can be available to populations of people and users without access to the traditional banking system."
Bitcoin as 'digital gold'
Still, it could take years for people to start using cryptocurrencies for everyday purchases on a large scale. Despite this, many cryptocurrency advocates see digital currencies, particularly Bitcoin, as a way to store value—digital gold, essentially.
"I don't think Bitcoin is going to be used as a transactional currency anytime in the next five years," billionaire investor Mike Novogratz recently told Bloomberg. "Bitcoin is being used as a store of value. [...] "Bitcoin as a gold, as digital gold, is just going to keep going higher. More and more people are going to want it as some portion of their portfolio."
There are obvious parallels between gold and Bitcoin: Both are mined, do not degrade over time, are finite in supply, and aren't directly tied to the value of fiat currency, making them relatively invulnerable to inflation. The obvious objection is that the price of Bitcoin, and cryptocurrencies in general, is far more volatile than gold.
But for investors who believe the inherent value of cryptocurrency technology will prove itself over the long term, these price fluctuations are just bumps on the long road to the future of currency.
"It's no longer a debate if crypto is a thing, if Bitcoin is an asset, if the blockchain is going to be part of the financial infrastructure," Novogratz said. "It's not if, it's when, and so every single company has to have a plan now."
Unfortunately, it's getting easier to predict what might happen to cryptocurrencies when the economy takes a nosedive.
- Born in the wake of the 2008 financial crisis, Bitcoin hasn't yet faced a downturn like we're starting to experience.
- Based on the developments of recent weeks, some crypto market trends are starting to emerge.
- Bitcoin's relationship to gold is strong, futures and options are losing their lure, and stablecoins are on the rise.
Although nobody knows yet what the outcome of the global coronavirus crisis will look like, there is one conclusion on which everyone seems to agree: The economic fallout is going to be significant. Last week, the U.S. government signed off on a $2 trillion relief bill, and governments around the world are printing money in an attempt to stave off a pending financial crisis.
No cryptocurrency has ever gone through a full economic cycle. Bitcoin was born from the depths of the 2008 global financial crisis. Famously, Bitcoin's genesis block contains the headline from The Times on the date that creator Satoshi Nakamoto mined the first ever Bitcoin: "Chancellor on brink of second bailout for banks."
So, until now, despite rampant speculation, it's been difficult to predict what might happen to cryptocurrencies when the economy takes a nosedive. However, the last couple of months, as the coronavirus has unfolded, have given us an idea of a few significant trends.
1. Bitcoin shows a higher correlation to gold
The idea of Bitcoin as "digital gold" has been around for a while. It's true that the two assets share some similarities: a price driven by the forces of supply and demand and limitations on supply, for example. However, whether or not investors would treat Bitcoin as a "safe haven" investment during times of turmoil in the stock market hadn't been proven.
On March 12, as the global stock markets plummeted and circuit breakers halted trading on the NYSE, the price of cryptocurrencies also took a nosedive. Bitcoin lost more than 40% of its value – the biggest single-day percentage drop in price since 2013.
However, on that day, gold held its price. Critics were quick to point out that the "digital gold" theory had been debunked, but perhaps they were a little too quick. Over the days that followed, gold recorded its sharpest drop in a single week, losing around 12% of its price.
Since then, the price of both assets has recovered somewhat, although Bitcoin to a lesser extent than gold, after recording a more significant decrease. Nevertheless, according to data aggregator Skew, Bitcoin and gold are showing record correlation levels of more than 50%, perhaps demonstrating that in times of economic uncertainty, the concept of Bitcoin as digital gold is more accurate than it initially seemed.
2. Open interest in futures and options takes a hit
March 12 was a pivotal moment on the cryptocurrency markets across derivatives, too. Before the coronavirus started to take hold, Bitcoin futures had been enjoying something of a moment. According to Skew, total open interest had more than doubled from around $2.2 billion in November 2019, to $5 billion in mid-February.
On March 12 and 13, as the price of Bitcoin dropped precipitously, crypto exchanges liquidated millions of dollars' worth of long positions.
Market leader BitMEX came under particular fire, as it had experienced two 25-minute outages meaning traders had no access to their accounts to top up margin or take any actions to hedge their positions. Traders on BitMEX saw over $1.5 billion of positions liquidated in the space of two days.
This drop illustrates the extent of investor panic, withdrawing from speculating even with short positions. It will be intriguing to see how quickly the crypto derivatives markets recover from this blow over the coming months, given that 2019 was a period of massive growth in these markets.
3. Demand for stablecoins skyrockets
Stablecoins were another asset class that was burgeoning before panic surrounding COVID-19 took hold. Because they're pegged to fiat currencies such as the USD, stablecoins had become the go-to currencies for traders entering and exiting positions. In 2019, the most popular stablecoin, Tether (USDT), had doubled its market cap from $2 billion to $4 billion, and overtaken Bitcoin as the most traded cryptocurrency.
During the market turmoil in March, while the rest of the market tanked, Tether came out smelling of roses. The market cap of USDT gained a further $1.5 billion in the second half of March alone, as Tether Limited attempted to mint enough stablecoins to meet the demand of investors keen to convert their gains or losses to a more predictable asset.
Sam Bankman-Fried, CEO of FTX Exchange and rapidly becoming something of a sage on crypto-Twitter, attributed Tether's March explosion to a flow of OTC originating in Asia, along with investors converting their Bitcoins to Tether as a means of hedging and reducing risk.
Uncertain times for token holders
The cryptocurrency markets are always notoriously volatile, even when the rest of the economy is sailing in smooth waters.
However, the events in March have provided a flavor of what we can expect from the crypto markets once the traditional markets experience tumult. Whether these trends continue to play out as the coronavirus bites harder, remains to be seen.
Why invest real money in digital coin? Because the payoff a decade from now could be enormous.
When it comes to Bitcoin it's all about the long game, says Abra founder and CEO Bill Barhydt. Bitcoin is flexible because you can break it up into smaller divisions, called Satoshis. In 10 to 15 years, those Satoshis alone could be $1000 a piece. It might take a while for Bitcoin to really start trading at the level of gold and silver, says Bill. Interestingly enough, says Bill, by and large, people who have Bitcoin are holding on to it, just like those precious metals. Once more of it is mined, we'll start to see the market become less volatile.
Once a lucrative exercise anyone could do, bitcoin mining has grown out of control, and governments are weighing what to do.
Bitcoin is a cryptocurrency located completely online and not tied to any central bank. Its origins are shrouded in mystery and very few people predicted the popularity it currently enjoys.
Rather than being approved by a nation's central bank, bitcoin is verified by individuals in an open ledger available for all to see. It was created in 2009 by 'Satoshi Nakamoto', which is likely a moniker designed to protects the identity of its creator. Satoshi Nakamoto is a Japanese man’s name as common as John Smith in America.
After being steady for years, the price of bitcoin has taken off since January of last year, and has been on an absolute tear since November. At the time of writing, it’s over $9,000 per unit. It first broke the $1,000 threshold on Jan. 1, 2017, and reached $19,000 in December of that same year. Afterward, it lost 50% of its value, only to begin a dramatic climb back up.
Since it’s not tied to any bank, bitcoin is unregulated and its control is decentralized. As a result, bitcoin owners remain anonymous. Records of transactions, however, are accessible via a public log. But bitcoin owners’ names are never revealed; only their bitcoin wallet IDs ever become known. (A bitcoin 'wallet' is an encrypted bank account where one’s digital currency is stored.) People can purchase bitcoin through online exchanges hosted by websites like Coinbase, Bitstamp, and Bitfinex.
It’s not totally safe, however. Bitfinex was hacked in 2016 and $60 million worth of bitcoins were stolen. The sheer nature of bitcoin makes them untraceable, revealing another dark aspect of cryptocurrencies: the digital money has become popular among those looking to buy or sell drugs, or other black market products, online.
Bitcoin’s trajectory over one year, February 14, 2017-18. Credit: Coindesk.com.
Can a person give bitcoins as a gift or use them to pay off a debt? A few small businesses accept them as payment for goods and services, and in this way, avoid the vendor charges that come with processing a credit card payment. Due to its decentralized nature, transactions using bitcoins have to be verified, which is where mining comes in. And just as with every resource, there’s scarcity.
There's a bitcoin scarcity (on purpose)
There will only ever be 21 million bitcoin in the world. So far, about 12 million have been mined. It’s estimated that the remaining 9 million remaining will all be mined by the year 2140. Since there’s a finite supply, bitcoins are thought to gain value over time, a fact which has motivated a mining boom.
Miners use computers to solve complex math puzzles in order to verify the bitcoins used in a transaction. The first person to crack the math problem becomes the winner. As a reward, they are usually given 12.5 bitcoins. Note that a bitcoin goes to eight decimal places. As you might expect, this setup causes some competition among bitcoin miners.
Thousands of miners worldwide compete to mine any single bitcoin transaction. Think about this—every ten minutes a miner earns bitcoins as a reward for verification. The network keeps a record of each bitcoin transaction. These records are bundled together with all the others made within that same time-period. A bundle is called a “block.” Blocks are then entered into the public record in chronological order, which is known as the blockchain. You can check the latest real-time bitcoin transactions through websites like Blockchain.info.
A bitcoin mining operation in Russia. Credit: Getty Images.
How bitcoin is mined, and where
It used to be that anyone could mine bitcoins. And while that's no longer true, you don’t have to necessarily be proficient in computers to mine. You’d need some open source, basic software such as GUI miner. As for hardware, you need a motherboard, some graphics processing chips, and fan to cool down your rig.
But today with the heightened interest and the math problems growing exceedingly difficult, outfits with more computing power have come to dominate this activity. It’s gotten to the point where bitcoin mining centers have become the majority of the network. These are places around the world where mining takes place on a large-scale, usually where energy is either inexpensive or free. So operators pack a facility with computers, servers, and cooling devices.
Certain areas of China see many such centers due to free hydroelectric power. But the country is looking to curtail bitcoin mining, which may send operations elsewhere. Canada is one possible location. In Iceland, where bitcoin mining has become a sensation, a number of mining centers have been proposed despite officials warning that they will use more electricity than is required to power all the homes in the country. Johann Snorri Sigurbergsson, the spokesman for Icelandic energy firm HS Orka, told the BBC, “If all these projects are realized, we won’t have enough energy for it.”
Large-scale bitcoin mining centers are low investment. In places with inexpensive or free power, returns can be significant. Credit: Getty Images.
Energy is inexpensive in Iceland because it is mainly harvested from renewable sources like wind and hydroelectric power. The small population of the island, just 340,000 people, use about 700 gigawatt hours of energy annually. The proposed bitcoin centers, meanwhile, are expected to consume 840 gigawatt hours of electricity per year.
Since massive amounts of power are used, the environmentally-minded consider the practice extremely wasteful. Bitcoin mining is a smart business model because it requires no staff and a small investment. Moreover, taxes on cryptocurrency mining operations are low, although that may change, as Iceland’s politicians have been made more aware of issues surrounding bitcoin mining.
As Smári McCarthy, an Icelandic member of parliament, told the AP, "We are spending tens or maybe hundreds of megawatts on producing something that has no tangible existence and no real use for humans outside the realm of financial speculation. That can't be good."
One report found that all the cryptocurrency mining occurring worldwide could power Ireland for a year, but those figures may not be accurate. As a result of concerns over power usage and a lack of control over bitcoin overall, some countries such as South Korea are mulling over a system to license and regulate bitcoin transactions.
Want to get a look inside a cryptocurrency mining center? Click here.
The term “hodl” originated in a drunken post about Bitcoin from 2013, but it’s evolved into a movement in the cryptocurrency community.
No matter what you believe the future holds for Bitcoin or the cryptocurrency market at large, rest assured, you’ll have no trouble finding people who agree with you.
Think it’s a bubble? So does Goldman Sachs, which wrote that “cryptocurrencies have moved beyond bubble levels in financial markets, and even beyond the levels seen during the Dutch ‘tulipmania’ between 1634 and early 1637.”
Do you predict cryptocurrencies will survive in general, but think Bitcoin will fall? Here’s an interview with Bill Gates in which he says blockchain technology is superior to modern banking, but “Bitcoin won’t be the dominant system.”
But forget about the opinions of banks and billionaires for a moment, because there’s one group of people whose beliefs will likely have more effect on the future of Bitcoin than any other: those who choose to hodl.
In the cryptocurrency community, hodl means to “hold on for dear life,” even though the term originated from a drunken misspelling of the word “hold” in a now-famous post about Bitcoin from 2013. Hodlers are committed to weathering the storm and holding Bitcoin until the rest of the world accepts that the flagship project of Internet money is king.
The opinions of these people, the hodlers, could prove in the mid-term to be the most important metric of Bitcoin’s value because, unlike those who merely talk about the fate of Bitcoin, hodlers are acting out their belief in the cryptocurrency by never selling, effectively establishing a floor on the Bitcoin price.
“Once enough people sell their bitcoin, only the hodlers are left, and they’re ready to buy more, which increases the percentage of the total supply of bitcoin that is held by the hodlers,” Bitcoin analyst Kyle Torpey wrote in an article for Forbes. A true hodler will never sell their bitcoin. Instead, the hodler waits patiently for the day when the use of Bitcoin is ubiquitous around the world and their everyday transactions can be made via the permissionless digital cash system. As the infamous meme based on a scene from The Matrix says, hodlers won’t have to sell by the time they’re ready to cash out.”
There are no doubt many hodlers in the Bitcoin market, but measuring how many exist and their precise effect on the price is basically impossible. A 2017 survey from LendEDU, an online marketplace for student loan refinancing, showed that the average price at which holders would sell was $200,000 per bitcoin. Of course, there’s no way of knowing just how truly committed holders or hodlers are, especially during volatile months like January 2018 when Bitcoin dropped from a high of about $17,000 to a low of nearly $10,000.
Still, it seems like any accurate bitcoin valuation process should account for the coin’s sturdy base of true believers who are holding on for dear life—at least, for now.