How the tables have turned. After rising 61% in 2021, Bitcoin (BTC -5.21%) has completely cratered, falling 56% so far this year. And the entire cryptocurrency market has dropped off a cliff, valued at just $931 billion as of this writing (compared to a Nov. 2021 peak of nearly $3 trillion).
Despite the extreme pessimism surrounding the asset class, investors should still try to take the time to understand some important information about this emerging technology, especially when it comes to Bitcoin.
1. Bitcoin’s purpose
With all of the new developments in the crypto space over the recent past, including things like decentralized finance (DeFi) protocols and non-fungible tokens (NFTs), the picture can get cloudy on what exactly Bitcoin’s actual purpose really is. Ethereum has become the top destination for these new use cases, and as a result, it is dubbed by many as the world’s decentralized computer.
Bitcoin, on the other hand, was created primarily to be a peer-to-peer payments network. The goal then and now is that anyone in the world with an internet connection can transfer their Bitcoin to anyone else directly without the need for an intermediary. This seems like a simple concept, but it was revolutionary, especially on the heels of the Great Recession when big financial institutions, whose entire business models predicate on extracting fees, were in the spotlight.
A clear use case for Bitcoin is to send money across borders. The $590 billion market for global remittances to low- and middle-income countries is an area ripe for disruption. The average fee to send money from the U.S., which is roughly 5%, would be nonexistent if Bitcoin’s network was used instead. Think of the positive economic impact this could have in developing countries.
2. Bitcoin’s consensus mechanism
Because cryptocurrencies are built on decentralized networks with no central authority controlling everything, there needs to be a way for all participants to agree on the state of the blockchain, as well as add new transactions to it. Since its founding in 2009, Bitcoin has operated with a proof-of-work (PoW) system. This means that miners must use expensive computers in order to solve complex mathematical puzzles to earn the right to validate new transactions.
Bitcoin was a breakthrough technology when it first launched, but now many are seeing the limitations of its PoW system. It is extremely energy-intensive, as continuously running and cooling huge computers is costly and not the best for the environment. This is an argument many bears like to point to.
Furthermore, while the Bitcoin network has actually never been hacked, this security comes at the expense of speed. According to bitinfocharts.com, Bitcoin can only process three transactions per second, substantially slower than the 65,000 that payments giant Visa has the capacity for. If Bitcoin wants to make a legitimate push toward real-world adoption, then its throughput must rise significantly.
3. Bitcoin’s historical performance
A discussion about Bitcoin would not be complete without talking about its past performance. Over the past five years, this top crypto has produced a total return of 705% (as of June 28). While this performance absolutely trounces that of the S&P 500 (74% five-year total return) and gold (46%), it has come with extreme volatility.
Even if a business has strong fundamentals, a bright outlook, and sells for a cheap valuation, many investors get spooked by wild price fluctuations. This situation is exacerbated when it comes to cryptocurrencies, as daily price swings greater than 10% are normal. For anyone to have benefited from Bitcoin’s monster returns of the past, they undoubtedly had to stomach the ups and downs. And this is likely to be the case going forward as well.
Supporting Bitcoin’s continued price appreciation is the fact that there will only ever be 21 million total bitcoins. Satoshi Nakamoto, Bitcoin’s anonymous founder(s), purposely created this cap and permanently wrote it into the network’s code. This was so that the cryptocurrency couldn’t be diluted away with the continuous minting of new coins, something that is commonplace with other tokens.
You are now equipped with three must-know facts about the world’s most valuable cryptocurrency that can help with making more informed investment decisions.
