Markets & Research
Bitcoin’s rambunctious year

The cryptocurrency’s all-that-glitters promise of riches has beguiled investors. But can virtual money ever live up to the hype?

When it rains, it pours, they say: The news deluge of the past year included a global pandemic, market disruptions, political upheaval and unprecedented government intervention. Yet there was still plenty of room for Bitcoin to make a splash. The digital currency hit stupefying heights, grazing $65,000 in April before shedding more than half its value a few weeks later. Of course, its recent low — a mere $29,031 — is more than three times its value in mid-2020.

As the first cryptocurrency, Bitcoin is at the forefront of what could be a financial inflection point. After all, virtual money would seem to be perfectly suited to the digital age, facilitating transactions across national borders far more quickly and efficiently than conventional “fiat” currencies. The combined value of Bitcoin and the thousands of other cryptocurrencies briefly topped $2 trillion in April.  For comparison, all the physical U.S. dollars in the world tallied up to about $2.1 trillion that month.

Amid this phenomenon, the Federal Reserve and other central banks are studying the feasibility of launching electronic versions of their currencies. China has announced plans for a digital currency, in large part to blunt encroachment from Bitcoin, while El Salvador recently became the first national government to adopt the coin as legal tender.

Then again, the attempt to reinvent money and rewire the international currency system could ultimately prove to be quixotic. Despite their putative advantages, cryptocurrencies face stiff challenges, including the specter of government intervention. Bitcoin’s recent plunge stems partly from a Chinese crackdown on mining and trading the coin. And governments around the world are expected to step up enforcement as criminal groups embrace crypto in ransomware attacks, with countries as disparate as Russia, Canada and Turkey restricting how the currency can be used.

Beyond that, the very trait that has kept Bitcoin in the public eye — the white-hot volatility powering dreams of easy riches — greatly complicates the effort to promote it as the currency of the future.

Bitcoin has experienced high volatility for years

This chart shows a history of how Bitcoin's price has changed from month-to-month. The points represent the final closing value for each month from May 2016 through May 2021. In that time, Bitcoin's price has often increased large amounts, enjoying 60% or better gains, but it also often lost significant value, suffering 30% or greater losses several times. Source: Statista. As of May 31, 2021.
Source: Statista. As of May 31, 2021.

The bottom line is that it’s too soon to tell if Bitcoin or any other virtual cash will break into the mainstream. 

“There’s no question that Bitcoin is an innovative technology, with some very commendable features. The idea that rebel programmers have created a substitute for the dollar is undeniably cool,” observes Capital Group equity portfolio manager Don O’Neal. “But demand today is largely speculative, and that will continue to drive volatility. And eventually, Bitcoin will face central bank competition.”

Anti-establishment roots powered Bitcoin’s rise.

Bitcoin launched in January 2009, when Satoshi Nakamoto — the pseudonym for an unknown person or group — published the currency’s source code. Nakamoto’s involvement appears to have ended by 2011, but Bitcoin enthusiasts remain animated by a core belief that any monetary system controlled by a government or central bank is inherently untrustworthy.

“For Nakamoto, the root problem of conventional currency is all the trust required to make it work,” says Capital Group equity portfolio manager Mark Casey. Users must trust that a central government will prudently steer monetary policy, that financial institutions won’t restrict how funds can be used and that buyers and sellers will act in good faith.

Nakamoto sought to create a “trustless” system open to everyone and governed by immutable, software-encoded rules rather than by a select group of decision-makers. Anyone can freely trade coins, while the underlying blockchain technology automatically maintains the ledger that records transactions. Middlemen don’t exist: Banks and financial networks can’t limit trading or take coins without the owners’ permission. Accounts are anonymous and not tied to a single user, so transactions can take place online between accounts or offline by trading the accounts themselves.

The core idea, Casey says, is that users don’t have to believe in a government, a bank or even one another — they only need faith in the Bitcoin system. To facilitate that, Bitcoin’s rules are clear, essentially immutable and designed to give users as much control as possible over their accounts.

Bitcoin has become more visible — and more expensive to maintain

Bitcoin has become more visible and accepted in recent years, as demonstrated by a 5413% increase in the number of Bitcoin ATMs from November 2015 to November 2020. Similarly, nearly half of 18-to-34-year-olds said in 2020 that they were likely to buy Bitcoin in the next five years. However, Bitcoin also uses a lot of energy; so far in 2021, its consumption has been equivalent to about 35% of Australia's. Source: Statista. ATM figure as of Nov. 30, 2020. Energy figure as of March 24, 2021. Likelihood to buy figure as of Dec. 31, 2020.
Source: Statista. ATM figure as of November 30, 2020. Energy figure as of March 24, 2021. Likelihood to buy figure as of December 31, 2020.

Bitcoin’s hard cap sets it apart.

One of the cryptocurrency’s most important attributes is its finite supply. No more than 21 million bitcoins will ever be mined. Once they’re all in the wild, no new coins will be created, not even to replace those stranded in abandoned or lost accounts. The system parcels out undistributed coins at a set pace.

These aren’t arbitrary decisions; they’re intended to make Bitcoin’s monetary policy eminently predictable. The finite supply and defined disbursements allow users to calculate how many coins will exist at any point. There’s no Bitcoin Central Bank adding or subtracting coins in response to economic pressures.

Perhaps most important for investors and speculators alike, the hard cap implies there’s no limit to how much Bitcoin’s value could grow. As long as the world’s economy grows, demand for assets, potentially including Bitcoin, should also increase. Without any mechanism to balance supply, Bitcoin’s price could continue to creep up with mounting demand — theoretically, at least.

No traditional store of value has this hard cap, Casey notes. Governments can increase the supply of their currencies, and they typically do so in large enough quantities to cause them to slightly depreciate each year. Similarly, naturally occurring assets such as gems and precious metals exist in untapped pockets around the globe. 

“Bitcoin is the first form of money ever to have a truly fixed supply,” Casey says. “That unique property creates the possibility of achieving positive real returns simply by holding Bitcoin, which isn’t possible with fiat currencies. The possibility that you might get positive real returns simply by holding rather than lending or investing. That’s never existed before.”

Of course, that doesn’t mean that Bitcoin will rise. If users abandon it, there won’t be any demand to drive up prices. Similarly, the concept of value may be more complicated than it seems at first blush.

“We shouldn’t ignore that fiat currency has worked pretty well for a long time,” O’Neal says. “Some Bitcoin proponents point to the dollar’s declining purchasing power, saying the dollar is completely worthless today compared to 1913. But I look around and see a society that is vastly more wealthy and vastly more advanced than anyone could imagine in 1913.”

Despite Bitcoin’s outsize growth, it’s not ready to be a currency.

The first official Bitcoin transaction has become something of a legend. In 2010, a hungry user exchanged 10,000 coins for two pizzas. The purchase informally set the value of a coin to about a quarter of a penny — about 26 million times lower than this year’s high of $64,829. Had the buyer sold at the peak, the coins would have fetched nearly $650 million.

That kind of meteoric rise has become a hallmark of Bitcoin, with run-ups often multiplying the currency’s value in weeks or even days. However, those manic gains have been punctuated by precipitous drops. This year’s pullback of more than 50% isn’t uncommon. The currency has suffered 80% peak-to-trough price declines three times in the past decade. 

That kind of wild volatility makes it hard to effectively use Bitcoin as money. When currency appreciates, holders shy from investing or fully participating in the economy because they’re worried their money will gain more value than what they’ve bought. And big price swings make planning difficult, both for household expenses and complex supply chains. After all, budgeting is a much harder task if you don’t know what your funds will be able to purchase in a few months.

“Bitcoin attracts attention because it might go up a lot,” O’Neal says. “It’s not as successful as a currency. When people think of money, they still think of dollars.”

Bitcoin’s unique traits could make it an asset akin to gold.

Bitcoin’s properties do suggest a financial use in the near term, as a “store of value,” or an asset that generally appreciates in price at least as fast as inflation. It ticks many of the boxes: It demonstrates a history of growth and the ability to recover from slumps. It’s relatively easy to sell quickly. And Bitcoin isn’t nearly as broadly held as comparable stores of value, such as gold, suggesting it has some room to expand.

Casey notes: “Bitcoin’s share of global savings is only 0.25%. Compare that to gold, which makes up 2% of global savings, or other money, which makes up about 18%. Bitcoin’s price can’t possibly increase by another factor of several million, but there’s room to grow.”

Some institutional investors — banks, investment firms and big companies looking for better returns than those offered by cash — are dabbling in Bitcoin as a hedge against inflation. They’re starting small, Casey says, but they’re entertaining the idea that Bitcoin is more than a fad.

Of course, volatility isn’t an ideal trait for a store of value. No one wants to cash in a long-held asset only to find out that a price swing has wiped out half its value. 

Bitcoin’s future is uncertain, and investors are still figuring it out.

“In the near term, I expect Bitcoin to become more popular in its current use case, as a speculative vehicle for capital appreciation,” Casey says. “But its unique properties make it the best final settlement system yet devised. It is vastly faster, less costly and more certain than nearly all existing systems using fiat currencies. Even central banks, many of which have learned the hard way how difficult it can be to repatriate gold reserves, might eventually want to use Bitcoin’s settlement system.”

O’Neal is less sanguine.

“I think demand for a safe, digital currency that enables cheap, easy transactions will grow tremendously, and I’m not surprised that innovation occurred first in the private sector,” he says. “But that doesn’t mean that the public sector won’t follow. If you had the option of an easy-to-use digital wallet based on the dollar that does basically what Bitcoin does but runs on fast, transparent and legal rails, would you prefer to use Bitcoin? The case for Bitcoin as ‘digital gold,’ a unique asset, is fairly interesting. However, the base case as a substitute currency is quite weak, in my opinion.”

For Bitcoin, or any other cryptocurrency, to serve as a true global
currency, it would have to meet all three of the following functions:

  • A medium of exchange: This might seem tautological, but people would have to be comfortable accepting Bitcoin before it could be a true currency. A big part of that is simply having enough people willing to spend it; the highest estimates say about 101 million people use the coin worldwide.
  • A measure of value: Perhaps the biggest obstacle for Bitcoin to overcome is its volatility. Many central banks have price stability as their top — or only — mandate, and Bitcoin simply doesn’t tick this box. If the day comes when the world can confidently price common goods such as a gallon of milk in Bitcoin, that would go a long way toward establishing its bona fides as money.
  •  A store of value: Something can be said to be a store of value if it maintains its price over time. Bitcoin so far has enjoyed a remarkable gain in value, but it’s also volatile, which makes it difficult to plan with. And while it’s often compared to gold, Bitcoin has a long way to go on this front — gold has been recognized as a valuable medium of exchange for thousands of years. Bitcoin might not need a millennia to prove it can sustain its price, but it only a 12-year history right now.

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