As we look back on the first 10 months of 2017, one thing is very clear to investors: It's belonged to cryptocurrencies. Since the year began, the aggregate value of all cryptocurrencies combined has grown from $17.65 billion to $167.88 billion as of Oct. 25, 2017. Just your run-of-the-mill 851% gain in 10 months! Comparatively, the stock market has taken decades to deliver the same magnitude of returns for investors.
Making sense of the hype surrounding bitcoin
Leading the charge higher has been bitcoin, the most popular digital currency, and unquestionably the largest by market cap. Bitcoin's market cap of $94.3 billion on Oct. 25 makes up 56% of the aggregate market value of nearly 1,200 cryptocurrencies.
Even though bitcoin hasn't been the top-performing cryptocurrency in 2017 on a percentage basis, its catalysts are, by far, some of the clearest in the space. Some investors remain excited about the payment-platform potential of bitcoin, while others have sought its safety as a store value amid a falling U.S. dollar. Since bitcoin's protocols limit the number of coins that can be mined, to 21 million, it's perceived to be a finite asset -- just like gold.
But the wildcard catalyst of the bunch is the potential for blockchain, the underlying technology of bitcoin and many other cryptocurrencies. Blockchain is the digital and decentralized ledger that records transactions without the need for a bank or financial intermediary. As open-source networks, blockchain makes it veritably impossible to alter logged data without being noticed, making it a potentially safer peer-to-peer and business-to-business transaction platform of the future.
Bitcoin just hard forked into two virtual currencies... again
Though blockchain is probably the most tangible and fundamental reason to invest in bitcoin, it's also arguably the greatest source of confusion. This past week saw bitcoin fork (i.e., split) into two separate currencies for the second time in three months as a result of a disagreement over the future of its blockchain from within the bitcoin community.
At the beginning of August, bitcoin hard forked into two separate currencies, bitcoin and bitcoin cash, after the community couldn't come to an appropriate consensus on what should be done to improve blockchain capacity and transaction settlement times. While roughly three-quarters of those involved believed bitcoin should market its blockchain to attract big business, a quarter of folks dissented and preferred that bitcoin remain a Libertarian's dream currency. This fell short of the required 80% consensus needed to avoid a fork into two separate currencies.
The result was a fork into bitcoin cash, which chose to simply upgrade within the existing framework of the blockchain, and bitcoin, which implemented the SegWit2x upgrade that took some info off of the blockchain in order to boost capacity, while simultaneously lowering transaction fees and speeding up settlement times.
This past Tuesday, Oct. 24, bitcoin forked, once again, into two separate currencies, bitcoin and bitcoin gold, as a result of the community being unable to decide on the future of its blockchain. In this instance, the community was divided over whether something should be done about just a small handful of miners having control of the high-end machinery needed to mine bitcoin.
While original bitcoin continues to allow this small group of miners to remain in control, the hard fork created new protocol in bitcoin gold that allows people and organizations with less powerful machines to mine bitcoin gold. The fork further decentralizes bitcoin, which some pundits believe helps prevent it from a potentially crippling cyberattack.
A hard fork isn't necessarily a good thing for bitcoin
Some folks within the bitcoin community would suggest that a hard fork is a smart move by bitcoin. If there's disagreement over the future of bitcoin or its blockchain, the community gets to sound off, and changes are made so that everyone's happy. Plus, as noted, the fork into two (more) currencies provides further decentralization of the network, which could come in handy if cybercriminals wanted to pray on bitcoin.
But the second fork in three months for bitcoin may not necessarily be viewed as a good thing. For starters, it's really confusing for the layman investor. The concept of virtual currencies and blockchain can already be challenging enough for a new investor to understand, so adding in another dimension of virtual currencies spinning off new virtual currencies is just a recipe for confusion. There's already enough emotion-driven trading on cryptocurrency exchanges, and these forks are liable to create even more volatility.
Perhaps the bigger issue is that these forks expose a fatal flaw in the "finiteness" argument of owning bitcoin. While it's true that protocols limit the number of mined bitcoin to 21 million, forking into separate currencies allows bitcoin to move beyond these limits by creating a new currency. Additionally, it's always possible the protocols in bitcoin could be rewritten to allow more mining, meaning it may not be as scarce as you realize.
New virtual currencies can also struggle to gain appeal, with bitcoin gold crashing as much as 66% following its debut. Few cryptocurrency exchange platforms have OK'd trading in bitcoin gold, and the website for the new currency has been overloaded with requests, crashing the server.
These risks, when coupled with regulatory concerns and a low barrier to entry in developing blockchain technology, could cause bitcoin to lose its luster. Despite bitcoin's hefty returns this year, I'd suggest keeping your distance from a situation that's looking more like a bubble with each passing day.