Over the long term, there's been no more consistent creator of wealth than the stock market. Stocks have returned an average of 7% per year, inclusive of dividend reinvestment and adjusted for inflation, which essentially equates to a doubling of invested money about once a decade.
But this year has unquestionably belonged to cryptocurrencies. Since the year began, the aggregate market cap of the more than 1,300 cryptocurrencies combined has jumped from $17.7 billion to $423 billion as of Dec. 7. That's an increase of nearly 2,300% in a matter of 11 months and a week, representing a lifetime's worth of gains in less than a year.
Leading the way has been the world's most popular cryptocurrency, and the first to be tradable on cryptocurrency exchanges, bitcoin. After beginning the year at roughly $967, it's exploded higher to nearly $17,000. Its $255 billion market cap is close to 100 times higher than it was during mid-2015, and it's even larger than Dow Jones Industrial Average stalwarts like AT&T and General Electric.
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Bitcoin's exponential gains, explained
What's fueling bitcoin, you wonder? Blockchain excitement probably tops the list. Blockchain is the infrastructure that underlies virtual currencies like bitcoin and logs transactions in a digital and decentralized manner. Blockchain could be a game-changer for the financial services industry, since it could improve network security, reduce costs (since there's no middleman), and speed up transaction settlement times since miners work 24 hours a day, seven days a week, to proof transactions.
Bitcoin has also been especially popular with merchants. Even though it would admittedly be difficult to solely live off bitcoin given its high volatility and unregulated nature, the number of virtual currencies merchants accept is growing, and bitcoin in leading that charge.
A falling dollar has also been a boon for bitcoin. When the dollar falls, investors holding cash see their wealth decline. Usually they seek the safety of a store of value like gold, which is a scarce asset that's been used as a form of currency for over 2,700 years. However, because bitcoin has protocols limiting the number of coins that can be mined to 21 million, it, too, is perceived to a "scarce" resource, and therefore a reasonable store of value. In short, some investors are choosing bitcoin over gold.
Lastly, emotions and the fear of missing out on once-in-a-lifetime gains is clearly playing a role. Since institutional investors have predominantly been kept on the sidelines, retail investors who are more emotionally invested in their trades have been responsible for driving bitcoin higher.
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One figure that should terrify investors
Nevertheless, skeptics abound. Some industry moguls, including buy-and-hold investing guru Warren Buffett, and the CEO of JPMorgan Chase (JPM +0.20%), Jamie Dimon, question whether bitcoin has any value at all. Buffett has equated bitcoin to nothing more than a means to transmit money, which is the same function a check serves, while Dimon has referred to bitcoin as a "fraud" that "won't end well."
But it's not the opinions of these investing moguls that are truly terrifying when it comes to bitcoin. Instead, I'd point to a bitcoin survey conducted a few months ago that should really concern investors.
Back in September, student loan refinancing marketplace LendEDU conducted a poll across the U.S. that found that 79% of Americans were aware of bitcoin, and nearly 40% would at least consider using bitcoin for transactions and purchases. Yet here's the kicker: When respondents were asked if it was illegal to own bitcoin in the U.S., just 42% correctly responded that it wasn't. Around 11% incorrectly believed it was illegal, while the remainder weren't sure. With almost half of all respondents completely unaware of bitcoin's legal status, it suggests that there's a major knowledge gap with regard to bitcoin. That's terrifying when it's being primarily driven by retail investors.
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But wait -- there's more
Of course, that's not the only worrisome figure. A slightly more recent LendEDU poll found that less than a third (31.6%) of respondents were aware of Ethereum, which is the second-largest cryptocurrency with a market cap of $42 billion. That respondents are unaware that other major virtual currencies exist is concerning, given that competing blockchains and digital currencies could offer advantages over bitcoin.
For instance, Ethereum's blockchain incorporates smart contracts, which are protocols that facilitate, verify, and enforce the negotiation of a contract. Some 200 organizations are currently testing a version of Ethereum's blockchain in the Ethereum Enterprise Alliance, representing a direct threat to bitcoin's long-term dominance. JPMorgan Chase just happens to be one of the company's testing a version of Ethereum's blockchain in this alliance.
In addition, 75% of respondents had never heard of initial coin offerings, which are the virtual currency equivalent of an initial public offering, except a new digital currency is brought to market.
Ignorance may have been bliss up until now for bitcoin and its investors, but it's unlikely to last forever if people are simply buying in without understanding all aspects of their investment. With futures trading kicking off just two days ago, and institutional investors now having a means to unleash their capital to bet against bitcoin, my suspicion is this bubble is readying to burst.
