Historically, no asset has been better at making investors money over time than the stock market. Looking back decades, stocks tend to average an annual return of 7%, inclusive of dividend reinvestment and adjusted for inflation. This beats out commodities like oil and gold, income options like bonds and CDs, and it handily trounces the appreciation in home prices. In fact, this data suggests that the average stock market investor should see his or her portfolio double around once a decade. That's a truly phenomenal return.
But to cryptocurrencies investors, a 7% annual return can be achievable in the blink of an eye. In fact, the aggregate market value of the more than 1,300 cryptocurrencies combined has jumped from $17.7 billion at the beginning of the year to $388 billion as of Dec. 9. In a bit over 11 months, we've witnessed a lifetime's worth of gains -- or, to be more specific, a return of 2,100%.
What's behind bitcoin's 1,350% year-to-date rally?
Even though it hasn't been the biggest percentage gainer this year, bitcoin is very much the glue that holds this rally together. Its Dec. 9 market cap of $234 billion made up more than 60% of the aggregate value of all cryptocurrencies combined. It's simply that big and that important to virtual currency investors.
So, why the enormous rally? In particular, cryptocurrency investors appear to be most excited about the future of blockchain technology. Blockchain in the digital and decentralized technology that underlies most cryptocurrencies and is responsible for logging transactions safely and efficiently, without the need for a financial intermediary like a bank. The decentralization aspect is designed to make blockchain considerably safer than current databases, while the lack of a middleman could make transactions cheaper.
There's also been a lot of buzz around using bitcoin as a payment facilitator. A handful of brand-name businesses began accepting bitcoin back in 2014, and new merchants have jumped on the bandwagon since then. As the world's most valuable virtual currency, some folks view it as becoming more popular than cash someday.
Clearly, emotions have played a critical role, too. Since institutional investors have mostly stuck to the sidelines, retail investors have been in charge of bitcoin's monstrous rally. The fear of missing out on 1,350% year-to-date gains has been more than enough of a dangling carrot to get new money flowing into bitcoin from the sidelines.
The biggest misconceptions about bitcoin
But for all bitcoin has become, misconceptions about the world's most popular cryptocurrency abound. Here are, in no particular order, the four biggest misconceptions about bitcoin.
1. Bitcoin's price only goes up
Sure, bitcoin has risen by more than 1,300% since the year began, but it's also had five major corrections since May, including two between Dec. 7 and Dec. 9. Bitcoin shed 38%, 40%, and 29% of its value from peak to trough between May and early November. On its most recent run that saw bitcoin briefly clip $19,000 on cryptocurrency exchange Coinbase, it dipped by more than 20% twice, from peak to trough, over a two-day span. Though the trend has been up for a while, bitcoin can most certainly go down.
In fact, the start of bitcoin futures trading through CBOE Global Markets (CBOE -0.94%) this week, and CME Group the following week, is opening the door for the first "fair" market cryptocurrency investors have ever seen. Instead of only being able to buy or sell bitcoin, investors will now have the option of betting against it and making money. With futures opening for business on the CBOE, institutional investors will finally have an avenue to put their money to work -- and my suspicion is many of those bets will be against bitcoin's success.
2. It's a much safer way to transmit money than current databases
Another common misconception is that bitcoin is a considerably safer way of transmitting money and processing payments than current databases. While it's true that decentralization ensures that cybercriminals have no way of crippling an entire cryptocurrency if they gain access to a server, it doesn't mean your virtual currency is necessarily safe.
For those who may not recall, Mt. Gox, which at one time processed around 70% of all bitcoin volume, was allegedly hacked by cybercriminals who wound up stealing around 850,000 bitcoin, and tens of millions of dollars in cash held by Mt. Gox. Today, those bitcoin would be worth more than $10 billion. A subsequent bankruptcy filing by Mt. Gox sent bitcoin's price into a year-long spiral. In short, bitcoin isn't impervious to disruption.
3. Bitcoin is the new gold
A third errant view about bitcoin is that it's setting itself up to become the new gold. This idea arises from the fact that bitcoin has protocols limiting the number of coins that can be mined to 21 million. Therefore, it has a scarcity factor similar to that of gold. Further, with the dollar weakening in 2017, some investors looking for a safe-haven investment have chosen bitcoin as opposed to gold.
But there are two fatal flaws with the assumption that bitcoin is the new gold. First, the only thing controlling bitcoin's scarcity are protocols -- and they can be rewritten. Plus, each time bitcoin forks into a new currency, it's technically demonstrating that there are ways around its protocol limits. It's not nearly as scarce as folks think.
The other factor is that bitcoin is worth only a fraction of what all the gold in the world is worth. Gold has also been an accepted currency for 2,700 years, meaning it'll retain its edge as the go-to store of value when the dollar falls.
4. It's completely anonymous
Lastly, bitcoin is often praised for its anonymity. The ability to use that which isn't backed by the federal government or a central bank is treasured by folks who value this libertarian's dream currency. But the reality is that bitcoin isn't so anonymous after all.
While it's true that you don't have to hand over your Social Security number or open a bank account to use bitcoin, it nevertheless records information that can, potentially, be linked back to you in the underlying blockchain. This recording is necessary to avoid having the same bitcoin spent twice, and to reduce the threat of criminal activity.
However, this recordkeeping also ensures that the federal government may be able to find bitcoin users, if need be. For instance, the Internal Revenue Service recently won a court case requiring that cryptocurrency exchange Coinbase turn over information related to more than 14,300 bitcoin traders who exchanged more than $20,000 worth of coins between 2013 and 2015. The reason? Bitcoin profits are taxable, and in the years in question, just 800 to 900 taxpayers reported bitcoin profits on their federal tax returns. In other words, the IRS is using blockchain technology to locate potential tax evaders, suggesting that it's not as anonymous as you think.