Whether you're a diehard bitcoin fan or you can't stop screaming mania, it's hard to ignore just how monumental bitcoin's surge has been. Bitcoin gained over 300% last year and is already up over 10% this year.
Here are five hard-to-believe facts about bitcoin and cryptocurrency that could be helpful for your own investment purposes, to impress your friends, or simply to gain a better handle on what bitcoin is and why it's surging.
Image source: Getty Images.
1. It's the third generation of currency
Human beings have been buying, selling, and trading things since the dawn of time, but currency is quite a different concept. At its core, currency is a store of value. The first currencies had intrinsic value, which could be anything from yams in Chinua Achebe's Things Fall Apart to precious metals. Under the economic system of mercantilism, buying and trading gold became an obsession that sparked widespread colonization, imperialism, and war. Having a gold standard meant that money was tied to how much gold a country had, not the wealth of a nation itself.
Adam Smith famously criticized this policy in his book The Wealth of Nations, published in 1776. One of his core arguments was that economies should grow based on incentives, productivity, technology, and industrialization, not how much gold you have. The result was capitalism and the popularization of fiat currency. Fiat currencies, like the U.S. dollar, are easily transferable stores of value meant to represent the wealth of a country or collection of countries despite being worthless in and of itself. (And we should note China figured this out long before Smith, having adopted fiat currency around 1000 AD.)
Bitcoin is the third generation of currency. It doesn't have any intrinsic value like gold or silver, or representative value like the U.S. dollar. But it has a limited supply, it's hard to counterfeit, and it can be transferred without a third party. (This isn't to say it's been successful as a currency -- more on that later.)
Image source: Getty Images.
2. It has a clear purpose
Bitcoin was developed during the global financial crisis and made available to the public in early 2009. Whether the crisis played into the development of bitcoin is unknown. But the context is key. Widespread distrust of banks and a crippled economy paved the way for new ideas. Cryptocurrency was a natural fit because it provided a way to conduct private transactions without going through a bank. Bitcoin became the first established cryptocurrency and combined the ease of a credit card with the privacy of cash, independent of an institution or government.
Bitcoin was made for a clear purpose, the details of which are outlined in "Bitcoin: A Peer-to-Peer Electronic Cash System," now commonly referred to as "the bitcoin white paper." Published in 2008, it detailed the flaws of existing currencies and outlined the benefits of a decentralized peer-to-peer network that eliminated the need for a third-party middleman like a financial institution.
The problem and solution that bitcoin's founder(s) identified can be best summed up by the following excerpt from the white paper: "What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party. Transactions that are computationally impractical to reverse would protect sellers from fraud, and routine escrow mechanisms could easily be implemented to protect buyers."
The takeaway here is that bitcoin wasn't founded to make money like a corporation. It was never intended to be an investment. Rather, its purpose was to change commerce itself by protecting consumers from corruption, whether that be from a government or an institution.
3. It's not always harder to mine
It's a common belief that each successive bitcoin is harder to mine than the last. While that is generally true, there are plenty of times when it isn't. In fact, just a few weeks ago, bitcoin was easier to mine -- that is, it took less computing power. The explanation is simple.
Let me back up. While bitcoins can be bought, or received for goods or services, they're also found (mined) by exerting computing power to solve a puzzle. These puzzles are random and require a lot of guesswork, so it's easier to solve them by increasing computing power. But there's a catch. The puzzle difficultly will increase based on the total computing power being used on the network. This is because bitcoin's founders wanted to limit supply by ensuring that one block of bitcoin is mined, on average, every 10 minutes. To counteract rising computing power, the difficulty adjusts every two weeks based on the prior period's average computing power.
The bitcoin reward per block also decreases. In fact, it halves after every 210,000 blocks are mined. It started at 50 in 2009. And since May 11, 2020, it's been 6.25 coins per block. Despite a surge in computing power (the cost to mine), and puzzles that are literally trillions of times harder now than 10 years ago, bitcoin's price increase has helped mining remain profitable.
Mining will continue to be profitable as long as the costs to mine remain less than the reward for mining. But because it takes so much more computing power and electricity to mine now than before, investing in a mining rig only makes sense if you believe bitcoin can stay above a certain price. It's like oil drilling. If the fixed and variable costs to drill an oil well can result in a breakeven price of $50 per barrel, and oil is at $52 per barrel, then it would be a bad idea to invest in that well considering you're only making a 4% return and could actually lose money if oil prices fall.
At an electricity cost of a conservative $0.07 per kWh, even the most sophisticated mining rigs break even at around $7,070 bitcoin. But their profit is just $17.70 per day at $30,000 bitcoin. With a starting cost of $3,000 per rig, it would take half a year to recoup your upfront costs. And that's assuming $30,000 bitcoin. Just like oil, it doesn't make sense to mine bitcoin -- even with the best technology available -- unless the price stays above a certain point.
Image source: Getty Images.
4. It has failed as a currency despite succeeding as an investment
Bitcoin has been a great investment but a terrible currency. As I mentioned earlier, fiat currencies like the U.S. dollar can't compete with bitcoin's security or flexibility. But the surge in bitcoin pricing has similar effects to hyperinflation. Currencies are meant to be stable. Lately, the value of the U.S. dollar has been decreasing by less than 2% per year (known as inflation), which is counteracted by saving and wage increases. But bitcoin can never be stable if the price routinely moves up or down by 1% in one day, let alone by 5% or more in a day. Just last week, bitcoin crashed 13% on Tuesday and then rose 7% on Wednesday. Imagine buying a car for 2,000 bitcoins in 2016 then selling it for two bitcoins in 2021. Or trying to buy a gallon of milk for 0.0001 bitcoin. Volatility has been bitcoin's fatal flaw as a currency.
It's difficult to know what percentage of bitcoin transactions are due to trading versus legitimate payments for goods and services. But there's a good chance its use as a currency generally goes down as volatility goes up. This is because bitcoin transaction volume (likely from trading) increases with volatility. And as a result, transaction fees rise as well. Bitcoin's metrics during the first week of the year illustrate this relationship well.
Bitcoin Price data by YCharts
Bitcoin's price rose above $40,000 for the first time in history, transactions crossed 400,000 per day, and the average fee per transaction surged past $12 by the end of the week. Bitcoin's transaction fees can be $1 or less during times of low volatility, so paying $12 for a transaction signals desperation. Again, the irony is that bitcoin's "success" as an investment works against its effectiveness as a currency.
5. Bitcoin's biggest fan is its worst enemy
As of Friday, Jan. 15, the cumulative value of all bitcoin was $678 billion, right behind Alibaba Group and ahead of Taiwan Semiconductor Manufacturing. If it were a company, it would have been the ninth-most valuable company traded on a U.S. stock exchange. We can verify this math by taking the supply, about 18.6 million, and multiplying it by the value of each coin, around $36,500.
Bitcoin's surge in value is due in part to Wall Street's interest in it. Jamie Dimon, the CEO of JPMorgan Chase, went from calling it a fraud to thinking it has upside. PayPal and Square have allowed their users to buy and sell cryptocurrency. And hedge-fund managers are even starting cryptocurrency funds to get in on the action. The irony is potent and painful -- the very institutions and third parties bitcoin's founder(s) was trying to avoid are now its biggest fans. As mentioned before, heightened trading drives volatility which increases transaction fees and makes bitcoin an ineffective currency. Bitcoin could very well continue to succeed as an investment. But it needs to be boring to succeed as a currency.
