Three years ago, Square's (SQ 0.04%) co-founder and CEO Jack Dorsey predicted bitcoin (BTC 0.12%) would overtake the U.S. dollar in global importance to become the internet's "single currency".

Bitcoin's price has risen more than 400% since Dorsey made that prediction to The Times, and many investors still closely associate Square's fintech business with bitcoin's future. However, Square's approach to bitcoin still differs from its competitors in four key ways.

Physical bitcoins placed on top of a reflective circuit board.

Image source: Getty Images.

1. Its first mover's advantage

Square added bitcoin trades to its Cash App, which was used for peer-to-peer payments, in early 2018. That feature differentiated Cash App from PayPal's (PYPL 0.23%) peer-to-peer payments app Venmo, and attracted new users who were looking for an easy way to buy and sell bitcoin.

Square's approach was disruptive, since bitcoin trading had previously been limited to niche exchanges like Mt. Gox and Coincheck, which both failed to protect their users from hacks and scams.

Square simplified the process by directly buying bitcoin, selling it to Cash App users at a slight margin, and not charging any additional transaction fees. It started allowing users of its Cash Card, a debit card which was linked to Cash App, to earn bitcoin "Boosts" from their purchases last year, then it added free peer-to-peer bitcoin transfers earlier this year.

Last year, more than 3 million customers bought and sold bitcoin on Square's Cash App. This January, over 1 million Cash App users bought bitcoin for the first time. Cash App had 36 million monthly active users at the end of 2020 -- so Square still has plenty of room to gain more bitcoin buyers.

2. It only sells bitcoin

Many other companies followed Square's lead. Robinhood launched free cryptocurrency trades about a month after Square, and PayPal -- which had repeatedly refused to enter the cryptocurrency market -- finally added crypto trades and payments to its main app in late 2020.

However, Square doesn't dabble in other cryptocurrencies besides bitcoin, even as Dorsey's fellow billionaires Elon Musk and Mark Cuban promote other cryptocurrencies like dogecoin (DOGE 4.26%).

3. It holds bitcoin on its balance sheet

Many companies that provide bitcoin trading services don't actually hold bitcoin on their balance sheets. Yet Square has gradually added more bitcoin to its own coffers (not Cash App) over the past few years, and its bitcoin holdings accounted for roughly 5% of its cash and cash equivalents at the end of 2020.

That investment won't break Square if bitcoin suddenly crashes, but it could still generate massive long-term returns. Considering how bullish Jack Dorsey is on bitcoin, it wouldn't be surprising to see Square add more bitcoin to its balance sheet this year -- especially after the cryptocurrency shed about 30% of its value over the past month.

4. It's not an all-in bet on bitcoin

Square usually generates most of its revenue from its transaction-based fees and seller services. But last year, many small and medium-sized businesses which use those services shut down during the pandemic.

Fortunately, Square's bitcoin revenues from Cash App skyrocketed roughly nine times year-over-year to $4.57 billion, or 48% of its top line, last year and offset the slowdown in its transaction-based business. However, it only retained 2% of those bitcoin revenues as gross profits, and the higher mix of lower-margin bitcoin revenues squeezed its adjusted earnings.

Therefore, Square's bitcoin business absorbed some of the pandemic's impact, but it definitely isn't an all-in bet on bitcoin and the cryptocurrency market. Instead, investors looking for a more speculative "pure play" on the crypto market should take a closer look at Coinbase (COIN 4.96%), the world's largest cryptocurrency exchange.

What does this all mean for investors?

Square's stock often rises and falls with bitcoin's price, but its business is only partly tethered to the world's top cryptocurrency. Its core business, which consists of payment processing services and other business tools, remains a more broadly diversified play on the growing fintech market.

Simply put, investors who believe in bitcoin should simply buy the cryptocurrency. Investors who want a more conservative fintech stock which isn't as exposed to cryptocurrencies might prefer PayPal, which trades at much lower valuations than Square. However, investors who want the best of both worlds and aren't afraid of a little near-term volatility should still consider Square to be a solid investment.