The first Bitcoin (BTC -4.47%) was mined 13 years ago. For the first three years, it was worth less than a penny. But in 2011, it crossed a major milestone when it achieved parity with the U.S. dollar.
At the time, many people scoffed at Bitcoin and argued it could never be used as a mainstream currency or a long-term investment. But if you had taken the contrarian view and bought a hundred Bitcoins with $100 that year, your investment would be worth a whopping $4.32 million today.
How did Bitcoin silence the critics?
When Bitcoin was created, the idea of using computer chips to mine a digital currency seemed outlandish and absurd. But in practice, it wasn't all that different from using industrial machinery to mine precious metals.
Image source: Getty Images.
Just like gold, Bitcoin is a finite resource. As more Bitcoins are mined, it becomes increasingly difficult and less cost effective to mine new Bitcoins. In the early days, Bitcoin could be mined with higher-end PC graphic processing units (GPUs).
But today, Bitcoin can't be effectively mined with regular GPUs due to the time and energy required to mine a single Bitcoin. Instead, expensive devices known as application specific integrated circuits (ASICs) are now required to mine a steady supply of Bitcoins. Still, the same economic logical applies to Bitcoin and precious metals: Miners can only make money if the costs of the machinery and labor don't outweigh the metal's market value.
Moreover, Bitcoin's algorithm limits its lifetime production to 21 million Bitcoins. It's commonly estimated that the last Bitcoin will be mined by 2140.
As more people grasped these concepts, they started to value Bitcoin as an asset alongside gold and other precious metals. Moreover, the anonymity and security of Bitcoin transactions, which is enabled by a distributed ledger technology called blockchain, also made it an appealing alternative to fiat currencies for financial transactions. A growing number of investors also started touting Bitcoin as a potential hedge against inflation.
The future of Bitcoin
After Bitcoin achieved parity with the U.S. dollar, more investors, analysts, entrepreneurs, and even governments jumped aboard the bandwagon.
Pure-play Bitcoin mining companies like Marathon Digital (MARA -1.80%) and Riot Blockchain (RIOT 0.25%) appeared, cryptocurrency exchanges like Coinbase (COIN -5.10%) grew, and the first Bitcoin exchange-traded funds (ETFs) hit the market.
Bitcoin evangelists like Jack Dorsey and Mark Cuban drummed up even more enthusiasm from mainstream investors, while a growing number of retailers started to accept Bitcoin as a payment option. El Salvador even became the first country to officially accept Bitcoin as a legal tender last year.
ARK Invest's Cathie Wood recently predicted Bitcoin's price would hit $560,000 by 2026 -- which would make your initial $100 investment worth $56 million. Wood believes Bitcoin can reach that lofty price target if all institutional investors allocated just 5% of their portfolios to the cryptocurrency.
But it's not all sunshine and rainbows
Bitcoin's future might seem rosy, but there are still a lot of challenges to overcome. Government regulators across the world have been rolling out bans, restrictions, and taxes for Bitcoin and other cryptocurrencies. Countries could also develop their own digital currencies pinned to their own fiat currencies as a viable alternative to cryptocurrencies.
The environmental cost of mining Bitcoin, which caused Elon Musk to turn against the cryptocurrency last year, also raises red flags. The Dutch economist Alex de Vries estimates that miners, should Bitcoin's price hit $500,000, will be pumping out more than 617 million metric tons of CO2 annually -- which exceeds the carbon output of countries like Brazil and the U.K.
Meanwhile, the volatility of Bitcoin could prevent it from ever being used for everyday transactions. If fewer retailers adopt Bitcoin as a payment option, it could fail as a currency and continue to be used as a speculative investment.
Is it too late to buy Bitcoin?
Bitcoin's volatility has prevented it from being an effective hedge against inflation over the past few months. But that could change in the future if Bitcoin's price stabilizes and the regulatory headwinds wane.
I think investors should have some exposure to Bitcoin, but it should only occupy a low-single-digit percentage of their portfolios. That way, you'll profit if Bitcoin's price skyrockets, but you also won't suffer any lasting damage if the bubble pops.
