03 Jun 2021

Bitcoin: The face of cryptocurrency

Bitcoin has become the face of cryptocurrency and for good reason! In 2010 Bitcoin was trading under $0.10 and has exploded in price over the past decade. Bitcoin has surpassed the $1 trillion market cap which is slowly creeping up on gold's total value of $10.4 trillion. While other digital currencies such as Ethereum contain smart contracts that offer a function built directly into the transaction Bitcoin has a different focus. Bitcoin's main intention is to become a store of value. However, before Bitcoin, very few people knew what a cryptocurrency was and why they should buy into an unproven and unknown asset class. Bitcoin was structured to gradually increase adoption over decades with a balance between the amount of new coins being created and the rewards to miners for creating those coins. Once people see the value increasing they want to buy in which increases the value and a positive feedback loop is created. This comes to an end in the year 2140 when all Bitcoins will have been mined and it can truly become a store of value due to its relative scarcity.

How does Bitcoin work?

Bitcoin was invented by Satoshi Nakamoto to create a decentralized storage of value. These coins do not have to go through financial institutions like typical fiat currency. Peer to peer transactions are managed via the blockchain. This decentralization allows for cheap transaction costs while still maintaining the guarantee that the funds will be transferred accurately with no fraud. The next question you might have with a digital currency is: What is stopping me from making two transactions at the same time with the same coin? This is part of the verification process that a Bitcoin miner handles while creating a new block. Miners ensure that there is no double-spending in the new block before adding it to the blockchain.

While fiat currencies constantly have to balance printing new money with the rate of inflation, Bitcoin was created to mitigate against inflation. There is an explicit cap on how many Bitcoins will ever exist set at 21 million. With an average of 44 blocks mined per day with 6.25 bitcoins per block, the max will take quite a while to reach.

Right now, miners earn most of their income via the block reward. When all 21 million bitcoins are mined, there won't be a block reward to pay to miners. When a Bitcoin user sends a BTC transaction, a small fee is attached. These fees go to miners and this is what will be used to pay miners instead of the block reward.

Is this a real asset or another speculative bubble?

An asset bubble is when investor speculation gets out of control and greed runs rampant. The first documented bubble in 1637 was called "Tulip Mania" which caused tulip bulbs to go from ~$1 in today's currency to over $100 each at the height of the frenzy. After the peak, the price crashed back down into the single digits.

So does Bitcoin qualify as a bubble? The boom and bust cycle seen in Bitcoin contains waves of exponential growth followed by a dramatic drop. By this definition, Bitcoin has gone through three bubble phases to date, but so far has recovered after each phase. As more people and companies buy into Bitcoin, it becomes more and more of a real asset class. While Bitcoin is more established than it was in the 2013 exponential growth phase, it is still a very risky asset and should be treated accordingly.

Four year cycle

Unlike other investments like the stock market or real estate, Bitcoin's supply is built into the technology itself. This is due to Bitcoin's halving event. Currently, 6.25 Bitcoin are rewarded to miners every ten minutes. This supply increase rate was halved from 12.5 in May 2020 and will continue to happen every 210,000 blocks that are mined. This is the core of the four-year cycle because it takes roughly 4 years to mine that many blocks.

The true genius of Bitcoin that is often overlooked is the halving event. Consistently and predictably squeezing supply while demand either stays the same or increases, naturally causes the value to increase. While the four-year cycle is not a guarantee of future performance, it has historically lined up with the phases that Bitcoin goes through which are: accumulation, recovery, exponential growth / all-time highs, and then the correction. By introducing a supply squeeze after the correction phase, Bitcoin stimulates the next growth phase. A great resource to visualize this four year cycle is the stock to flow model by Look Into Bitcoin.