Ananya Ashta, Nancy Zheng, and Bryan
Bitcoin reaching an all-time high as investors worry about future inflation
We are living in an economic period where a record level of monetary easing and fiscal stimulus are flooding the market with cash. Bitcoin has become a popular tool for major investors to hedge against inflation and reduction in the purchasing power of the US dollar. To give a short explanation, this is because bitcoin’s limited supply is not influenced by its price, but rather by its relative attractiveness when yields tend towards zero. In a way, this allows for hedging against all negative consequences that usually accompany it. (Acheson, 2021)
The rise in institutional involvement in cryptocurrency has made the price of one bitcoin to exceed the $50,000 mark for the first time on 16th February, other cryptocurrencies such as Ethereum and Dogecoin followed suit. Ethereum, the second largest cryptocurrency in terms of capitalisation and volume, also reached its peak of $1938 (which was a 4.6% increase from $1936.94) on 17th February (Chavez-Dreyfuss, 2021).
Tesla has made a huge profit from Bitcoin through investing $1.5 billion in Bitcoin in January (Katje, 2021). In the previous month, Bitcoin was traded in the range between $29,000 and $37,000, we could estimate that Tesla invested about 44,000 Bitcoin. With the current price of Bitcoin, Tesla could have earned a profit of $0.65 billion (Katje, 2021).
Long-awaited Bitcoin ETF may finally get approved this year
Not everyone has the knowledge and the time to mine bitcoin; ETFs are a possible remedy to this. Bringing Bitcoins to the format of traditionally traded funds is an important step in solidifying its reputation in the financial market. Last year, more than 10 companies filed but failed to acquire approval for Bitcoin exchange-traded funds (ETFs), as the Securities and Exchange Commission (SEC) was concerned about the market's immaturity. With the Biden administration this year, the SEC is expected to approve such an ETF with new leadership under Gary Gensler. Two ETFs have been approved in Canada (Helms). With more than $1.7 billion assets under management, Evolve Funds Group Inc. has now become one of the fastest growing ETF providers in Canada.
Increasing adoption of major retailers
PayPal and Square also demonstrated their interest in bitcoin by enabling more than 350 million active users to transact bitcoins on their platforms. In addition, there is a rising number of places to spend cryptocurrency. Microsoft accepts the token for app and games payment on its digital store, while Starbucks also allows customers to pay using bitcoin on its Bakk’s app (Vega). The customers in the US are now allowed to buy, sell and hold bitcoin in their online wallets, which is a huge step forward in promoting the use of bitcoin. Bitcoin seems to be heading to the mainstream, but it isn’t the only cryptocurrency. The next section highlights how cryptocurrencies in general work and which are the ones to look out for in the coming years.
Different cryptocurrencies
Seeing as bitcoin and other cryptocurrencies are gaining in popularity and value, more and more retail and institutional investors alike are hopping on to the crypto-bandwagon. But what are some of the different cryptocurrencies and how do they differ from each other?
Market Capitalisation/ Popularity
Market capitalisation is an indicator that measures and keeps track of the market value of a cryptocurrency. Market cap is used as an indicator of the dominance and popularity of cryptocurrencies
Market Cap = Price (X times) Circulating Supply
Large-cap cryptocurrencies are considered to be relatively safe crypto investments. These are companies with a market cap of more than $10 billion. These coins are likely to be less volatile than other cryptocurrencies but still more volatile than traditional assets like stocks.
Mid-cap cryptos are more volatile but also have a lot more growth potential than large-cap cryptocurrencies.
Small-cap cryptocurrencies are often extremely volatile and considered a highly risky investment, albeit sometimes with a lot of potential (short-term) growth.
Here are the top cryptocurrencies by market cap in the world as of 21 Feb 2021, according to coinmarketcap.com (Conway, 2021):
1. Bitcoin (1.069T)
2. Ethereum (225.74B)
3. Binance Coin (43.94B)
4. Polkadot (36.18B)
5. Cardano (35.61B)
Algorithms (proof of stake/ proof of work)
In 2021, Ethereum plans to change its consensus algorithm from proof-of-work to proof-of-stake. This move will allow Ethereum's network to run itself with far less energy as well as improved transaction speed. Proof-of-stake allows network participants to “stake” their ether to the network. This process helps to secure the network and process the transactions that occur. Those who do this are rewarded either similar to an interest account. This is an alternative to Bitcoin’s proof-of-work mechanism where miners are rewarded more Bitcoin for processing transactions.
Transaction times (transactions per second)
There are two general criteria in analysing transaction speeds for a given cryptocurrency. One is the time it takes to get from one wallet to the other — the confirmation time. And the other is the amount of transactions per second (tps), which is a key figure in determining the scalability of a particular cryptocurrency.
The time it takes to complete a cryptocurrency transaction depends on two primary factors: the blockchain fee and the current load on the blockchain network. Proof of Work requires miners to solve complicated equations before the transaction is accepted. Each block of transaction takes around 10 minutes to process. If a user wants to ensure their transaction is added, they may pay the miner an additional fee. A sudden inflow of new users would cause congestion, increasing transaction times and costs.
Transaction time matters because it represents the amount of time taken for a transaction to be confirmed. Because current transaction times are too slow (Bitcoin’s tps is less than 1% of the tps of Visa), Bitcoin cannot be used to process quick transactions required in our daily lives. Moreover, it is difficult to scale up the use of cryptocurrencies with the existing technology as the transaction times decrease as traffic increases.
A Simple Explanation
There are ample explanations of how cryptocurrencies work, as well as criticisms of the same. The genius behind them is also the source of much distrust. As a revolutionary alternative to fiat money, they’ve caused quite a stir. India is due to pass a bill that regulates them, an action that has already been taken by countries such as China, Iran, Nigeria, Canada and Bolivia among others. The issue with country backed cryptocurrencies is that they cannot enjoy the same reputation that decentralised ones like Bitcoin can.
So if it cannot be backed by a government’s reputation or by a standard such as gold, what is the origin of their value? To put it simply, it is backed by the cost of mining it. For example, the value of Bitcoin is proportional to the amount of energy required to mine it. According to the Labour theory of value, labour (in this case energy) is the source of value. This does not hold true for Bitcoin as it is the price that determines the cost. A person who is mining Bitcoin would only do so if the value of Bitcoin (say $100) is higher than the cost of energy to mine it. Since the algorithm adds one new block to the blockchain at the average rate of one every 10 minutes. The level of mining difficulty is concurrently adjusted to ensure a constant rate of block production; this would mean that since the market cost (of energy or electricity) is lower than the market value of the Bitcoin, mining would never stop. (Granot, 2019)
This logic is applied by countries who wish to create their own cryptocurrencies. It provides a way to evade sanctions and aids in reducing printing costs while providing access to the digital economy without having to depend on a currency outside of their control. While we may not know if cryptocurrencies will evolve as independent sources of money or if countries will float their own versions, one thing remains clear: those who wish to regulate the same cannot simply wish it away.
References
Raju, V., 2020. Economic Dimensions of Blockchain Technology: In the Context of Extention of Cryptocurrencies. International Journal of Psychosocial Rehabilitation, 24(2), pp.29-39.
Granot, E., 2019. On the Origin of the Value of Cryptocurrencies. Blockchain and Cryptocurrencies,.
Nicolas Vega, 2021. Bitcoin passed $50,000—here’s what you need to know about the popular cryptocurrency
Gertrude Chavez-Dreyfuss, 2021, Cryptocurrency Ethereum hits record high, lifted by bitcoin, institutional demand
Kelvin, Helms, 2021, Canada Has Approved Two Bitcoin ETFs — First One Starts Trading Today
Katje, Chris 2021, Tesla may have already made more in profits from Bitcoin than Electronic Vehicles.
Luke Conway, 2021, The 10 Most Important Cryptocurrencies other than Bitcoin
Bitpanda Academy, What is Market Cap and Why does it matter?
Medium.com, 2018, Understanding Cryptocurrency Transaction Speeds
Oleg Strelenko, 2018, Blockchain and Transaction Speed: Why Does it Matter?
Acheson, N., 2021. Bitcoin Is a Hedge Against Inflation, but It's Also a Hedge Against 'Crazy' - CoinDesk. [online] CoinDesk. Available at: <https://www.coindesk.com/bitcoin-hedge-inflation-crazy> [Accessed 8 March 2021].