Bitcoin, a form of cryptocurrency that is slowly becoming mainstream, may turn out to be a generational investment with an eventual value far above even today’s lofty highs. But the road to that future may be so volatile that it could trigger a financial panic.
The more people invest in it through banks and investment houses, the more its importance grows. Its risks are also increasing cause for concern, and its endgame will be important. Soon, bitcoin will take another step toward that endgame. The key is whether enough governments, companies, and individuals trust that a string of computer code can protect them against financial disaster.
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What is bitcoin’s endgame? The question grows more pertinent due to a planned “halving” of the cryptocurrency this month. It comes down to a matter of trust, as with other matters around valuing currencies.
“Bitcoin is money insurance … backup money that people, companies, [and] governments will always want to keep a little bit of,” says Omid Malekan, a Columbia Business School professor.
As long as the price of bitcoin doubles, its “miners” will continue to earn a profit. In the future, miners will become increasingly reliant on fees paid by those who buy and sell bitcoin. On Monday afternoon, bitcoin was trading $71,800, not far from its all-time high.
Investors realize bitcoin is risky, but so are stocks and even the U.S. dollar when inflation is high, says Scott Baker, a finance professor at Northwestern University. “This is a hedge against some of those risks.”
It’s hotter than the hottest Big Tech companies. It’s more volatile than the stock market.
The world’s best-known digital currency – bitcoin – could either permanently eclipse all of today’s government-issued money or sink into oblivion.
Amid great debate over bitcoin’s endgame, a middle ground is emerging. As bitcoin takes its first steps into Wall Street’s mainstream and undergoes an important valuation step known as a “halving,” the cryptocurrency is potentially becoming an important hedge against financial disaster. Paradoxically, the more it goes mainstream, the more risk it poses for the larger financial system if things go really wrong.
Why We Wrote This
A story focused on
What is bitcoin’s endgame? The question grows more pertinent due to a planned “halving” of the cryptocurrency this month. It comes down to a matter of trust, as with other matters around valuing currencies.
The key to its sustainability is whether enough governments, companies, and individuals will put their long-term trust in a string of computer code.
“Bitcoin is money insurance … backup money that people, companies, [and] governments will always want to keep a little bit of,” says Omid Malekan, a Columbia Business School professor and author of “Re-Architecting Trust,” a book on cryptocurrencies. How much people value that insurance depends on how chaotic they think things will become.
Trusting in the value of computer code isn’t as crazy as it sounds. Gold, paper money, and Picasso paintings all hold value because people decided they’re worth something.
But bitcoin differs from traditional stores of value such as gold or silver because it also operates as a decentralized ledger, whereby each transaction is independently verifiable by all users in the network. It can bypass trusted intermediaries, like banks.
Another selling point: Its total supply will be limited to 21 million coins. That means there’s little danger that a government will step in, create more bitcoin, and stoke inflation. That total won’t be reached for another century, around 2141. Bitcoin are created through a process known as mining, whereby supercomputers solve extremely complicated computational problems to verify other transactions on the bitcoin chain. That total supply of 21 million coins may seem like a lot, but big computer operations that “mine” bitcoin have already created more than 19.6 million digital coins.
Bitcoin’s endgame should become apparent long before 2100. This is where the trust in the digital currency begins to get tricky.
The reason it will take so long to mine the remaining bitcoin is the halving, which happens about every four years. In a few days, around April 17, the bitcoin miners who validate each new block of transactions will receive 3.125 bitcoin per block, down from the 6.25 bitcoin they currently receive. That’s the opposite of inflationary. On its surface, it’s deflationary, meaning the miners will receive less for the same amount of work.
As long as the price of bitcoin doubles, halving is not a problem. The increase in value will continue to earn them a profit. Computer power and energy are costly to validate the chain of transaction blocks (known as the blockchain).
But at some point, miners will have to rely on transaction fees rather than new bitcoin for most of their revenues. Lyn Alden, an independent investment strategist who has studied the issue, estimates it will take several more halvings before that happens.
The timing is hard to pin down, she explains in an email, so that those revenues could be highly variable. The bitcoin system can process 120 million to 150 million transactions a year. If the average transaction is $10, miners could make up to $1.5 billion a year, she points out. If, in the end, fees average 1% of the transaction amount and transactions average $100,000, miners’ total annual revenues would potentially rise as high as $150 billion.
All this will depend on how much bitcoin is worth and how much it changes hands in a year.
The history is encouraging to bitcoin enthusiasts. At its first halving in 2012, three years after its inception, bitcoin was worth $12.35. At its second halving in 2016, it was $650; at its third, $8,821. Approaching its fourth halving, it was trading on Monday afternoon at $71,800, not far from its all-time high.
But past performance is no guarantee of future gains. And these gains mask bitcoin’s extreme volatility. A year after reaching its last peak, it lost three-quarters of its value in what became known as the crypto winter. Few analysts expect this volatility to abate going forward.
Should the rewards of mining fall below its costs for a significant period, miners will no longer mine, the blockchain won’t be validated, and the system’s vulnerability to manipulation will rise. Such downturns have triggered big business scandals in the past, from the bankruptcy of bitcoin exchange Mt. Gox in 2014 to the fraudulent FTX cryptocurrency exchange, which has led to several business and bank failures.
Such cryptocurrency earthquakes have had limited impact on the traditional finance world so far. “The crypto-asset world has had few links with and provided few services to the real economy, none of them vital,” the European Systemic Risk Board reported last year.
But as those links grow, so do the dangers for the financial system, warns Hilary Allen, a law professor at American University. She says that bitcoin is backed by nothing but faith, like a Ponzi scheme. “All you really own is a computer file, which may or may not have value depending on whether someone wants it from you,’’ she says. “[But] the longer it sticks around, the more intertwined it is going to become with our more traditional financial system.”
In January, Wall Street firms began offering retail investors access to bitcoin via exchange-traded funds. They’ve already attracted nearly $30 billion in investments despite warnings from high-profile skeptics that they are inherently risky. Now, major Chinese asset managers are pushing to open their own bitcoin ETFs.
There are other technical challenges to bitcoin, such as the hard limit on the number of transactions, says Robert Murphy, chief economist for Infineo, a tech company aiming to transform life insurance through blockchain and artificial intelligence. He says gold, which is trading at record highs, offers the more likely path to a stable currency not issued by a government.
So far, the evidence suggests that most investors are not buying into either extreme of bitcoin believers or detractors. A recent study of cryptocurrency investors for the National Bureau of Economic Research found that they come from all income levels and, for the most part, resemble traditional investors.
They realize bitcoin is risky, but so are stocks and even the U.S. dollar when inflation is high, says Scott Baker, a finance professor at Northwestern University and co-author of the study. “So this is a hedge against some of those risks.”