A discerning observer of global events will readily recognize an increasing demand for an open and more transparent monetary infrastructure. In fact, several factors show that such a shift is already underway in modern society.
National currencies are no longer ‘sound money’
Over the past few years, events in countries where inflation is spinning out of control have revealed more clearly than ever just how volatile the value of money issued by centralized, governmental authorities can be. For example, as reported by The Economist in early 2018, the bolívar – Venezuela’s national currency – lost 99.9% of its value in just two years. The Turkish lira has experienced similar problems in the past and much indicates it may face another currency crisis in the future.
Such examples may seem extreme. Still, the fact of the matter is that the use of fractional-reserve banking is so widespread that, even though few national currencies may face the same fate as the bolívar, constant inflation is the rule rather than the exception in the economies based on fiat currencies.
A world where banking is for everybody
When new customers sign up for banking services, they are thoroughly screened to ensure they comply with the bank’s requirements. If a customer does not meet these standards, they may not be eligible to obtain a certain financial service. At times, a customer may be turned away even if he or she has a good credit score simply because he or she may not be considered “good business”.
The consequences of such a system are often dramatic. With no access to banking services they need, a person may have trouble finding a job, have limited housing opportunities, and be precluded from fully participating in the society.
With bitcoin and cryptocurrencies, there are no limitations as to who can participate as the entry barriers are extremely low. In fact, a prospective crypto user will only need to download and install a simple application on his or her device. That’s all it takes to be able to use cryptocurrencies.
A borderless payment method and assets that can’t be confiscated
Anyone who has ever tried to wire money across continents using standard banking means knows how cumbersome that process is. Additional fees may at times apply; it can take several days to process the transaction and there may be an additional clearance time on both ends.
The reason for these hurdles is that payments must go through one or more intermediaries before they reach their destination. However, with bitcoin or other cryptocurrencies, you can carry out transactions with no intermediaries whatsoever. More importantly, your funds are never at risk of being frozen, charged with additional fees, or seized. Such negative ‘user-experiences’ simply do not exist in the crypto world. This advantage cannot be overstated as cryptocurrencies are the first medium in the world that offers this particular value proposition.
The Design of Bitcoin and Cryptocurrencies
The key to bitcoin’s success lies in its technological design. Two noteworthy features that make this payment method unique are that the bitcoin network works autonomously while also following rigid mathematical rules.
No One Party Can Govern the Network
With the help of a sophisticated algorithm, the bitcoin network autonomously rewards participating computers for being part of the network. In other words, there is a built-in incentive for participating. Once you are part of the network, the amount of computational power you provide will at the same time give you influence over the decision-making process within the network. This results in a unique governance structure where:
- everybody is able to participate, and
- participation grants influence.
This is often referred to as ‘decentralized’ governance, meaning that there is no central entity that controls or holds power over other participants or the network as a whole.
Predictable Distribution and Maximum Supply
Secondly, the supply of bitcoins that are being released into the network follows a mathematical pattern, which allows to predict both the maximum supply (the total number of bitcoins that will eventually exist) as well as the current distribution (the number of bitcoins that are currently in circulation). Such predictability and the finite number of available bitcoins mean that in the long-term, the price of bitcoin can be expected to rise as a result of increased demand.
This is a significant improvement in comparison to how the fiat currency system works. Today, central authorities are able to increase the total supply of money available in an economy. It can happen at any given moment and in a politically motivated manner. This, in turn, can lead to unpredictable fluctuations of any national currency’s value over time.
Bitcoins Are Programmable
Bitcoin, in its essence, is a piece of software. As a natural consequence, this creates possibilities for the development of applications that can interact with it. Other payment gateways have also offered such possibilities in the past but what sets bitcoin apart is no reliance on any third party.
This introduces a new paradigm for how we – now and in the future – perceive money and monetary transactions; a paradigm that allows for open and trustless communication directly with the “money” rather than with the trusted third parties we use today.
Early Stages of Adoption
Since its inception, bitcoin has experienced multiple waves of adoption where large numbers of new people started using the cryptocurrency. Interestingly enough, the adoption of bitcoin has been spearheaded mainly by retail investors and not institutions – as it is usually the case with other investment schemes.
The Waves of Adoption
The idea that led to the creation of Bitcoin was originally conceived in a community of technologists and cryptographers. It is no surprise, then, that the first wave of people who adopted the currency were tech-savvy individuals with an interest in cryptography.
The next wave of adopters came in 2011 when bitcoin became tradeable on liquid crypto exchanges. Listed on a tradeable exchange, bitcoin was now much more accessible and could be bought without direct contact with a seller. This opened up the speculative potential of bitcoin because price discovery would now happen in real-time.
Fast forward to 2013, the price of bitcoin had climbed from $10 to about $1200. It was an astonishing price increase that sparked worldwide news coverage and attracted many more individual investors.
The third wave came in 2017 when prices started to increase rapidly again. The immense number of new people joining the ecosystem in 2017 caused cryptocurrency prices to explode across the board and the entire market capitalization combined went from 17 billion to 795 billion.
In hindsight, it is obvious that these numbers were unsustainable. The adoption of bitcoin and other cryptocurrencies seems to be driven by their boom and bust price cycles. Every time a new bull market starts unfolding and prices begin to rise, there is a large number of new investors who join the markets. Research on the subject has shown that most investors in the cryptocurrency markets are retail investors.
This fact deserves careful consideration. In the established markets (e.g., stock markets), institutional investors are estimated to make up more than 90 percent of the overall trading volume, and yet, here is a market that seems to be dominated by retail investors. In other words, a limited number of institutions have been willing or able to get on board so far.
The reason is obviously not that institutions don’t want to participate in the crypto market. After all, who wouldn’t be interested in joining a market economy that can go up 4,500 percent in one year?
Rather, institutional players have not been able to participate in the cryptocurrency market because, up until now, these markets have not been regulated to a degree that could make it possible for them to participate. In other words, they were left to watch the plane take off in 2017 before they could secure a seat.
This particular point is extraordinarily interesting because it leaves open the possibility that institutional players will seek to enter these markets once they have the opportunity to do so. Given the amount of work that is currently being put into developing regulatory frameworks for this new economy, we project that the time when institutions have not been able to participate in crypto markets is coming to an end.
An important benchmark to follow is the size of the bitcoin economy. As an economy, bitcoin used to be too small for sustained measurement. However, as of the second half of 2018, Bitcoin now represents about one percent of the size of the gold market. Needless to say, bitcoin is by no means insignificant anymore but there is still plenty of room for growth.
A Must-Have in Every Diversified Investment Portfolio
It takes no more than a single glance at the BITCOIN to USD conversion chart to realize that, despite severe drawdowns along the way, bitcoin has probably been one of the best-performing financial instruments in the last 10 years. Of course, as we have covered briefly in the previous section, bitcoin’s performance metrics must be taken with a grain of salt – after all, the cryptocurrency was trading at close to no value at all in the very early days. However, even with the price action in more recent years taken into account, it is still clear that bitcoin really is an ‘animal’ of its own. For example, at the end of 2017, the value of bitcoin was 2000 percent higher than in the beginning of that year. This is quite a remarkable performance that seems to have caused a great deal of confusion among renowned investors and economists worldwide. This is not only because they struggle with the characteristics of bitcoin as an asset class, but also because very few of them have been able to understand the performance of this beast called bitcoin. While we definitely acknowledge that its performance 12 has been nothing short of astonishing, we also agree with an argument repeated ad nauseam by bitcoin critics: that it is too volatile for the average investor to handle. The above chart illustrates this exact point: how well Bitcoin has performed in the long run, and how severe the drawdowns it has produced along the way really were. A look towards the upper part of the chart reveals the trajectory bitcoin’s price has been drawing since 2011. The highlighted parts of the chart display periods of extreme downward movement, showing drawdowns close to 90 percent three times since 2011. The volatility argument is, however, easy to counter. In a report published by Deloitte (2017), it was estimated that by the year 2025, the daily volatility of bitcoin would have smoothed out to match that of the U.S. Dollar. That said, 2025 is far away – especially in terms of the development of cryptocurrency markets – and for that reason, it is still strongly recommended that investors use caution when trading in these markets. Unless you know what you are doing, high volatility and asset security are critical issues that can potentially obliterate the profits made on investments in these instruments. These two issues are, therefore, among the core value propositions of ARK36, which specializes in the management of investment portfolios containing cryptocurrency.