Should You Invest in Bitcoin?

Is Bitcoin a good investment?

Bitcoin is the world’s most well-known cryptocurrency. Bitcoin's price fluctuations are now being widely reported in mainstream financial circles, increasing attention even further.

Bitcoin’s popularity hinges on its founding as the first decentralised cryptocurrency. Bitcoin is packed with advantageous traits, some of which are shared with other cryptocurrencies, like Ethereum, while some traits are attributable to Bitcoin’s market-leading status.

Bitcoin also has some important downsides that should give would-be investors and everyday users a reason to pause. Like the broader pros and cons of cryptocurrency, these Bitcoin-specific drawbacks — and advantages, to be sure — deserve careful consideration. Before we take a closer look, let’s cover some Bitcoin basics.

What Is Bitcoin?

Bitcoin is a cryptocurrency, a virtual currency designed to act as money and a form of payment outside the control of any one person, group, or entity, thus removing the need for third-party involvement in financial transactions.

How Does Bitcoin Work?

Computers (“nodes”) on the peer-to-peer Bitcoin network verify transactions through cryptography and record them in a public distributed ledger, called a blockchain, without central oversight. Consensus between nodes is achieved using an intensive computing process that follows set rules and is based on proof of work, called mining, which requires increasing quantities of electricity and guarantees the security of the Bitcoin blockchain. A tiny sum of Bitcoin is paid to ‘blockchain miners’ for verifying transactions.

How Old Is Bitcoin?

Bitcoin was introduced to the public in 2009 by an anonymous developer or group of developers using the name Satoshi Nakamoto. Its popularity has inspired the development of many other cryptocurrencies.

Bitcoin has some inherent weaknesses and risks that make it unsuitable for many investors and consumers. Many of its advantages are also weaknesses!

Advantages of Holding and Using Bitcoin

Bitcoin offers some distinct advantages both in relation to other cryptocurrencies and to fiat currencies. (Fiat money is a government-issued currency that is not backed by a physical commodity, such as gold or silver, but rather by the government that issued it. Most modern paper currencies are fiat currencies, including the New Zealand dollar, the British Pound, Euro, Australian dollar, US Dollar and most major global currencies).

Most of Bitcoin’s advantages relate to its decentralised nature, inherent anonymity, and independence from political and corporate influence.

Increasing Acceptance as a Payment Method

An increasing array of merchants accept Bitcoin payments, so it is now possible to buy virtually any physical item using Bitcoin. If you’re serious about reducing your exposure to fiat currencies, Bitcoin’s growing mainstream acceptance is likely to be a big help.

Ease of International Transactions, Lower Transaction Fees

Bitcoin transactions that cross international borders are no different from Bitcoin transactions that stay in-country. There aren’t any international transaction fees or red tape to navigate, as is often the case with credit card payments, ATM cash withdrawals, and international money transfers.

Bitcoin usually comes with lower transaction fees compared to other digital payment methods, such as credit cards and PayPal. Although such fees are variable, a recent estimate suggested Bitcoin transactions cost about 0.16% of the transaction value, which is the fee paid to the blockchain miners. Compare that to 2% to 3% for most other digital payments. With time, Bitcoin transaction costs are likely to drop even further.

Independence From Political Agents and Its Creators

Governments and authorities the world over love having their own national currency. Across nearly all the globe, currency zones correspond to that state's borders. Two exceptions are the Eurozone and the handful of tiny nations which use the US dollar. Even the poorest nations on earth nearly all issue their own currency. This is not a coincidence. Why? – control.

There is no natural law or sound economic theory that tells us that the world needs territorial currencies created by states.

Unlike money issued by governments, Bitcoin has no entral bank, no retail banks, and no physical notes.

Because Bitcoin isn’t created or controlled by any state entity, such as a central or reserve bank, it’s not subject to political influence and the power plays that can occur with sovereign currencies. Because Bitcoin exists outside any political system, it’s also much harder for governments to freeze or seize Bitcoin units, whether in the course of legitimate criminal investigations or as retribution for political acts, as often occurs in repressive states in which one-third of the total human population lives. This also means Bitcoin could be removed from the changes in fiat currency values that can occur based on regional strife such as wars and natural disasters, election outcomes or political events such as Brexit, and even troublesome activities such as Eurozone-infighting.

Due to its completely decentralised nature, popularity, and liquidity, Bitcoin is not tied to its creators. Many less popular cryptocurrencies are characterised by concentrated holdings — most existing units are held in a handful of accounts. This allows the currencies’ creators to manipulate supply and, to an extent, value relative to other cryptocurrencies, negatively impacting other holders.

Inflation Protection by In-Build Scarcity

Bitcoin’s built-in scarcity feature is likely to support its long-term value against traditional currencies, as well as non-scarce cryptocurrencies, a popular Bitcoin alternative. Bitcoin’s fans point out that this scarcity gives the currency intrinsic value — like gold and other precious metals.

In contrast, most traditional (fiat) currencies controlled by national governments are not scarce. Central banks can create new units of currency at will, and often do — for example, the U.S. Federal Reserve began a program of quantitative easing (“money printing”) that created trillions of dollars in the aftermath of the global financial crisis. Then, most governments, including the Reserve Bank of New Zealand, followed suit and did the same in response to Covid-19, and even at the time were widely criticised for it. Although the long-term impacts of such policies are unclear, these have been blamed for a range of issues including spiking house prices, inequality, inflation, and more. In fact, the purchasing power of the New Zealand Dollar has declined nearly 20 percent since March 2018 when Adrian Orr became the Governor of the Reserve Bank of New Zealand, according to its inflation calculator - a situation he describes as “terrible”. Situations such as this give added weight to the appeal of decentralised and scare currencies such as Bitcoin, and incidentally, may eventually undermine the credibility of the central banking system.

Diversification

Diversification is often called the only free lunch when it comes to investing.

Proponents of Bitcoin, and cryptocurrencies more broadly, point to the diversification benefits. This means investors are protected against declines in the value of other asset classes, like equities and bonds. Should the values of those assets drop, Bitcoin will hold up the overall value of an investment portfolio, and vice-versa.

Privacy, Perhaps

Holding New Zealand dollars or other fiat currencies in an online bank account or executing online credit card and PayPal transactions doesn’t protect your privacy any more than physically handing cash or a credit card across the shop counter. Although your online accounts are hopefully protected from all but the most sophisticated hackers, they’re clearly associated with you – meaning private merchants, your bank, credit card providers, and public authorities can track how you spend and receive your electronic funds.

By contrast, Bitcoin’s built-in privacy protections allow users to separate their Bitcoin accounts from their public personas if they so choose. Although it’s possible to track Bitcoin flows between users, it’s challenging to figure out who those users really are.

However, as all Bitcoin transactions are recorded on an open ledger they might not be quite as private as some people believe.   

Disadvantages of Holding and Using Bitcoin

Bitcoin has some inherent weaknesses and risks that make it unsuitable for many investors and consumers. In fact, many of the advantages explained in the paragraphs above are also weaknesses!

Decentralised currencies tend to attract unscrupulous actors who threaten — directly or indirectly — more honest participants, and Bitcoin’s price volatility is not for the faint of heart. Bitcoin also presents an ethical quandary for environmentalists due to its vast carbon footprint. Let’s explore these areas in detail.

No Intrinsic Value

Bitcoin and other cryptocurrencies have no intrinsic value, in that they generate no income (such as a rental property or dividend-paying share) and are only worth what someone is prepared to pay for them.

This means that it’s a stretch to call Bitcoin an investment. Of course, the same criticism can also be levelled at; fiat currencies, gold (which has limited practical use and is mostly stored in bunkers or worn as jewellery), artwork, and many other things too. In other words, a Bitcoin fan could refute this disadvantage by saying “well, if Bitcoin is worth nothing, give me yours for free” in the same way someone might say “if your New Zealand dollar is worth nothing, then give me yours for free”.

This area might be changing too, as it is possible for Bitcoin to generate income through lending in the same way that money saved in the bank can earn interest.

Black Market Activity May Undermine Bitcoin’s Reputation

Despite high-visibility prosecutions of some largescale offenders, Bitcoin remains attractive to criminals.

At least some of this is a perception issue: if you were a big-time criminal, would you want all your transactions openly displayed on a visible ledger? Even as far back as September 2015, the FBI Assistant General Counsel said “…investigators can follow the money…” regarding the strange new world of Bitcoin.

Still, if it is perceived that shady uses for Bitcoin outweigh legitimate uses by law-abiding citizens, then Bitcoin’s credibility could be undermined.

High Profile Failures

The cryptocurrency market faced a wave of high-profile failures in late 2022 which trickled into early 2024. The most notable collapse was FTX, a major exchange, which crumbled due to mismanagement and lack of oversight which resulted in the founder being jailed for 25 years. This triggered a domino effect, with other firms like Genesis Global Capital halting withdrawals while another major exchange, Binance, saw its founder and CEO plead guilty to US Federal money laundering charges. These failures have shaken investor confidence and highlighted the need for stricter regulations in the still-evolving cryptocurrency space.

Regulation

Bitcoin, and cryptocurrencies in general, challenge the financial status quo and show early signs of threatening to upend traditional power structures in banking and finance by decentralising payments and lending. The most profitable corporates in New Zealand and Australia are the big banks, and they won’t give this up without a fight and some significant lobbying – perhaps for anti-cryptocurrency regulation!

Slowly but surely, nation-states are predictably moving to crush unregulated crypto-threats to their currencies and payments and banking systems, often based on claims that cryptocurrencies are being used by criminals and terrorists as an anonymous medium of exchange. China banned cryptocurrencies in 2021 and Russia is proposing to follow suit. In total, at least 40 countries have explicitly or implicitly banned digital currencies.

What might further regulation look like? Well, up until the mid-1970’s it was a criminal offence for US citizens to own or trade gold anywhere in the world after it was compulsorily acquired by the US Government in the early 1930’s.

Bitcoin-Specific Scams, Fraud, Loss, and Risk of Theft

As the world’s most popular cryptocurrency, Bitcoin has seen more than its fair share of medium-specific scams, fraud, and attacks.

Bitcoin users are also vulnerable to smaller-scale theft, including scammers targeting individual users. One common type of Bitcoin theft is the unauthorised use of private keys. When stored in internet-connected Bitcoin exchanges or cloud storage drives, private keys can be hacked, stolen, and used to access and spend or transfer the key owners’ Bitcoin holdings — depriving them of the value stored within.

Some other cryptocurrencies don’t have the critical mass of users necessary to make such malfeasance profitable to criminals, and such activity is more likely to be prosecuted by law enforcement agencies when traditional currencies and payment platforms are involved.

Cryptocurrencies may be stored in places called vaults, but you can lose your password and never get access again or have your vault emptied by hackers. And if either happens, there is no regulator or supervisor to run to.

No Chargebacks or Refunds

One of Bitcoin’s biggest drawbacks is a lack of a standardised policy for chargebacks or refunds, as all credit card companies and traditional online payment processors have. Users affected by transaction fraud — for instance, they purchase goods that the seller never delivers — can’t request a refund through Bitcoin. In fact, Bitcoin’s decentralised structure makes it impossible for any single party to arbitrate disputes between users. While miners take responsibility for recording transactions, they’re not qualified to assess their legitimacy.

Some newer cryptocurrencies have rudimentary chargeback and refund functions, but this feature is yet to be built into Bitcoin.

Potential to Be Replaced by Superior Cryptocurrency

Bitcoin spawned a host of successor cryptocurrencies. Although many are structurally quite similar to Bitcoin, others — such as Ethereum — make notable improvements.

Some newer cryptocurrencies make it even harder to track money flows or identify users. Others use “smart contract” systems that hold service providers accountable for their promises. Some even have in-house exchanges that let users exchange cryptocurrency units directly for fiat currency units, eliminating third-party exchanges and reducing associated fraud risks.

Over time, one or more of these alternatives could take over from Bitcoin as the world’s dominant cryptocurrency. That could negatively impact Bitcoin’s value, leaving long-term users holding the bag.

Bitcoin’s Price Is Correlated

It was suggested cryptocurrencies were a powerful portfolio diversifier, protecting investors against declines in the value of other asset-classes, like equities and bonds.

In practice, cryptocurrencies have proven to be highly correlated both with one another and with listed equities, amplifying traditional portfolio risks rather than reducing them. Bitcoin's price has shown a strong correlation with the United States' major stock market indices, namely the S&P500 and NASDAQ Composite. For instance, this correlation led to a significant drop in Bitcoin's value, plummeting by 63% from its peak of US$68,991 in late 2021 to a low of US$25,424 by May 2022. This decline resulted in a decrease of US$800 billion in Bitcoin's market capitalisation, and worse, it occurred at the same time valuations of stock and bond markets fell. It then rebounded as stock markets recovered. Bitcoin amplified traditional investment portfolio risks, rather than reducing them. Diversification serves no point if all investment asset prices move in the same way.

Questionable Inflation Protection

A popular idea was that cryptocurrencies were a hedge against a bout of inflation. Yet in the worst bout of sustained inflation in 40 years, when inflation spiked starting around 2022, cryptocurrencies including Bitcoin failed to perform. Bitcoin and other cryptocurrency valuations were torched, along with the valuation of anything else that didn’t provide income.

If you were worried about inflation during this time, cryptocurrencies were about the worst possible place to hide.

Environmental Impact of Bitcoin Mining

Bitcoin mining consumes vast amounts of electricity. According to Business Insider, some of the biggest Bitcoin mining companies are based in China, where most power comes from coal power plants.

Believe it or not, there is more than a little debate over this, with some highly-educated people suggesting that over the long run, Bitcoin mining could positively impact renewable energy sources and provide a more reliable power grid.

Bitcoin Is Hardly a Payment Method

For all the promise of cryptocurrencies acting as a viable medium of exchange, we have yet to see its widespread take-up. 13 years after minting and trading Bitcoin began, cryptocurrencies have proven to be of limited practical use. This is partly due to scale.

Visa and Mastercard have vastly higher transaction processing capacities than Bitcoin. Visa, for instance, has the capability to process over 65,000 transactions per second, while Mastercard boasts a capacity of over 38,000 transactions per second. In contrast, Bitcoin can muster 6-12 transactions per second. These numbers illustrate the gulf in throughput between traditional payment networks and Bitcoin's blockchain, highlighting the scalability challenges faced by cryptocurrencies in comparison to established financial systems.

Scalable and trusted mediums of exchange normally require regulation and government guarantees (sovereign backing) and need to be intermediated by the government-backed banking system. This is even more important during times of crisis, as non-bank entities outside the banking system frequently fail during large shocks and recessions when they cannot rely on central bank liquidity and government guarantees to bail them out, as big banks can.

Volatility

Bitcoin is wildly volatile. That means its value changes so much and so regularly it is unsuitable for all but the most risk-tolerant investors and even then, probably only as a tiny portion of someone’s overall wealth. Sometimes the value of Bitcoin can spike or plunge just based on an online post from a celebrity!

Bitcoin's history as a store of value has been turbulent; it has undergone several boom-and-bust cycles over its relatively short lifespan.

These shifts in prices also mean it is impractical for use as a mainstream currency, though perhaps its price will stabilise over future years and eliminate this issue.  

The Bottom Line – Should You Invest in Bitcoin?

As the world’s most popular and widely used cryptocurrency, Bitcoin has some inherent advantages over competing coins and traditional “fiat” currencies. But it is probably very early days for cryptocurrencies, and Bitcoin has some glaring downsides as well.

As a current or would-be Bitcoin user, it’s up to you to decide whether the advantages of the world’s most popular crypto coin outweigh the downsides. There’s no “right” or “wrong” answer here, only the answer that works best for your investing objectives, values, and tolerance for risk.

There are several important technological innovations, such as blockchain, that have been developed as part of the cryptocurrency ecosystem. These innovations may endure and become immensely valuable over time.

One thing is for sure, the following reasons mean it will be fascinating to see what currencies and the global monetary system look like in another few decades:

• The long-term impacts of money printing (“quantitative easing”) include inflation which has devalued currencies
• A multi-decade trend of decreasing faith in governments across nearly all major countries, which may extend to reduced faith in government-backed fiat currencies
• Continued innovation with cryptocurrencies including Bitcoin
• Decentralised challenges to traditional financial players such as banks, brokers, and merchants
• Decentralised challenges to central banks and fiat currencies

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