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Blogs

The Buzz About Bitcoin

Dave Donabedian, CFA

February 22, 2021

Bitcoin has received plenty of headline attention, yet it remains a mystery to experienced and casual investors alike.

Bitcoin appeared seemingly out of nowhere, 11 years ago, and has since become the fastest-growing, best-performing asset/currency in the world.[1] 

Let’s pull back the curtain and learn more about this phenomenon.

A brief history of Bitcoin

Bitcoin was launched in 2009 by a pseudonymous person or group named Satoshi Nakamoto as an electronic medium of exchange. In the beginning, it was used to make small, trial purchases on the online marketplace. One famous example was a software developer who used 10,000 bitcoins to purchase two pizzas in May 2010.

It didn’t take long before the first online cryptocurrency exchange opened in 2010, and traders began to speculate in Bitcoin soon after. Today there are more than 8,000 different cryptocurrencies,[2] but Bitcoin is by far the largest, with the total value of outstanding coins exceeding $800 billion.[3]

What is Bitcoin—And what’s the blockchain all about?

Bitcoin has become synonymous with cryptocurrency; it’s the standard by which all cryptocurrencies are measured. Bitcoin is best defined as a digital (virtual) currency, operating without government or bank involvement, for the purpose of transferring funds from one party to another. It doesn’t exist in physical form; there are no actual coins you can hold in your hand. Think of it as an anonymous method of exchange, via the internet, relying on decentralized but massive processing power for verification.

Is Bitcoin a full-fledged currency? No, but it’s getting there…
 

Characteristics of a currency

Characteristics of a currencySource: Federal Reserve Bank of St. Louis Review, First Quarter 2018; Strategas; CIBC Private Wealth.

There’s a fixed supply of Bitcoin—21 million, with 18.6 million currently in circulation.[4] Today, Bitcoin is primarily used for financial speculation or as a hedge against inflation (like gold, but much more volatile).

Every Bitcoin transaction is recorded in an electronic public ledger, or Bitcoin blockchain. A Bitcoin blockchain (each cryptocurrency has its own blockchain) is a type of digital database, which stores all Bitcoin transactions in a series of separate blocks. These blocks are chained together chronologically and spread across a vast network of thousands of computers operated by separate individuals or groups. All data entered on the blockchain is permanently recorded, irreversible, transparent and viewable by anyone.

Thus, the blockchain platform provides a complete, secure history, linking individuals and companies to Bitcoin purchases and ownership by allowing individual parties, called miners, to process payments and verify transactions. Once a coin is spent, it can’t be used again or counterfeited.[5]

Bull versus bear—Arguments for and against Bitcoin

Is Bitcoin here to stay? Or is it just another hyped-up mania—the latest version of the “tulip bubble?”

Bitcoin advocates say:

  • Bitcoin is digital “gold.” It’s a scarce asset with fixed supply, and the underlying blockchain technology helps cement it as a legitimate store of value.
  • Investment demand has accelerated for Bitcoin, greatly outstripping its limited supply.
  • Major companies—PayPal, J.P. Morgan, Tesla, BlackRock— have started using Bitcoin and/or blockchain, giving investors confidence for its long-term potential.
  • Outside the US, more countries are recognizing Bitcoin as a valid financial entity and are creating regulations for its use.
  • Bitcoin could be an effective hedge against the threat of runaway inflation and government debt when the global economy recovers.

Bitcoin skeptics argue:

  • Bitcoin is highly volatile and too unstable to be a reliable store of value. Bitcoin crashed six times between March and December in 2017, fell 83% in 2018, and surged to a record-high of $41,958 (from $8,000) in less than one month in early January 2021.[6]
  • Bitcoin has existed since 2009, and its usage is still limited. While blockchain technology is beneficial in helping institutions manage financial transfers, Bitcoin itself is not a widely accepted medium of exchange.
  • Unlike dollars, which are backed by the full faith and credit of the US government, Bitcoin isn’t backed by any established central authority.
  • Bitcoin is drawing the ire of environmentalists. Annual electricity use to mine new Bitcoin equals that of Chile, a nation of 20 million people. One Bitcoin transaction uses the same amount of power as 436,000 credit card transactions processed by Visa.[7]
  • The Bitcoin brand could be tarnished by its use in high-profile illegal activities, like ransomware attacks and money laundering.

Bitcoin as an investment

It’s legitimate to question whether Bitcoin will find acceptance as a mainstream currency, but its role in global payment systems is on the rise. That’s especially true as more financial transactions take place online, with no physical exchange of currency taking place. 

As an investment, Bitcoin is highly speculative, and CIBC Private Wealth doesn’t see that changing anytime soon. What is compelling, however, is blockchain technology, which has the potential to transform financial transactions, business and government operations, and other large-scale information storage needs.

We dive deeper into the investment possibilities—both good and bad—in our companion piece that will be released in the weeks ahead.

Dave Donabedian is chief investment officer of CIBC Private Wealth Management, serving in that capacity since 2009. His responsibilities include chairing the Asset Allocation Committee, as well as providing oversight of internal investment strategies and the external manager selection platform.

1.    https://finance.yahoo.com/news/cryptocurrencies-outlook-2021-best-performing-223028146.html
2.    https://www.coinmarketcap.com/all/views/all/
3.    Bloomberg, as of February 15, 2021
4.    Alpine Macro Report: The Crypto Mania: Is Bitcoin Money?
5.    https://www.investopedia.com/terms/b/blockchain.asp
6.    https://medium.com/illumination/what-is-bitcoin-and-what-it-isnt-f511243d2396
7.    https://www.ft.com/content/a9bd5b42-272e-465c-9284-9fe2a7906f48