updated June 07, 2022
6 minutes of reading
Reading: Is bitcoin a bubble
Bitcoin is now up 40% just a year ago, and other cryptocurrencies have seen price increases of up to 18,000%. But is it a golden opportunity, or a bubble in imminent danger of collapsing? Is it worth the environmental cost of cryptocurrencies? article by nick green.
when you walk into a bitcoin mining factory, the size of an ikea superstore, packed with gleaming banks of computers stretching as far as the eye can see, pumping out heat, roaring like a jet plane, you’d be forgiven for wondering if the world has lost its mind. just one of these giant sheds can house more than 20,000 mining ‘rigs’, each of which is a computer many times more powerful than a good laptop, and one factory in iceland alone consumes more energy than all the homes in that country together. Collectively, bitcoin uses more electricity than the Netherlands or Argentina, and that’s before taking into account the hundreds (actually thousands) of other cryptocurrencies out there.
what is it about? The basic principle of cryptocurrency is simpler than many people think. it is the same basic premise as buying gold. Gold has long been used as money for two key reasons: it is rare and very difficult to counterfeit. this makes it a reliable display of value. the same applies to cryptocurrencies: they are “mined” by solving complex sums that only large computers can handle (see above). so when you have a coin, you and the whole world know it’s real. counterfeiting such a coin would be pointless, since it would cost you as much as the real coin (and would indeed be the real coin).
so the idea of cryptocurrencies as usable money is absolutely sound. it’s digital gold. the problem is that people not only use cryptocurrencies as ordinary money, but as an investment. In its early days, bitcoin’s value would rise by hundreds of percentage points in just a few months, followed by equally steep declines. the pandemic announced one of its strongest increases, more than 200% over the course of 2020, to reach a record price. meanwhile, some younger cryptocurrencies, such as ethereum and dogecoin, currently offer returns of up to 18,000%.
In the face of these surreal growth figures, many people have become evangelical converts to the cause of bitcoin (there’s even a name for them, bitcoiners, with ‘nocoiners’ being the derogatory term for those who don’t believe the hype) . who wouldn’t want an investment that can multiply their money exponentially? the problem is that investments just don’t do that. bubbles do.
The fact that all cryptocurrencies are just a bubble is probably their worst kept secret. the money that fuels the massive price increases comes solely from other investors who pour their capital into it, hoping to ride the surge. The name of such a phenomenon, where the investors’ money only generates the returns, is a ponzi scheme. cryptocurrency investing may be a voluntary version of one, but otherwise the description fits very well.
As Bank of England Governor Andrew Bailey recently said, “[cryptocurrencies] have no intrinsic value… only buy them if you’re prepared to lose all your money.”
the high cost of betting on cryptocurrencies
one of the many investors who have learned this lesson the hard way is craig e of lincolnshire. Unable to afford the high-priced Bitcoin, Craig invested several thousand pounds in the reassuringly named cryptocurrency surefire moon. Despite some slightly different rules meant to reward those who hold the coins longer, safemoon is ultimately no different than any other cryptocurrency in terms of price volatility. however, its current low price—just a fraction of a fraction of a dollar—may tempt many investors to think of it as a low-risk investment. Buying something that costs much less than a penny can seem like it’s okay. but of course people don’t just buy one.
Craig’s purchases worked well at first, so he increased his holding to £4,000 (borrowing from his credit card), only to see the price of the sure moon plummet. he made him lose nearly £3,000 and put him in debt. After this revelation, he quickly understood how the coin generated returns for him. he encourages investors to invite other people to invest, which drives up the price. but then, when the previous investors sell their coins, the price falls again, leaving the new investors without money. “It almost feels like a ponzi scheme,” admits Craig. “I should have known better than to risk money I didn’t have, and I should have been more cautious.”
craig blames himself in part for choosing a minor cryptocurrency, but the fact is that this type of loss can happen with any cryptocurrency, including major ones like bitcoin and ethereum. The price of Ethereum hit an all-time high recently, while Dogecoin, a currency founded as a joke, has attracted real interest due to the endorsement of Elon Musk, who announced that his company would accept payments in it.
The skyrocketing prices of all these cryptocurrencies mean that the combined value of the cryptocurrency market is now over $2.5 trillion, or nearly double that of amazon. and yet none of these currencies actually produce anything, nor are they attached to any tangible assets. all that value stems from one thing: investors’ belief that the price will go even higher. and this is backed up by little more than hype and evocative brand names.
The bitcoin frenzy is such that even major banks are falling for it. Goldman Sachs, which burned down in 2018 when it set up its bitcoin desk just before a big price crash, has reinstated the desk to trade bitcoin-linked derivatives. With bitcoin soaring today, this must have been a tough move to resist, but history will most likely repeat itself. even the bank of england is considering issuing a central cryptocurrency, called, with crushing inevitability, ‘britcoin,’ and has discussed with other central banks the economic merits of digital currencies.
There are strong arguments for digital currencies to gradually replace traditional ones. But when they’re seen as a means of generating wealth out of thin air (or rather, from terawatts of electricity and hundreds of tons of computers), there’s all the more reason to be skeptical.
is bitcoin worth it?
can you get rich investing in cryptocurrencies? absolutely, just like you can get rich playing in a casino or betting on horses. the principle is the same: you only make money because other people, in other places, are paying for it. in the case of cryptocurrencies, that person may simply be you in the future. it is still a zero sum game. It also seems to be a very specialized game, at least for the moment. a 2020 survey of us adults found that only 4% considered themselves “somewhat likely” or “very likely” to buy a cryptocurrency in the next year. and it is estimated that less than 2% of the world population currently owns any cryptocurrency.
That’s a soberingly small number, considering the sheer scale of resources and capital being invested in cryptocurrencies. the effort required to mine coins increases over time, as the sums become more difficult and the computing power required to crack them spirals higher and higher. processors, hard drives and graphics cards, all key tools in cryptocurrency factories, have been in short supply as demand outstrips supply. The total computing power on the bitcoin network alone is now around ten times that of the world’s 500 largest supercomputers combined. That kind of computing power could offer myriad practical benefits, from scientific research to fighting climate change, but instead it’s being used to mine bitcoin. many respected commentators still claim it’s worth the cost, and for a lucky few it may well be. but no one really knows what will happen if (when?) the bubble finally bursts.
You will find it difficult to find a financial advisor who is willing to advise you on cryptocurrencies, and even then their advice will probably be: “if you do, you are on your own”. Still, with some banks considering trading bitcoin derivatives, there may be a case for the higher-risk portion of a well-balanced portfolio to include some form of crypto, such as wild cards. Talk to your financial advisor about this, so you are absolutely clear on the risks versus potential benefits.
If you found this article useful, you may also find our cryptocurrency tax guide and informative nfts article!
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