Bitcoin, the world’s largest digital currency, topped $59,000 this week, surprising finance professionals who had dismissed it as a fad.
Bitcoin’s value has quintupled in the last year alone. On Feb. 16, 2020, it was trading at just under $10,000. By Feb. 21, it had surpassed $57,000 before falling back below $50,000 on Feb 23.
So what’s driving the market? We asked experts including Zack Seward, managing editor of CoinDesk which chronicles digital currencies; Mauro Guillen, professor of International Management at the Wharton School at Penn, and Michelle Lowry, TD Bank Professor of Finance at the LeBow School of Business at Drexel University. Here are their answers.
What is bitcoin?
Bitcoin is a virtual currency, created a dozen years ago as an alternative to government-issued “medium of exchange” that we know as cash. It has a similar function as a “store of value” like gold. But unlike the precious metal, you can’t hold bitcoin or fashion it into jewelry. It exists only as an electronic file. Transactions are recorded on a distributed and decentralized ledger. So if you lose your bitcoin’s web address, it’s gone for good. No governments regulate it.
Bitcoin can be used to buy many things pseudonymously, from Tesla cars to illegal items on the Dark Web. And unlike the greenback, only a limited amount exists.
How do you buy bitcoin or another cryptocurrency?
The easiest way to buy cryptocurrency is through a centralized exchange, such as Coinbase, Binance, or Cashapp. Each charges a small fee per transaction and usually will accept credit cards for payment. There are also bitcoin ATMs scattered through the region that will accept cash for bitcoin.
What’s the downside of cryptocurrencies?
There are a lot of negatives to consider before buying digital currencies. If you want to use them to actually buy something, bitcoin, Lowry points out, has very long processing times. “It can take up to 10 minutes for a transaction. Other mainstream platforms — credit cards, Venmo and Paypal — take seconds.
Fundamentally, speculating on anything is a gamble. Bitcoin is the darling of the crypto world now, but even if it gets more widespread adoption “it’s never been clear if bitcoin will remain the dominant player here,” Lowry said.
“If you’re interested and want to invest a small portion of your portfolio in crypto to diversify, that should be fine,” Lowry said. “But know it’s extremely volatile. Bitcoin has risen a lot over this past year, but know that what happens next may not mirror the same price pattern. Be cautious. There may be parallels between this and the internet bubble.”
Why is the price of bitcoin rocketing?
The surge in bitcoin’s price has been triggered by “a broader worldview shift,” said Seward, of Coindesk, the leading news site specializing in cryptocurrency news.
“Big companies increasingly see it as a legitimate store of value,” Seward said.
Elon Musk, the mega-billionaire CEO of Tesla, recently bought $1.5 billion of bitcoin and said his company will accept it as payment for its electric cars. Mastercard this month announced it would support selected cryptocurrencies in its payment network. Apple Pay last week said it would allow bitcoin to be spent online, in retail stores and on apps. BNY Mellon last week said it would hold bitcoin and other cryptocurrencies for its clients.
Is there a precedent for bitcoin’s spike?
In 2017, the price of bitcoin saw a similar run-up when within the year speculators drove bitcoin from about $1,200 to its then-high of $19,783. The “great crypto crash’ followed with its value tumbling 80%. It languished under $10,000 until the summer of 2020, when bitcoin began to regain strength, fueled by concerns about the federal stimulus program and fears of inflation.
“This rally is very different from 2017 in that this is very much driven by institution adoption,” Seward said. “Look at MassMutual, a huge old-timey insurance company that bought $100 million of bitcoin in December. The real pioneers are MicroStrategy, a publicly traded firm, whose CEO, Michael Saylor, has bet really big on bitcoin as a treasury asset. They have something like $3 billion of it.”
“Now you have big institutional investors and retail investors now hearing about this this,” said Lowry, “and you have a bit of FOMO going on, fear of missing out.”
But the recent history of bitcoin should also serve as a warning, Lowry said.
An academic paper in the Journal of Finance concluded that half of the price rise of bitcoin in 2017 was linked to manipulation, Lowry said. “And that should be enough to make everybody pause right now.”
Are there other causes for bitcoin’s rise?
Guillen said the fascination in the cryptocurrency also is being driven by interest rates.
“A lot of people are sitting on a lot of cash and they’re getting low returns in their other assets,” Guillen said. “There’s a lot of liquidity and very, very low interest rates. That’s contributed to the demand for it.”
Unlike U.S. currency, which the federal government can print in unlimited amounts, the amount of bitcoin is constrained.
“We’ve got a lot more money printing going on by the government and that raises the risk of inflation,” Lowry said. “What you do as an institutional investor is protect against it. That makes cryptocurrency a natural strategy. It has essentially zero correlation with any other financial asset, so it’s a valuable source of diversification.”
Are there alternatives to bitcoin?
Bitcoin is far from the only cryptocurrency. There are literally thousands of them. Bitcoin, however, is the best capitalized, with a current market cap of $925 billion. Among the other popular virtual currencies are ether, litecoin, and monero.
Ether, in particular, has also seen a huge surge in its price, from about $260 last February to an all-time high of nearly $1,800 this week. Lowry points out that ether also can be used by businesses to execute contracts.
Some cryptocurrencies are extremely limited in their business applications. One that circulated a few years ago, could be used only to make payments to dentists.
“Each coin has its own following,” said Seward. “Bitcoin maximalists, for example, believe in bitcoin and only bitcoin.”
What is dogecoin?
Another cryptocurrency, dogecoin, was based on a popular meme. It was created in 2013 as a joke that made fun of the rise of cryptocurrencies. (Though it was trading for about a nickel per Dogecoin, its total market cap on Tuesday was a very real $6.6 billion.)
Dogecoin began its recent spike to a rich 8 cents on Feb. 4 after Elon Musk issued a series of cryptic tweets, cheekily calling it “the future currency of Earth.” Rapper Snoop Dogg and Kiss bassist Gene Simmons also chimed in and helped drive up the value. Dogecoin collapsed back to 5 cents after the celebrities stopped tweeting about it.
“Dogecoin is still a joke,” said Seward. “But the landscape has shifted so it’s no more of a joke than GameStop or AMC stocks. The world has caught up to the absurdity and surrealism of the cryptocurrency markets. It’s crazy.”