Bitcoin’s popularity has reached a fever pitch in the past year and has come under unprecedented scrutiny given its astonishing rise in value. The cryptocurrency has become an overhyped concept with many people evangelising only the upsides of Bitcoin, viewing it as a phenomenon that has the potential to shape our financial future. Before arriving at a definite conclusion as to how beneficial Bitcoin is, I deem it useful to take a critical approach in examining Bitcoin both as a fintech innovation, and an investment asset, taking into account both the pros and cons.
Below I outline a few complications of Bitcoin from a fintech perspective.
Very slow production process
The cryptocurrency is tied to the blockchain which is based on a ledger-recording technology supported by users without central administration. Transactions are verified on a decentralised network of computers all over the world, which makes it difficult to manipulate.
The nature of blockchain technology however requires that some speed and resources be sacrificed, which makes the production process of Bitcoin very slow. Also, Bitcoin mining requires a lot of resources that can be summarised as 10,1 barrels of oil equivalent needed to produce one Bitcoin (Bitcoin consumes seven times more energy to produce each digital coin than it does for each gold oz.- 1,4 barrels oil equivalent needed, according to SRSrocco Report).
Slow transaction processing
Bitcoin transactions are by far slower in comparison to banks that deal with credit card transactions. Visa processes 150 million transactions per day, averaging out to roughly 1,700 transactions per second, whereas the Bitcoin network processes 7 transactions per second. This points to the fact that the potential of Bitcoin to work as an efficient payment system has fallen away somewhat as it cannot compete other mainstream payment systems.
Transactions take about 10 minutes to process and as the network of Bitcoin users grows, waiting times will increase, because there are more transactions to process without a change in the underlying technology that processes them.
Increasing the speed of the transaction verification process can be done by employing two major solutions: either to make the amount of data that need to be verified in each block smaller, making transactions faster and cheaper; or to make the blocks of data bigger, so that more information can be processed at one time. But it is hardly possible for the decentralised system to be able to solve this problem.
Bitcoin supply is limited
In fact, only 21 million Bitcoins can be mined in total. This means that the supply of Bitcoin is limited and is going to end in the near future, unless Bitcoin’s protocol is changed to allow for a larger supply. The current supply is around 16 million or above. So what will be the benefit of keeping all this bitcoin miner farms consuming large amounts of energy just to support the protocol? Bitcoin is widely known for transaction costs that are close to zero; interestingly, these costs cannot substantially sustain the Bitcoin network. Increasing transaction fees is not a viable solution of course because this is not what people expect at all.
Having taken a close look at some key technical characteristics of Bitcoin, let’s explore a few other important aspects of Bitcoin that every crypto investor should be aware of:
Bitcoin is volatile
Undoubtedly, 2017 was the year Bitcoin marked its highest increase in price, moving from $1,000 to just under $20,000 before dropping down to around $13,000 at the end of the year. Financial experts collectively agree that Bitcoin is subject to abrupt price movements within short time. Most probably cryptocurrencies will lose some of that volatility in the course of time, however, building a diversified portfolio and following a solid risk management plan might be the ideal option for those seeking exposure to cryptocurrencies.
Bitcoin’s popularity has heightened exponentially, as the cryptocurrency continues to go mainstream. However, in the light of Bitcoin’s popularity and market cap that has impacted fiat currency valuations, many governments have taken drastic measures including putting outright bans on Bitcoin trading. In general, the potential of cryptocurrencies and the technology behind it is still not fully understood by global regulators, which may be the reason why some governments have not yet addressed what regulation applies to Bitcoin’s use.
Psychological background of pricing
It is false to consider that Bitcoin will keep growing in value forever. Being a relatively new market, with no proven mechanism to predict how it will act in the future, investors should be cautious as it is subject to factors that are difficult to control including, adoption rates, negative press, political uncertainty and regulatory stance. As with any uncertain speculation, a good rule to follow is to only invest what you can afford to lose.
All in all, Bitcoin has captured the attention of financial speculators and has established itself as an alternative investment to fiat currencies. The demand for Bitcoin exists; however, it is simply too soon to predict whether Bitcoin is here to stay as a revolutionary innovation, or just another speculative boom. Before embarking on Bitcoin trading, make sure you evaluate whether this is the right investment move for you considering your individual circumstances such as your level of experience, your portfolio composition and risk appetite. It goes without saying that practicing proper risk management is the best approach to control your trading risk.
What do you think about Bitcoin? Let us know in the comments section below.