Top 10 risks and myths of Bitcoin
The price of Bitcoin has risen by almost 300% since the crash in March 2020. Over Christmas, many of us will be debating its value as a global asset, as economists highlight the possibility of rising inflation, and as Bitcoin continues to outperform all other major asset classes.
On the one hand, Bitcoin enthusiasts argue that the coin is a hedge against inflation, anew “digital gold”, acting as a store of value as governments around the world continue to print money. In contrast, Bitcoin sceptics contend that cryptocurrencies provide a safe haven for criminals, are bad for the environment, and will eventually be destroyed by government regulation. As digital currencies becomes mainstream, below are some of the most credible risks as well as the relevant counter-arguments.
Before diving in, please note that I am not a financial advisor and none of the information contained in this article should be taken as financial advice.
1. Bitcoin is a volatile investment that could crash to zero
Bitcoin and other cryptocurrencies are more volatile than the stock market. They commonly witness 10–20% drawdowns even as prices continue to rise. However, what Bitcoin investors understand is the potential upside and risk-to-return ratio. Despite a global pandemic, Bitcoin is up over 150% one year to date (since December 2019). The potential for Bitcoin to witness another crash is not impossible, although it becomes less likely as more major players start to buy in. Every dip in Bitcoin’s price seems to be bought up more quickly than the last, and as the number of investors grows, the volatility is expected to continue to decrease.
2. Bitcoin is only as safe and scalable as its technology, and could be destroyed by quantum computing
Bitcoin is only an algorithm, i.e. it is only as good as its underlying computer code. As computing power increases, quantum computing could potentially enable hackers to bypass the 12- or 24-word passphrases that Bitcoiners use to secure their digital wallets. However, if computing makes rapid progress then arguably, all sectors will be at risk — including major companies like Amazon, Apple, or Netflix. Bitcoin investors argue that there is still plenty of time to upgrade the Bitcoin blockchain.
3. Bitcoin could be crushed by government regulation
Governments around the world are trying their best to understand and regulate cryptocurrency, but taxation is still a little messy and varies widely from country to country. Governments have much more to gain from imposing capital gains tax, than to lose, by making it illegal.
4. Bitcoin could become useless alongside the emergence of Central bank digital currencies (CBDCs)
Governments around the world are starting to consider issuing their own digital currencies, known as CBDCs. The European Central Bank (ECB) and national central banks of the euro area are currently exploring the benefits and risks of a digital Euro. The ECB argues that “digitalisation has spread to every corner of our lives and transformed how we pay. In this new era, a digital euro would guarantee that citizens in the euro area can maintain free access to a simple, universally accepted, safe and trusted means of payment.” Similarly, China is trialling launched its Central Bank Digital Currency (CBDC), which could be introduced as early as 2021. CBDCs will certainly increase traceability and facilitate taxation. But that despite this progress, many Central Banks are continuing to debase the value of their national currencies (fiat) by printing more money. In contrast, Bitcoin has a hard supply of 21 million coins and is therefore seen by many as a protected store of value.
5. Bitcoin destroys the environment
The process of “mining” (creating) Bitcoin comes with a considerable energy cost. Some have estimated that it uses just under 1% of global electricity consumption. New, alternative cryptocurrencies are trying to develop faster, more scalable, and less energy-intensive solutions. However, despite some of its flaws, Bitcoin remains by far the dominant asset class in terms of market capital for mass adoption, and it is unlikely that these secondary cryptocurrencies will overtake Bitcoin any time soon.
6. Bitcoin is the preferred currency of criminals
Many argue cryptocurrencies are used by drug dealers, money launderers and all kinds of criminals on the dark web. But by definition, every transaction is traceable on the blockchain. The whole point of blockchain technology is “trust by transparency”: it makes criminal transactions more difficult. There are indeed ways to circumvent traceability, such as “CoinJoin” methods or using special privacy coins like Monero. But many argue that privacy coins are not as untraceable as they seem. Ultimately, traceability is at the heart of blockchain technology.
7. Bitcoin’s price is manipulated by a small number of wealthy investors
A large fraction of the total Bitcoin supply has historically been concentrated in the hands of a small number of investors, known as “whales”. It is hard to say to what extent the price can truly be manipulated by these billionnaires, but it is clear that over the long term, as the number of long-term Bitcoin holders increases, the risk of manipulation continues to decrease.
8. Bitcoin is easy to misplace and lose
The underlying idea of Bitcoin is decentralisation. However, with decentralisation comes responsibility: users become personally responsible for their coins by using a passphrase known as a set of “keys”. The expression “not your keys, not your coins” is commonly used to encourage people to remove their coins from exchanges and store them offline in more secure “cold wallets” such as Ledger or Tresor. There have been countless examples of people forgetting where they have written down their Bitcoin wallet keys. If your only backup is a piece of paper, then it could be lost in a fire, flood, or robbery. Multiple solutions exist, such as keeping backup wallets in different locations, using “multi-sig”, or metal wallets that store your keys on a fireproof, waterproof and shockproof piece of steel.
9. Bitcoin puts you at risk of being hacked
If you hold your money online on an exchange or in a “hot wallet” (free storage applications), there is always a chance of being hacked through phishing scams, malware, viruses, ransomware, sim swaps, and more. If you want to invest in Bitcoin, security is important: many crypto investors value their anonymity and use “cold wallets” which provide secure offline hardware storage. For this reason, crypto security is an increasingly important market (see point 8).
10. Bitcoin insurance doesn’t exist
Insurance does actually exist. Many of the major exchanges like Coinbase offer insurance to their customers. Private insurance can also be purchased. Life insurance companies, like MassMutual, are also slowly starting to purchase Bitcoin.
Most of these are legitimate arguments, worthy of discussion. Crypto investors need to be aware of the debates surrounding Bitcoin. Education remains the solution to developing a more nuanced understanding of the real risks and upsides of the booming crypto market. There are many professional traders, investors and CEOs who are helping the market by sharing quality content, information and education on platforms like YouTube, Twitter (e.g. @michael_saylor, @APompliano), podcasts (The Wolf of All Streets, Market Meditations) and Tiktok (e.g. virtualbacon, crypto.dinosaur, the wolfofbitcoins, cryptowendyo).
Have I missed anything? Please let me know in the comments below.
This is a draft that I will continue to update.