With Bitcoin briefly crossing the US$11,000 mark on Wednesday, you might be wondering whether you should get in on the action.
After all, one Bitcoin was trading for less than US$750 this time last year. If you’d bought $100 worth of Bitcoin 12 months ago, you’d be over $1,000 richer today.
And since mid-November alone, the cryptocurrency has nearly doubled in value. The thing is, though, that no one is quite sure why.
There are a few convincing theories about why Bitcoin’s value has been rising since debuting in 2009 when it was only worth a few cents.
According to Andreas Park, professor of finance at the University of Toronto, Bitcoin has “deflation built into it,” because whoever set up the digital currency – a programmer or group of programmers whose identity remains unknown – established a finite supply of it. There can only be 21 million Bitcoins in the world, a ceiling that keeps getting closer.
There are currently around 16.7 million Bitcoins in circulation, according to Coin Market Cap, and 12.5 new Bitcoins are created every 10 minutes on average, although that pace is set to slow down in the future.
Bitcoin’s limited supply means its value tends to go up over time as demand for it increases and people come to expect that it will keep appreciating. It’s the opposite of what generally happens with traditional currencies, whose supply is regulated by central banks that aim for low and steady inflation.
As to why demand is increasing, Anthony Diiorio, founder of Toronto-based fintech and cryptocurrencies company Decentral, believes that’s primarily because more and more investors are beginning to understand the enormous potential of blockchain, the technology that underpins Bitcoin.
Before blockchain, anything digital could be easily duplicated, which made it impossible to create a digital currency. Blockchain solves this problem by providing a way to keep track of who owns what and when that ownership is transferred, creating a decentralized network for moving value that doesn’t need to rely on a central authority or intermediaries.
More and more people are realizing that blockchain will do to humanity’s ability to store and transfer value what the internet did to people’s ability to spread information, said Diiorio, who used to be chief digital officer at the TMX Group and the Toronto Stock Exchange.
The fact that Bitcoin has a supply cap and keeps growing in popularity among investors may explain why it has been rising. But why that climb has turned into skyrocketing appreciation in the past few months remains a mystery.
As Bloomberg columnist Stephen Gandel recently noted, Bitcoin has now soared far beyond where tech stocks were in the dot-com bubble.
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If the current Bitcoin rally is a bubble, it might burst. But what might cause the pop and when is also hard to tell.
One thing is for sure: While the cryptocurrency has been climbing much faster than major stock indices this year, it is also many times more volatile. Just this week, it rose above US$11,000 on Wednesday only to plunge below $9,500 on the same day.
The drop appeared to be the result of cyber attacks against Bitcoin exchanges aimed at triggering a depreciation, said Diiorio.
Get used to hacking attempts if you invest in Bitcoin, because they happen often. And while Diiorio noted that their impact is short-lived, several Bitcoin exchanges have been victims of high-profile thefts.
And if Bitcoin seems to regularly rebound from temporary drops, it might soon encounter a more formidable roadblock: government regulation.
“Governments are concerned with losing control of currencies and potential money laundering,” said Diiorio.
Indeed, Bitcoin has made its share of headlines for its part in facilitating the flourishing of online black markets like the Silk Road, where criminals went to buy and sell drugs and perform other illicit transactions.
Diiorio is optimistic about regulators’ ability to apply a light touch to the emerging cryptocurrency market. Others aren’t.
There is also the question of whether and how long Bitcoin will maintain its dominant position. Ethereum, a blockchain-based computing platform that Diiorio co-founded, for example, is rapidly gaining steam. So are Bitcoin spinoffs Bitcoin Cash and Bitcoin Gold.
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Not the kind of money that buys coffee
Most people buy Bitcoins and other digital currencies on online exchanges, although people also trade directly with each other on online marketplaces. There are also Bitcoin ATMs in a number of Canadian cities that will also allow you to trade cryptocurrencies for cash.
You don’t need to buy a whole $10,000-worth Bitcoin. Bitcoins can bit sliced up into up to 100 million bits. The smallest unit is a Satoshi, named after, Satoshi Nakamoto, the mysterious creator of the currency. It is currently worth around US $0.0001.
When it comes to spending your digital riches, though, the options are limited. A growing number of retailers and service providers are starting to accept Bitcoins. But while you might be able to use your digital tokens for a new laptop or even plastic surgery, you might want to stick to cash for small purchases.
The average fee for a transaction was recently hovering around $7, said Park. That’s great if you’re transferring $100,000 worth of value but not so great if you’re buying a $4.50 latte.
Still, users don’t always have to pay for transferring Bitcoins, according to Coindesk.
More fundamentally, though, it is the collective expectation that Bitcoin will continue to increase in value that makes it a flawed means of exchange.
Instead of spending their digital money, “people hold on to their Bitcoins because they believe that sometime in the future they will be worth more,” said Park. And that, he added, is not “how good money works.”