Cryptocurrency and blockchain technology are still new enough that their history is still being written. But while there are few certainties, the picture is becoming clearer for the way digital assets will become a part of the mainstream financial landscape.
Launched in 2009, Bitcoin is still only 12 years old, but the last year has seen accelerating adoption of cryptocurrency as an asset class. What does the future hold for crypto and what role will digital assets play in the financial system?
Money has taken many forms over the course of human history, from cowrie shells and animal skins to salt, grain and even huge blocks of limestone. For thousands of years, gold and silver were popular as money across the world, before the rise of “fiat” money in the last century. Today, all major currencies are fiat, or state-issued currencies that are not backed by any tangible assets. Governments and central banks can print more fiat whenever they want – notably, in the recent rounds of Quantitative Easing. Creating more money in this way raises the likelihood of inflation: when money becomes worth less over time, since there is more and more of it in existence.
Ultimately, money is whatever people agree it is and are willing to accept as a mutual store of value (saving), means of transacting (spending), and unit of account (pricing). And some forms of money are better than others in fulfilling these roles.
Since the middle of the 20th century, money has moved increasingly into the electronic realm. Transactions can be made online, using credit cards, and through the banking system. Physical cash – coins and notes – are used less and less.
Electronic money requires middlemen like banks, credit card companies and payment processors. That’s because data is easy to copy, and so without a trusted third party to keep accounts, it’s impossible to know how much money each person has, and funds could be spent over and over. Of course, those trusted parties also charge fees, and can block or reverse transactions if they want.
Satoshi Nakamoto, the inventor of Bitcoin, solved the problem of trusting third parties using a blockchain, or shared database. In simple terms, allowing everyone to see and verify everyone else’s balances ensures that no single entity can take control of the system. By trusting everyone, the user doesn’t have to trust anyone.
Bitcoin (BTC) was first intended to operate as digital cash, and in the early days, that’s largely how it was used. Bitcoin and other cryptocurrencies based on the same principles allow anyone, anywhere in the world, to send money to anyone else with nothing but an internet-connected device.
Because the shared ledger of the blockchain records all transactions permanently, transfers are irreversible once made. And because the system is open, there are no restrictions on who can use crypto, making it ideal for those who lack banking facilities.
However, it was another property of Bitcoin that prompted significant adoption. There will only ever be 21 million Bitcoins. Unlike fiat money, no more can be created. This fixed supply made Bitcoin very popular among those looking for a store of value, since it is not subject to inflation like fiat money. And, as more and more people sought to buy Bitcoin, they had to compete for that limited supply on the open market, pushing up prices.
This dynamic led to Bitcoin being viewed as ‘digital gold’, since it shares gold’s property of limited supply and resistance to inflation. The idea of a digital store of value that can be transferred and held easily has proven very attractive in the economic turmoil that resulted from the coronavirus pandemic.
The demand for cryptocurrency has been growing for years, but until relatively recently the systems and regulation did not exist to allow many larger investors to participate.
The development of legal frameworks and precedents over the past few years have paved the way for wider adoption. Most major jurisdictions have declared that crypto is legal and should be recognised as an asset class, also clarifying the tax status of crypto assets.
Another significant milestone is the development of custody solutions, which allow large investors to purchase and store crypto while maintaining security and full compliance with necessary regulations. Without these solutions and the regulatory frameworks around them, it was not possible for institutional investors to purchase crypto assets with their customers’ money. Thus the development of these new custody solutions has opened to door to a wave of institutional investment.
Some of the first and largest corporate investors in Bitcoin have been big tech firms, who understand both the technology behind crypto and the financial landscape that makes it so attractive. Michael Saylor, the CEO of tech giant Microstrategy, has invested billions of dollars in Bitcoin – realising that the companies cash reserves were likely to lose value fast, and there were no other asset classes that would protect the company’s finances in the same way. Microstrategy was joined by Square – Twitter founder Jack Dorsey’s payments service – and many other tech companies, as well as a growing number of hedge funds and other financial institutions.
These new entrants to the crypto market have catalysed a sharp increase in prices over the past year. This ‘bull market’ is a virtuous circle whereby new investors recognise the significance of Bitcoin as a store of value and a legitimate element of their investment portfolio.
Despite Bitcoin’s remarkable rise to over $60,000, many analysts are forecasting much higher prices over the coming years, with $100,000 being a conservative estimate for 2021 and predictions of $250,000 and even higher being made by major investment houses.
However high Bitcoin rises, it will not be a smooth ride. Crypto is notorious for its volatility, and every previous Bitcoin bull market has seen repeated ‘corrections’ or drops of 30-40% – during which many investors lose their nerve and sell for fear their coins will soon be worth even less, only to find that prices are soon rising again after all. Only those with confidence in Bitcoin’s long-term future have reaped the rewards by remaining patient.
There are literally thousands of cryptocurrencies, most of which offer little or no innovation and have very limited markets. However, a number of digital assets beyond Bitcoin are attracting interest from larger investors, including Ether (ETH), the native token of Ethereum, which acts as the infrastructure of a trustless financial system and a thriving ecosystem of decentralised applications.
Despite this growing interest, Bitcoin remains the largest and most popular cryptocurrency by some margin. Bitcoin is the best-known and longest-established crypto, as well as being the largest by overall value and has a strong network effect, meaning that it becomes more attractive as an asset the more widely it is adopted and used. As the best-established digital asset, it is the most trusted crypto and will likely remain so for the foreseeable future. It has seen the greatest institutional interest. Several other cryptocurrencies are gaining greater adoption by financial institutions, but Bitcoin remains the most significant crypto in the digital asset space by far.
In most jurisdictions it is legal to own crypto or to trade it. There is also now clear regulation about the tax treatment of crypto. However, you should always check the rules in your jurisdiction, since there are countries where it is illegal to own crypto, or the regulations are still unclear.
Bitcoin’s supply is algorithmically controlled, and there will only ever be a maximum of 21 million BTC. This makes Bitcoin more like gold, which also has limited supply, than fiat currencies like the dollar or euro. Because more and more of these are printed every year, inflation erodes their value over time – while the value of gold (and ‘digital gold’) tends to rise.
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