$72,902,650. That is how much you would have made by mid-February 2021 if you had invested $100 in Bitcoin on July 28, 2010, according to calculations by Fortune. That’s a staggering 72,902,550% return on investment or 259.51% in annualised terms.
However, no one can blame you for failing to foresee the potential of the cryptocurrency. Bitcoin was mostly viewed as a geeky pastime, more San Francisco Bay than Wall Street in its early years. Later on, the cryptocurrency became better known for its stratospheric price rises and precipitous busts – catnip for hardcore speculators, but a put-off for practically everyone else – and associations with crime.
The unprecedented buy-ins
All that seems to have changed if the immediate past is anything to go by. For instance, since November 2020, PayPal has been allowing its U.S. account holders to buy, hold and sell Bitcoin and other cryptocurrencies. And in the second week of February 2021, MasterCard announced that it would allow merchants to accept these currencies.
Large financial institutions are showing interest as well; Blackrock, BNY Mellon and Morgan Stanley, for example, plan to offer a cryptocurrency asset class. Even Elon Musk has gotten into the game! In the first week of February 2021, Tesla announced that it had invested $1.5 billion in Bitcoin and planned to accept payments in the cryptocurrency. The Bitcoin price surged to nearly $50,000, its highest point ever, on the news.
Should you follow Musk’s lead? It is, admittedly, difficult to figure out how Bitcoin will perform as an investment in the coming months and years. Do not let that scare you off, though; with knowledge, patience and an extra-large helping of caution, it is possible to make money off a Bitcoin investment.
Peering into the bitcoin price crystal ball
The attraction of Bitcoin as an investment rests on the assumption that its price will keep rising in the future. That assumption has not always held true in the past; the price of the cryptocurrency has fallen by as much as 80% several times in its existence. However, there are several reasons to think that its price may keep rising, at least for the foreseeable future.
Reason one: blossoming interest from wealthy individuals and institutional investors, which we looked at in the previous section. Apart from Musk, other affluent people who have invested in Bitcoin include Christian Armbruester, the founder of Blu Family Office, a London-based investment firm for wealthy clients and Mexican media billionaire Ricardo Salinas Pliego. Wall Street legends such as Stanley Druckenmiller, former chairman and president of Duquesne Capital, and Bill Miller, a former chairman and chief investment officer of Legg Mason Capital Management, have endorsed buying the cryptocurrency.
The growing interest from wealthy individuals and institutional investors has, in turn, encouraged the development of an industry dedicated to helping people successfully navigate the legal and trading risks of Bitcoin so that they can treat it like any other asset. This is likely to spur greater Bitcoin demand – and a further price rise.
Stock-To-Flow, or SF, model predictions also suggest that the price of Bitcoin will keep rising. The SF model is a statistical framework that analysts use to predict the future price of commodities such as gold and silver by determining their scarcity. To compute an SF ratio, analysts divide the commodity’s quantity in inventory by the amount produced or mined every year. You can probably see why analysts would use this model to try and predict the future price of Bitcoin. And it works surprisingly well, too, considering just how volatile the price of the cryptocurrency is.
A high SF ratio indicates that the annual production is a tiny fraction of the total quantity available and is associated with a high per-unit price. In contrast, a low SF ratio shows otherwise. Gold had an SF ratio of 58 at the close of November 2019, one of the highest amongst all precious metals. After the May 2020 halving, Bitcoin had an SF ratio of 52, suggesting that if supply is further constrained and demand increases, its price could well hit highs of $100,000 or more.
Halving events, in which the reward per block that miners receive is reduced by 50%, constrain the supply of Bitcoin by a significant degree and almost always result in price surges. The first halving was in 2012 when the price of the cryptocurrency was $11. In the days after the halving, the price rose to $12; in a year, that had surged to $1100. The second halving was in 2016, after which the price oscillated between $500 and $1000 for a few months. By December 2017, though, the price had hit $20,000. The third halving was in May 2020, at which point the cryptocurrency was trading at $9000. By December of that year, Bitcoin was trading at nearly $20,000 a pop.
Another reason why the price the Bitcoin may keep rising is deflation. Unlike your typical fiat currency, whose number can be endlessly increased at the behest of governments and central bankers, the supply of Bitcoins is capped at 21 million. The total number of spendable Bitcoins will actually be lower than the theoretical maximum due to factors that include accidental loss and willful destruction. This combination of informal limits and a hard cap imposes severe deflationary pressure on the cryptocurrency, implying continuing price increases.
Increasing adoption could also keep nudging the price of the cryptocurrency upwards. More than 400 million Bitcoin transactions have been recorded to date, with the cryptocurrency averaging over 350,000 transactions a day. The number of daily transactions actually hit a high of 400,000 in January 2021 as demand for Bitcoin surged. The rising number of transactions may be a sign that investors are increasingly confident Bitcoin will sustain higher valuations and prices.
However, there are several caveats you should keep in mind. First, just because the SF model has proven accurate for historical data does not mean it will always be on the money in the future. For instance, PlanB, the anonymous personage who first used the SF model to analyze Bitcoin prices, predicted that the cryptocurrency’s price would hit $10,000 at the close of 2019. Its highest price in December 2019, however, was a hair below $7600. This means you should take SF-based prognostications with a grain of salt.
SF analyses may have another weakness; scarcity may not play as important a role in the price of Bitcoin as the model assumes. As Bloomberg Markets editor Joe Weisenthal and gold bull Peter Schiff noted in tweets and blog posts in 2019, commodities such as gold are not valuable simply due to their scarcity, but also because they have real-world uses. Cryptocurrency analyst Alex Krüger went even further in a series of tweets in 2019, arguing that the price of Bitcoin is primarily driven by speculative demand, not supply restrictions. These and other debates are a tacit acknowledgement that the reasons for the cryptocurrency’s price swings are not always clear.
Another caveat you should keep in mind is Bitcoin prices are susceptible to manipulation. For instance, a forensic study by professors John Griffin of the University of Texas and Amin Shams of the Ohio State University revealed that the Bitcoin boom of 2017, in which prices hit $20,000, was almost entirely the result of an unidentified market manipulator. Another study published in 2019 by Bitwise, an asset manager in the process of listing a Bitcoin exchange-traded fund, showed that 95% of Bitcoin spot trading is faked by unregulated exchanges.
The last caveat you should keep in mind concerns Bitcoin’s volatility. While prices have stabilized somewhat over the last few years, wild price swings are not uncommon.
So, should you invest in Bitcoin? Yes… maybe. It all depends on your risk profile and investment horizon. If you are aged 85, and your investments are your primary income source, investing in Bitcoin may not be a good idea because of its volatility. If you are young, a buy-and-hold strategy – ‘holding,’ in the argot of cryptocurrency investors – may be a good option because it allows you to ride out the volatility
That being said, you should not invest more than you can afford to lose; Bitcoin remains a highly speculative investment. Thoroughly research before you invest, conduct your purchases through regulated exchanges to avoid scams, and steer clear of deals that seem too good; they probably are. Store your holdings in hardware or offline wallets to keep them safe from hackers – and do not forget your wallet password! Consult others, and learn from your mistakes. All the best!