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Investing

If you are exploring Bitcoin—5 things you need to know

Don’t go at it blindly. We believe you should know these key facts about this cryptoasset.


 

Investors of all types are paying a lot of attention to Bitcoin (BTC). But is it right for you?

While it may seem that BTC naysayers are still prevalent, SEC filings show a substantial uptick in BTC mentions, suggesting institutional investors are becoming believers.1 These investors can be in it for the long game, and their investment is a key milestone on the path toward the broad adoption required for BTC’s ultimate success. 

If you are thinking about investing in BTC, here are answers to five important questions that can help inform your decision.

 

1) What is BTC?  

Bitcoin is a digital coin that facilitates transactions without the need for a third party such as a bank or a credit card provider. This decentralized approach removes traditional financial intermediaries; that can speed up certain transactions and avoid large fees.

 

Bitcoin’s decentralized approach solves for frictions in the traditional banking system

 

2) How does BTC work?

Previous attempts to enable peer-to-peer monetary transfers over the internet, without a trusted intermediary, failed. That’s exactly what the BTC protocol solved for—a peer-to-peer verification system. This verification and tracking system is called the blockchain, which essentially consists of self-interested bookkeepers (i.e., “miners”) who verify groups or “blocks” of transactions and add them to a public ledger for all to see. To compensate the miners for their work, in addition to a small user fee, they are given a reward consisting of newly minted BTC for each block they add to the blockchain.

You might think, sounds great, sign me up to be a miner and quickly win Bitcoin. Not exactly. Miners compete with one another to approve every block of transactions by solving mathematical puzzles—but you’ll need more than just your brainpower to win. Solutions to these trial-and-error problems require expensive equipment, and large amounts of computer power and energy.

The process is fairly slow by design; in order to ensure the global network is in sync, blocks are added to the blockchain only once every 10 minutes, resulting in slow transaction speeds.2 While estimates vary, roughly seven transactions can be executed per second with Bitcoin,3 compared to Visa, which executes roughly 1,700 transactions per second (with a capacity closer to 24,000 per second).4 When the network gets busy, it slows further, taking anywhere from a few minutes to days to complete a transaction, causing transaction costs to soar.

 

3) What are Bitcoin’s defining characteristics?

In the long term—a contender with gold

Bitcoin shares two key characteristics with gold:

a) It’s finite. No more than 21 million bitcoins will ever be created—This limitation is by design and embedded in Bitcoin’s rigid rules framework. There are roughly 19 million bitcoins in the market currently, and when all 21 million are created, miners will have to rely strictly on fees to be compensated (we estimate that will happen in 2140, so it’s not an imminent concern for network functionality).

b) It’s decentralized. Like gold, BTC is neither issued nor controlled by any entity, institution or government. In times of heightened economic or political uncertainty, decentralization encourages investors to flock to gold’s safety. Bitcoin has the potential to play a similar safe haven role. But remember—Bitcoin implicitly has no government backstops, unlike fiat currencies such as the U.S. dollar.5 In the United States, the FDIC insures your checking account against theft.6 However, if you lose your Bitcoin password, or if the exchange that is holding your Bitcoin gets hacked, there is no insurance to make you whole.

Today—a high-risk/high-reward profile

While BTC may eventually challenge gold as a protection asset in portfolios, it’s not an established contender today. It’s important to note that BTC has significantly more volatility.

Bitcoin is highly volatile. Over the last five years, BTC has had an annualized volatility of 72%—roughly five times that of the equity market or gold. Furthermore, over the last five years, BTC has had little to no correlation with other major financial assets. 

 

Bitcoin’s correlations with major assets have been inconsistent

4) Are there other risks I should be aware of? 

Three additional risks could threaten Bitcoin’s broad adoption, adding to its high-risk/high-reward profile:

a) Hacking—There have been many heavily publicized hacking events that resulted in BTC theft, giving Bitcoin a lawless stigma. However, it was the means through which BTC was custodied that was at fault in these hacking events, not the BTC protocol itself.

Your Bitcoin transactions require a wallet: either a hot wallet (connected to the internet, thus increasing the risk of hacking) or a cold wallet (not connected to the internet, thus more secure). Over recent years, custodial services for BTC have improved, making hacking events less prevalent.  But if you plan to invest, protect your digital assets; be aware of the various custodial and wallet options, and the pros and cons of each.

b) Regulations—Most global regulators, except China’s, have trended toward adopting and supporting digital assets. About 80% of central banks are engaging in central bank digital coin research or adoption, but how far they are willing to go is very uncertain. Regulators are likely to encourage protections for crypto holders to ensure financial stability. While news of regulations may introduce additional volatility, the goal is customer protection—a potential long-term tailwind for the asset class.

c) Climate change tensions—Bitcoin consumes a lot of energy; this is by design and unlikely to change. As Bitcoin traffic increases, mining activity picks up, and the network demands more energy. What really matters is how much of the energy comes from renewables versus traditional carbon emissions. As of 2020, just under 1% of global electricity consumption was tied to Bitcoin and only 40% of that 1% was from renewables.7 Bitcoin bears see this as a problem, while bulls would say renewable energy usage is trending higher quickly and will help encourage broader Bitcoin adoption.  

 

5) Should I add Bitcoin to my portfolio?

Know your goal first! An investment in Bitcoin could be rewarding but, given its volatility and high-risk/high-reward profile, any money that you might need in the near term should not be considered for an allocation to BTC. Even if you have a long time horizon, if your investment is intended to fund a high-priority goal and you aren’t comfortable with a wide range of outcomes (make it big or lose it all), this asset might not be right for you.

 

What this means for investors

As with any investment, if you are considering investing in Bitcoin, we encourage you to understand the risks and rewards that can come with it. Contact your J.P. Morgan team for more information.

 

1.Bloomberg Finance L.P., J.P. Morgan Private Bank. Data as of June 30, 2021.
2.There are two factors that slow down the network: Block size is limited to 1MB to reduce CPU time, and blocks are added to the blockchain only once every 10 minutes to allow time for nodes to sync globally, to prevent the same BTC from being spent twice.
3.Adem Efe Gencer, “On Scalability of Blockchain Technologies,” Ph.D. diss. (Cornell University, August 2017).
4.“Bitcoin 101,” Coindesk, December 2020. (https://www.coindesk.com/learn/bitcoin-101/what-is-bitcoin)
5.Fiat currencies are government-issued currencies not backed by a commodity such as gold.
6.The standard deposit insurance coverage limit is $250,000 per depositor, per FDIC-insured bank, per ownership category.
7.3rd global crypto asset benchmarking study, Cambridge Centre for Alternative Finance, September 2020. https://www.jbs.cam.ac.uk/faculty-research/centres/alternative-finance/publications/3rd-global-cryptoasset-benchmarking-study/

 

Cryptocurrencies are not a regulated form of currency. They can experience extreme volatility. Investors may lose all of their investment.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

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