If you bought $100 in Bitcoin in early 2010 and held it, you’d have more than $20 million today. With such high returns, it’s difficult not to think “Why not me?”
Investing in cryptocurrencies is a high-risk proposition. The price fluctuates dramatically, and there’s no consistent pattern to the price increase or decrease. For example, the value of Bitcoin plummeted in 2020 when consumer prices began to increase, only to decline again in 2021 and 2022 in the aftermath of the Covid-19 pandemic.
Let’s look at 7 key indicators that investors should consider when evaluating Bitcoin.
Uncertainty
Uncertainty is a major concern for investors when it comes to cryptocurrencies like Bitcoin. Unlike stocks and bonds, there is little evidence to support the idea that cryptocurrencies are safe investments. The price of bitcoin is subject to significant volatility. The volatility of the digital currency can be as high as 40 percent, and some analysts are still attempting to determine its fair value and determine important price levels.
For example, JPMorgan has estimated the fair value of bitcoin at $38,000 and compares its volatility to that of gold, which is a good hedge against economic uncertainty.
The price of Bitcoin is affected by a number of factors, including the amount of uncertainty surrounding its future value. The price ratio of Bitcoin relative to the price of Tether is also influenced by uncertainty. In addition, it depends on the price of other currencies.
Volatility
While Bitcoin’s volatile price is a warning sign for investors, it is also an opportunity to learn about the cryptocurrency market. The cryptocurrency market’s supply and lack of central bank control are two major factors that cause its volatility.
While this may sound like a curse, crypto developers say it is a blessing. Lack of central control allows for a broader range of value creation than with conventional assets.
Currently, there are no Bitcoin exchange traded funds available in the United States. However, if they were, they would likely exhibit similar volatility characteristics.
Taxes
The question of how investors should react to Bitcoin is a complex one. While the Bitcoin price has been soaring over the past couple of months, the risks and rewards are not the same as with traditional investments. For example, Bitcoin is still not a usable currency and investors have been selling it to people who don’t intend to use it. The Bitcoin price is also incredibly volatile, and if you sell it at the wrong time, you could suffer a large loss. Hence, investors should take this into consideration before investing in bitcoins.
Regulation
Digital assets are subject to regulation under the Securities Exchange Commission (SEC). Securities are investments that carry risks and require an investor to exercise their due diligence before purchasing them. Under the federal securities laws, exchanges must maintain certain standards in order to ensure the integrity of their markets and promote fair trade. If these standards are not met, investors may not be protected from losses.
Several state governments are considering regulations for cryptocurrencies. The US Treasury has emphasized the importance of regulating the cryptocurrency market, citing the proliferation of international and domestic criminal activities.
For example, FinCen recently proposed a new regulation that would impose data collection requirements on digital wallets and exchanges. This rule is expected to be implemented by fall 2022. It will require exchanges and wallets to report any suspicious transactions and will require wallet owners to identify themselves when they send more than $3,000 in a single transaction.
Futures markets
Futures markets are designed for investors who wish to speculate on how the price of a certain asset will behave in the future. These contracts are standardized and convey the right to buy or sell an asset at a future date. They have a specific number of units, pricing, and margin requirements, as well as a specific method of settlement. Traders can also buy and sell futures contracts in order to offset positions.
Bitcoin futures contracts were launched last December by the CME Group and the Chicago Mercantile Exchange group. This study examines how Bitcoin’s spot market reacts to the launch of these contracts. It uses a combination of event-study methodology and an adjusted asset pricing model.
Findings indicate that the launch of futures contracts for Bitcoin initially drove prices up, but they subsequently declined. This behavior is consistent with the normal trading patterns after the launch of a new futures product.
Emerging market economies
While Bitcoin has gained popularity in developed countries, many emerging markets have yet to see the same effect. However, the rise of this new cryptocurrency could help them achieve their financial goals.
For example, El Salvador recently became the first country in the world to officially recognize Bitcoin as legal tender. As a result, residents of the country are now able to pay taxes and settle debts with the currency. While the move was met with some opposition, some politicians from other parts of the region have also expressed support for legalizing Bitcoin.
However, El Salvador has spent $375M and lost $60M on their Bitcoin experiment.
Although governments around the world initially took a hands-off approach to the new cryptocurrency, the rapid rise of the price of bitcoin and other cryptocurrencies forced regulators to devise rules for this emerging sector. This could take several years, and the regulations differ widely. Some governments embrace cryptocurrencies, while others ban them altogether.
For regulators, the challenge is balancing traditional financial risks with innovation.
Impact of Pandemic on Bitcoin
The Pandemic has caused many to question the legitimacy of cryptocurrencies, but it also has many positive implications for the market. One study from Kingston University argues that Bitcoin exhibits the characteristics of both a currency and a speculative asset. The fact that Bitcoin is decentralized from the central financial system of any country makes it attractive as a haven for funds during times of crisis. Economists often refer to this phenomenon as the “flight to safety.”
The study estimates that the COVID-19 pandemic has an equal impact on Bitcoin and the S&P 500. However, the volatility of Bitcoin explains about one-sixth of the variation in S&P 500 returns during the pandemic. This suggests that a sharp drop in Bitcoin prices could cause investors to become more risk averse and reduce their investment in stock markets. Moreover, spillovers from one crypto to another can be similar in magnitude.
Final thoughts
“Traders of any asset are fair-weather fans, and with major cryptocurrencies such as Bitcoin and Ethereum down more than 70% from their all-time highs, it’s little wonder that the shine has come off these coins,” said James Royal, principal reporter at Bankrate.
Declining Bitcoin prices along with prices for major cryptocurrencies like Ethereum and Cardano don’t help the cause of attracting new investors to the market.
When prices are rising and FOMO kicks in it brings a lot of new investors into the space along with high expectations. As a result many investors don’t understand what they’re getting themselves into, lose money and pull out of the market.
If you choose to invest, it’s important to maintain a diversified portfolio that includes several different types of investments to reduce your overall risk exposure. As a general rule, you should not invest more than 10% of your portfolio in risky assets such as Bitcoin.