What the heck is happening to Bitcoin?

Several of my friends started asking me again about Bitcoin. This happens whenever the value spikes. Recently it reached USD 1,700+ per 1 BTC.

It was 4 years ago I last wrote about Bitcoin in my blog explaining the basics. Much has happened since. Here, I would like to summarize some of the key points I feel are important to know about when it comes to the developments in the crypto currency world.

Typically one of the first question about Bitcoin is whether it's a good time to buy, and what is causing the price increase? Before we get to the buying part, let me explain to the best of my knowledge what is going on.

There are several reasons for the price increase as I see it:

Halving

A few month ago the amount of new Bitcoins produced each ten minutes has halved, which means there is less available to sell by miners, while the demand for the tokens gradually increased. This created an upward pressure on price. The next halving is in 2020. It happens every four years.

Civil War

The Bitcoin network has reached its maximum capacity due to increased number of users and use cases. It processes about 300,000 transactions a day, but the demand is higher. Bitcoin is code, and thus it can scale in many different ways, but any code change can only happen if the great majority of the community agrees on the terms. There are two fighting fractions in the community who agree that Bitcoin needs to scale, but they disagree on how it should happen. This uncertainty puts a downward pressure on price because less people want to buy. But, the same events also give a different signal to seasoned investors. They think it is a good time to buy, because there is proverbial blood on the street. Smart money buys when people are disillusioned, and sell when they are euphoric. Investors expect the scaling issue to be eventually resolved increasing the network capacity, and with it the token's value.

Second Layers

Besides capacity increase solutions like the Lightning Network, there are many other interesting projects that use Bitcoin as their settlement layer. One of them is Rootstock, which is ported technology from another crypto currency Ethereum. It allows smart contracts on top of Bitcoin as a second layer. This opens up Bitcoin to a wide variety of applications, for example automated corporations to name one. Ethereum's technology combined with Bitcoin's extremely high security (4,000 Petahash / second) may create a sweet combination that large corporations and small governments are looking for to optimize and secure their operations. Another one is colored coins, which allows small fractions of bitcoins to represent property, like land titles, company shares, etc. All these services need Bitcoin as a vehicle, thus investors expect the demand for the tokens to increase in the future to satisfy business needs.

Altcoin Market

Lots of people are buying so called alt coins, which are Bitcoin clones with various additional features. For example, Litecoin offers 4x faster confirmations and capacity at the cost of security. Ethereum offers smart contracts at the cost of complexity and security. Dash and Monero offer increased privacy, but they are also significantly less secure than Bitcoin because of much smaller miner infrastructure. These alt coins have increased 10x or more in their price in the recent months because of speculation and in hopes that they may displace Bitcoin as the number one crypto currency. However, these new features can be and likely will be ported back to Bitcoin in some form at one point. Once that happens, lots of people will be selling their alts to buy back into the safer Bitcoin. This happened several times before in the past. The more alts are growing, the more investors expect all those funds to eventually and at least partially flow back to Bitcoin.

Developed Infrastructure

Bitcoin has been in a constant growth since it's inception. In 7 out of 8 years of its existence it was in the black. The legislative framework around bitcoin is in place in most countries. The infrastructure of exchanges, wallets, merchant services, and various other services have reached maturity. Bitcoin companies are well funded, and ready to possibly disrupt traditional financial services, expanding the number of Bitcoin users around the world.

Network Effects

It feels like the network effect of Bitcoin is reaching a tipping point. It's no longer a currency of curious nerds. You can buy virtually anything with BTC online. You can find a service provider in any area of need who will accept and even welcome bitcoins for payment. As a parallel, the telephone network at the beginning was virtually useless, but as more families had a phone, the system became exponentially more valuable. Eventually the network reached a level of saturation where having a phone was not an option, but a necessity for any family and business. Same goes for internet connection. Bitcoin will likely become the money of the internet, and more generally a settlement layer for any trust less system, that currently relies on centralized corporations or authorities with large overheads.

Should You Invest?

If you want to invest in Bitcoin, remember that it's still an experimental project, even though it has been reviewed by the best mathematicians and programmers in the world over and over, thanks to the excitement of world changing opportunities that the technology can open up, and the very high incentive to find a flaw that can be profited from. Bitcoin still can potentially have a bug that can disrupt it for a while.

Only invest as much as you can afford to lose. Certain funds put 3-5% of their assets into Bitcoin to serve as a hedge against the possible loss on more traditional investments. If you are young, you can risk more. If you are older, you may want to risk less just to diversify savings. Hold coins long term. The price is volatile, so don't panic sell if the price drops even by a large percentage. Eventually it will likely recover, and you will be sorry to realize a loss. Wait till 2020 for the next halving before considering to realize profit, unless of course you need to pay for something urgently. By then, you will probably not need to sell at all, as Bitcoin will be widely used around the world.

Lots of Bitcoiners are buying small amounts regularly to reduce the risk of buying at the wrong time.

Take Security Seriously

It's important that you get a good wallet on a safe system, like Bitpay on iOS. Write down your backup phrase and keep it in a safe location. If you buy a lot, invest in a hardware wallet, like Ledger. Don't keep your coins on an exchange, unless it's a trusted one with a cold wallet like Coinbase has. With Bitcoin there is no customer service to call to complain if you lost your backup. You are responsible for your own security.

Learn by Doing

The best investment you can do is to spend some time learning about cryptocurrencies. It's likely there will be a great need for people who know about such technologies in the near future. No matter what you want to do, read up on Bitcoin to understand the fundamentals.

Use a little Bitcoin to learn first. Make test transactions between friends. Here is a referral code to Coinbase that should give you $10 worth of Bitcoins.

If you are a developer or entrepreneur, see if there is a service or product that you can offer to the Bitcoin ecosystem. It's early enough in the game to be able to grow big within a few years.

Disclaimer: This post is not investment advice.

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