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"A look at three major factors driving the unprecedented rise in the price of Bitcoin, and by extension, other major cryptocurrencies, and why." — Jim Barth, Eminent Scholar in Finance at the Harbert College of Business
The recent market highs reached by Bitcoin, Ethereum, and other major cryptocurrencies have sparked a dramatic uptick in interest in this 10-year-old class of digital currency. Fueled in part by renewed coverage in mainstream media and announcements of large purchases by hedge funds and traditional investment pools, Bitcoin and a handful of other leading cryptocurrencies are rapidly becoming embraced by merchants, financial institutions, and consumers alike. Many experts believe that the higher-profile cryptocurrencies are on the brink of an explosion in popularity and value in the coming years.
Bitcoin Leads the Way
Bitcoin, the original cryptocurrency, was introduced in January 2009 by Satoshi Nakamoto (a pseudonym) and is by far the most well-known and popular cryptocurrency in the world, comprising approximately two thirds of the more than $1 trillion market capitalization of all cryptocurrencies. Following a few big crashes over the past two years, Bitcoin has rebounded to reach its highest price ever, reaching almost $42,000 on January 8.
Jim Barth is a Senior Fellow at the Milken Institute and has authored more than 300 articles in professional journals. His research focuses on financial institutions and capital markets, with special emphasis on regulatory issues.
The question many financial analysts are asking is, will this phenomenal rise in the value of Bitcoin continue?
My answer is a resounding “Yes.” Indeed, I predict that each Bitcoin could be worth as much as $75,000 by the end of 2021, perhaps even more. A look at three major factors driving the unprecedented rise in the price of Bitcoin, and by extension, other major cryptocurrencies, reveals why.
The first key factor ramping up the value of Bitcoins is its growing popularity as a method of payment, particularly among younger consumers. Initially a fringe movement supported by a small fraction of early adopters, the use of cryptocurrencies is following the trajectory of cell phone adoption, online shopping, touchless payment systems, and other technological and behavioral evolutions. These innovations started slowly as well before reaching an inflection point followed by explosive expansion.
The security and privacy offered by cryptocurrencies is also a factor in the growth of consumer adoption, as more and more shoppers appreciate the fact that their purchases are not traced by advertisers who bombard them with ads following “traditional” online payments.
The acceptance of cryptocurrencies as a viable payment method by financial institutions is another factor driving consumer adoption, as mainstream payments firms, including PayPal, now offer customers the ability to buy and sell Bitcoins – or fractions of Bitcoins – from their accounts. And an increasing number of tech companies, including Square Inc., accept payments in Bitcoins and hold portions of their cash reserves in the digital currency. Even VISA has jumped into the fray. Coinbase, the largest U.S. cryptocurrency exchange, will soon offer a VISA debit card that lets customers spend Bitcoins from their Coinbase VISA accounts.
Beyond the explosion in consumer adoption, one of the biggest drivers of the rise in the value of Bitcoins is the age-old law of supply and demand. Unlike paper currencies, which governments can manipulate by simply printing more bills, there is a maximum number of Bitcoins eventually available for use – 21 million. Once those coins are created, or “mined,” that’s it, no more can be created. Currently, there are a little over 18.5 million Bitcoins in existence, with more being mined at a gradually decreasing daily rate. As the popularity of Bitcoins as a method of payment grows and their perceived potential as an investment vehicle soars, the demand for the limited number of Bitcoins in existence drives up the value of each coin tremendously as consumers and professional investors scramble to get it in the action.
While a little more than 18.5 million Bitcoins have been mined, the number available for use as payments on any given day is much lower than that – more like 8 million. Much of the rest is held by longer-term investors and speculative traders interested in benefiting from the projected rise in the value of Bitcoins as an asset rather than as a means to directly buy or sell products and services. As more large investors and investment banks such as Goldman Sachs scoop up Bitcoins – either for their own accounts or as part of cryptocurrency funds for their clients – the number available for payments continues to decline.
A helpful analogy here is the “float” of publicly traded stocks, in which the number of shares outstanding may be in the tens of millions, while the number of shares available to trade in the market is much lower. All you have to do is look at what happens when shares previously covered by Rule 144 sales restrictions on insiders and early investors following an IPO are eventually freed up to trade on the public market – the price of those shares drops immediately based on the increased number of shares now available to trade. The reverse is also true – a smaller float of shares available to trade makes each share more valuable on the open market.
The same is true with Bitcoins – a constrained float serves to drive up the price of each coin, especially when transaction adoption is increasing so rapidly. Supply and demand at work.
Trust Drives Everything
One overarching key to mainstream adoption of Bitcoin and other cryptocurrencies is trust – trust in the concept of cryptocurrencies, trust in the underlying technology, trust in all the participants in the payment process, and trust in the judgment of some of the biggest players in the investment community that Bitcoins and other top-tier cryptocurrencies represent long-term potential as viable investments.
This growing level of confidence is critical to the continued use of Bitcoin and others as both a payment option and as a potentially lucrative investment opportunity. Without that trust, expansion beyond early adopters would not be possible.
The Time Has Come
My observations of consumer behavior, merchant acceptance, adoption by financial payment firms and recent large purchases by some of the most reputable investment institutions in the world tell me we’re quickly reaching the inflection point that could boost Bitcoin and a select few other major cryptocurrencies to unprecedented new heights.
James Barth is Lowder Eminent Scholar in Finance at Auburn University’s Raymond J. Harbert College of Business. Dr. Barth has authored more than 300 articles in professional journals and has contributed to The New York Times, The Wall Street Journal, Barron’s, and countless other financial industry publications. He is a Senior Fellow at the Milken Institute, and a Fellow at the Wharton Financial Institution Center. An appointee of Presidents Reagan and George H.W. Bush, he served as chief economist of the Office of Thrift Supervision and the Federal Home Loan Bank Board. His world renown research focuses on financial institutions and capital markets, both domestic and global, with special emphasis on regulatory issues.