Akin to any commodity, currency, or asset, investing in bitcoin isn’t without its risks. But beyond its inherent volatility, what evidence is there to suggest that bitcoin is a safe investment?
Is bitcoin immune to a hack?
While stories of bitcoin being lifted from exchanges, wallets, or users are all too common, the fault often lies with the party holding the keys. Fortunately, the bitcoin network itself is extremely secure. Rather than storing all of its sensitive information within a central server, bitcoin’s transactional data is decentralised, distributed across a vast network of users who continually secure and validate transactions.
However, despite bitcoin being a tough nut to crack, it’s not altogether impossible. Though merely hypothetical at this stage, bitcoin could be exploited via a 51% attack. As the name suggests, this attack vector occurs when a miner, or group of miners, come into control of more than 50% of a blockchain’s hash rate or computing power.
Once in control of a network, malicious actors can halt and reverse transactions. Stopping others from confirming transactions allows the hacker(s) to monopolise the block reward. Meanwhile, reversing completed transactions tricks the network into allowing the same funds to be spent twice—otherwise known as a double-spend.
It’s important to stress that a 51% attack is highly improbable in this stage of bitcoin’s adoption cycle. To pull it off, a miner or mining collective would need to source more computing power than over half the existing miners and mining pools on the network—currently estimated as the equivalent of the electrical consumption of Austria.
An attack of such scale is economically unviable. To amass the computing power needed to maintain control of the bitcoin network would cost billions of dollars. Moreover, hacking bitcoin would likely result in mutually assured destruction for all involved as the market would react negatively. As such, hackers would have an extremely low chance of making back the capital it took to attack the network in the first place.
In other words (and to put any nagging doubts to rest), the odds of a 51% attack on the bitcoin network are slim to none.
Would a bitcoin ban endanger investors?
India is the latest country to stir up fear, uncertainty, and doubt around bitcoin’s durability. The legal status of cryptocurrencies in the south Asian country has long been debated. Now, the Indian government is inching closer to an outright ban on crypto trading—in spite of the broadly positive impact it could have on the country’s economy.
Regardless, it raises the question: can bitcoin truly be banned?
In November last year, billionaire fund manager Ray Dalio suggested that governments may simply “outlaw” bitcoin if it grew too successful. Dalio’s argument leans on the precedent of America’s 1933 ban on gold, where an executive order forced US citizens to fork over their precious metals to the government.
However, despite their numerous shared qualities, bitcoin is nowhere near as easy to prohibit as the precious metal. Similar to how decentralisation offsets the potential of a bitcoin hack, the network’s distributed nature makes a bitcoin ‘ban’ highly unlikely. Outlawing bitcoin would be akin to banning the internet: implausible if not entirely impossible.
Moreover, analysis from financial services firm Unchained Capital highlights the upshot of jurisdictional bans on bitcoin. In the hypothetical event that bitcoin is outlawed in one county, another would likely gain that country’s BTC outflows. In any case, bitcoin wins.
How risky is volatility really?
Another slightly more evidential investor concern comes in the form of bitcoin’s trademark volatility.
BTC is often analogised alongside gold for several reasons. They both share a finite supply, they’ve both proven their ability to maintain or increase their value over time, and they’re similarly produced via mining (albeit via dramatically different methods). Yet, when it comes to volatility, the pair couldn’t be more distinct—or so it would appear.
In actual fact, according to Bloomberg data, bitcoin’s annual volatility is at its lowest ebb ever versus gold and the S&P 500. Moreover, BTC volatility currency matches levels witnessed during gold’s mega price rally in 1980.
While it often deters investors, bitcoin’s volatility can be seen as a feature, not a bug. Bitcoin’s multiple boom and bust cycles have acted as a catalyst for the asset’s long-term growth and sustainability—something that wouldn’t be possible without that early-stage volatility.
How can I hedge against bitcoin’s potential pitfalls?
While most of these scenarios can be easily debunked, any exposure to any asset holds its share of risk.
Diversification reduces exposure to this risk, and, if executed effectively, does so without diminishing returns. Modern Portfolio Theory (MPT) advises that investors shouldn’t over-allocate to a single asset—the same goes for bitcoin.
MPT urges investors to construct a portfolio from several non-correlated assets, regardless of the risk each asset brings to the table. Given the broadly uncorrelated nature of cryptocurrencies, these nascent assets make an excellent candidate for portfolio diversification, but only if they don’t become a concentration risk in themselves.
As for whether bitcoin is a safe investment, the answer depends very much on risk appetite. However, it’s becoming widely accepted that no exposure to bitcoin could end up being more detrimental than a small allocation.
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Disclaimer: Opinions expressed in this article do not constitute investment advice from Evai