Today is “Bitcoin Pizza Day”, the 7-year anniversary of the first real-world bitcoin transaction, performed on May 22, 2010. The story goes that Laszlo Hanyecz, a programmer, paid 10,000 bitcoins for two Papa John’s pizzas. At the time, bitcoin was just over a year old, having been launched in early January 2009.
At the time of Laszlo’s purchase, those bitcoins were worth about $25.
Today, that same 10,000 bitcoin pizza would cost over $20,000,000. What a difference just 7 years has made with bitcoin rising from 1/4 of a cent to over $2,000 per bitcoin today!
Is the Price of Bitcoin Justified?
The price of bitcoin has more than doubled since the start of 2017. Is this based on the price of bitcoin catching up to its true value, or could bitcoin be in a bubble? That is a question that many analysts have been considering, and the answer may surprise you.
Most people are familiar with the “technical analysis” component of bitcoin. This is a process where active traders look at charts and identify various patterns to determine where the price of bitcoin, or a stock, will go next. This allows traders to make informed decisions, based on pattern analysis, about whether to buy or sell and when to trade as well. This type of analysis is the basis for “technical trading”.
Many bitcoin traders have been doing quite well, as volatility in bitcoin has created frequent opportunities to benefit from a change in the bitcoin price, whether it was moving down or up.
Yet, there is another consideration. In the world of stocks and other equities there is something called “fundamental analysis”. This type of analysis, as opposed to technical analysis, looks at the underlying company’s “intrinsic value”, that is, what gives a company its true worth. Factors such as revenues, earnings, future growth potential, and others are used to determine value. The big question has been, however, how do you perform fundamental analysis on bitcoin and other digital currencies? As there is no underlying company or balance sheet to review, does this mean that cryptocurrencies need a whole new set of metrics?
Bitcoin Fundamental Analysis
Even though bitcoin is considered a new asset class, the rules that apply to fiat currencies like the Dollar, Euro, and Yuan also apply to cryptocurrencies (cryptos), said Tim Enneking, chairman of Crypto Asset Management. “All the laws of economics apply – in full – to cryptocurrencies,” he said. So, what are those rules?
Several factors affect the demand of bitcoin and other cryptos, including user adoption, transaction activity and trading volume. Regarding user adoption, this clearly has been increasing for bitcoin. The number of people in the market, many for the first time, have been buying and driving the price higher. But why is user adoption growing?
When it comes to any type of currency, there are several factors, which I describe in my book, “The Bitcoin Tutor: Unlocking the Secrets of Bitcoin“. These include using a currency as a store of value and its use as a medium of exchange. The store of value component is well-known to “buy and hold” investors in bitcoin, as the amazing ride upward since late 2016 has really paid off for them.
As a medium of exchange, over 100,000 companies now accept bitcoin. These include local restaurants, bars, and cafes around the world. Large companies like Microsoft, Dell, eBay, and PayPal are also accepting bitcoin payments from its consumer customers, driving the bitcoin economy and what is often referred to as the “velocity of money”.
The number of daily transactions, publicly available to view on the bitcoin blockchain, has continually increased over the past several years. In 2012, there were about 7,000 transactions per day. Today, the number is greater than 300,000 transactions.
Furthermore, cryptocurrencies all have a maximum money supply, an algorithm that mathematically limits the amount of new currency created each year. For bitcoin, the maximum amount is 21 million. This applies an amount of scarcity to each cryptos, much like the finite supplies of gold, silver, and oil that exist. This is a dramatic difference from fiat currencies which are simply “printed” at will by governments and central banks, continually debasing these currencies.
What Are the Risks?
First, the cost of trading bitcoins has been increasing steadily. Where bitcoin transactions used to cost only a few cents, today fees can top $1.00 or more per transaction. While this cost is still dramatically less than the 2-3% fees charged for using credit cards, it is drawing more value out of the bitcoin economy (just as Wall Street draws more and more value out of the US economy).
This is due primarily to a scaling issue, where the number of bitcoins being traded on the blockchain have increased dramatically to a point where one of several competing solutions needs to be put in place. Since everything in the bitcoin network occurs by consensus, the scaling issue continues to be debated. At one point in the near future, a 51% majority will be available and important updates will be applied to the bitcoin network of computers worldwide.
What Is the Best Approach?
Many students ask, what is the best approach in buying and selling cryptos like bitcoin? I believe it is best to consider both fundamental and technical analysis together.
Use fundamental analysis to better understand the trends, adoption, and long-term potential for the crypto. Then, apply technical analysis to time you trade based on historical trading patterns.
The technique can be as simple as “buying the dips” when bitcoin drops in value, and for many, continuing to accumulate bitcoin over the long haul. Buying a specific amount of bitcoin, say $100 worth of bitcoin each month, allows you to “dollar cost average”. So, when the value of bitcoin goes down, your $100 buys more bitcoin; when the price goes up, your $100 buys less. Either way, you are continuing to invest in and grow your ownership in bitcoin and other cryptos while “averaging” the price you pay to buy.
Whatever strategy you choose, cryptos are here to stay. Not all of the cryptos are likely to survive, but I expect bitcoin to make it. What’s more, I expect bitcoin to be one of the dominant and most valuable cryptocurrencies for many years to come! After all, bitcoin started it all!