If there is anyone who knows about volatility, it is those who own cryptocurrencies. Special, Bitcoin (CRYPTO:BTC) has been an absolute roller coaster ride over the years. In the last five years alone, Bitcoin prices have fallen from their peak twice by over 30% and once by over 60%!
But you'd be pretty happy if you bought it five years ago and kept it forever. A $1,000 investment in Bitcoin five years ago has grown to over $13,000 today.
So what is the lesson from this and how can investors apply it to Bitcoin in the future?
Here's what you need to know.
Why is Bitcoin so volatile?
Bitcoin and other cryptocurrencies have some similarities to stocks. First of all, their short-term prices are determined by supply and demand. Prices rise when more people want to buy than want to sell, and vice versa. But stocks represent underlying companies – tangible companies. They make profits, and stocks represent ownership of a portion of them.
Cryptocurrencies are a bit more complex because they technically have no tangible value. That doesn't mean it's worthless. Finally, the same applies to fiat currencies. Its value comes from what it represents. In the case of the US dollar, the currency represents legal tender backed by the government. The value of the dollar can fluctuate against other currencies, but the US dollar is generally stable due to this support. For this reason, it is the reserve currency of the world.
Bitcoin is decentralized – no bank or government supports it. Some may argue that this makes Bitcoin and other cryptocurrencies some kind of pyramid scheme, but that is not necessarily true. Decentralization is both a bug and a feature. Bitcoin is still a young asset. It is volatile because it is not yet as widespread as fiat money. But the more people own and trade it, the more stable the price is likely to be.
What determines the long-term value of Bitcoin?
Over time, the value of Bitcoin will again depend on supply and demand, but on a much larger scale. In theory, demand for Bitcoin will increase as adoption increases. The more people own and use it, the more people will want it.
The story goes on
The supply side of the equation is interesting. With fiat money like the US dollar, the Federal Reserve controls the money supply. It may increase or decrease, but as you can see below, the supply is almost always increasing. This is measured as the M2 money supply, essentially the total number of dollars circulating in the economy.
US M2 monetary supply chart
The more dollars there are in the economy, the higher the demand for goods and services, which causes prices to rise. In particular, inflation causes the purchasing power of the dollar to decrease. In other words, you can't buy nearly as much with a dollar today as it did 50 years ago. Just compare the cost of a house in 1960 to the cost today.
Bitcoin was created with a hard supply cap of 21 million Bitcoin. There can never be more. Today there are approximately 19.6 million Bitcoins. The last Bitcoin will be mined in 2140. The idea is that Bitcoin's purchasing power increases over time rather than decreasing. Why? Because there will only be so many Bitcoins to meet the ever-increasing demand. This purchasing power should ultimately increase value.
How should investors buy Bitcoin today?
The volatility makes trying to time Bitcoin and other cryptocurrencies a near-impossible task. But Bitcoin has continually increased in value over time, just as its creator intended. Although Bitcoin prices are almost 30% below their peak today and tomorrow S&P 500 At an all-time high, Bitcoin has gained far more than the broader stock market over the past 10 years.
Investors should own Bitcoin not to speculate, but because they believe in Bitcoin's purpose and its long-term potential as an alternative to fiat currency.
Bitcoin price chart
Consider buying Bitcoin with a dollar-cost averaging strategy. Always buy small quantities, often on a schedule, regardless of price. Over time you will buy some at high prices and some at low prices, but the average will even out. This way you don't invest all your money at the wrong time.
Continuous purchases and a long time horizon should allow investors to enjoy Bitcoin's success despite its sometimes wild price fluctuations.
Should you invest $1,000 in Bitcoin now?
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Justin Pope has positions in Bitcoin. The Motley Fool has positions in and recommends Bitcoin. The Motley Fool has a disclosure policy.
“If You Invested $1,000 in Bitcoin 5 Years Ago, Here's How Much You'd Have Now” was originally published by The Motley Fool
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