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Currently, cryptocurrencies are everywhere – in the news and commercials. A Dutch radio broadcasting company recently advertised a competition to win a Bitcoin. Simultaneously legally questionable hypes like ‘pump and dump’ (where investors join forces to artificially push a coins’ value and afterwards sell it to profit) seem to suggest that cryptocurrency are rather a bubble than a safe haven. But we have also seen Coinbase, one of the largest platforms in cryptocurrency, going public at Nasdaq and large investment companies setting up an infrastructure for Bitcoin. Does this reflect a new momentum for cryptocurrency? Is it the new gold or just a rush? And what about the threat of increasing power usage connected to Bitcoin and the influence of Elon Musk?

‘Blockchain, Bitcoin, crypto – many of these terms are often used interchangeably. But we have to distinguish Bitcoin from other cryptocurrencies and the underlying technology - blockchain,’ says Thomas Walther from the Utrecht ľ¹Ï¸£ÀûÓ°ÊÓ School of Economics (U.S.E.): ‘there are countless types and very different ways to establish a cryptocurrency. And if you look broader than Bitcoin, the ideas of blockchain and trust without a third party are spreading even more. We see a movement of acceptance of cryptocurrency.’

Thomas Walther is a financial econometrician and is studying the modelling and forecasting of volatility measures (i.e. the price range of financial assets like stocks or cryptocurrencies). ‘The state of the economy for example is a strong predictor for the price range of crypto currencies,’ he says. ‘When there is a lot of uncertainty in the market, we see higher price ranges.’

Some economists, like Rens van Tilburg from the Sustainable Finance Lab, suggest that an unstable economy boosts the investments in cryptocurrencies. With the global effect of the Covid pandemic and the effects on the economy in mind, this could also be the case in springtime this year.'

Does Thomas Walther think there is a new momentum for cryptocurrency?

A movement of acceptance

‘When your neighbour is telling you which crypto you have to buy, usually that is the moment where markets crash, right? Other people even call Bitcoin a pyramid scheme, although it was out of the hands of its creators from a very early stage because of the decentralised nature of the blockchain.

A cryptocurrency is only worth as much value as people attribute to it. And if more people and institutional parties believe in cryptocurrencies, they will be more stable. Bitcoin is the first, most matured, and most prominent of the cryptocurrencies and that’s why investors go into Bitcoin – ironically to minimize the risk while investing in a cryptocurrency. Bitcoin is by far not as volatile as it was. While Bitcoin experienced large price movements in the past, today it behaves more like a risky stock with daily jumps occasionally up to 10%.

Bitcoin is not the new gold

In 2018, the Bitcoin price went up to about 20.000 dollars and it was praised as the ‘new gold’. A safe haven for investments for times when traditional markets crash with the universal appeal of a gold rush. In our paper, we actually show that Bitcoin behaves contrary to that belief. We find that Bitcoin prices tend to jointly drop with the stock market. Hence, it is not a safe investment if stock markets go south. Newer studies mostly arrive at the same conclusion. Nothing much has changed – until last year.

For cryptocurrencies and especially Bitcoin, we see a movement of acceptance from institutional investors. Big investment companies like Goldman Sachs and JP Morgan are rethinking their strategies with regard to crypto currencies. That is really a game changer. It is also a reason for the price going up: large money is going into that market. Plus: the general perception is changing and more retail investors are following this trend. Another indicator for acceptance: the largest US based cryptocurrency exchange platform Coinbase went public on Nasdaq, in early 2021, which pushed crypto markets as well.'

Big investment companies like Goldman Sachs and JP Morgan are rethinking their strategies with regard to crypto currencies. That is really a game changer.

'And let’s not forget Elon Musk (Tesla). He pushed the nonsense cryptocurrency dogecoin (a currency that was introduced to mock the cryptocurrency concept), lets Tesla invest millions of dollars in Bitcoin, and offers customers to pay their cars in Bitcoin or their prospective space travels in dogecoins. Musk may not be an institutional investor, but as an influencer he attracts a lot of media attention and awareness for cryptocurrencies as investments. How much impact on the market he has was apparent in the last days, when he suspended the option to buy Tesla cars with Bitcoins due to environmental concerns.'

trust without a third party

Not just Bitcoin

‘Unfortunately, people often confuse Bitcoin with the wider set of cryptocurrencies or even the concept of blockchain. Bitcoin is just one out of many cryptocurrencies, and only one particular use case for the blockchain technology. The last time I checked, there were more than 9,000 different cryptocurrencies. While some are just clones of Bitcoin, most of them are conceptionally very different from Bitcoin.

For example, Bitcoin uses a concept called ‘proof-of-work’ to avoid the necessity of a central party to verify transactions (consensus). Simply speaking, the concept is a large lottery and the lottery tickets are paid with computer power. The winner is allowed to create a new ‘block’ in the ‘chain of blocks’ which verifies transactions. That is why this concept, and Bitcoin in particular, is so energy intense, with currently more than 100 TWh per year, which is about the annual consumption as the Netherlands.

But, there are other, less energy intense concepts. For instance, cryptocurrencies like Tezos, Dash, or Cardano use ‘proof-of-stake’, where users receive more lottery tickets the more coins they own. The second largest cryptocurrency Ethereum has plans to switch to this concept.

Also, most of these cryptocurrencies use a public blockchain technology, which is in need of some kind of consensus idea (e.g. ‘proof-of-work’ or ‘proof-of-stake’). This technology is great for use cases where one doesn’t have or want a central party involved. Alternatively, a private blockchain with a central, trusted party is also less energy intense since it does not have to establish a consensus. The private blockchain is therefore in the centre of use cases for verification processes in the industry, or for central bank digital currencies.'

For Bitcoin, even after those exceptional changes in the acceptance, we can’t tell if it is the new gold, a safe haven for investments, before we actually experience the next financial crisis. In any case, Bitcoin is paving the way for cryptocurrencies in general, especially for the more energy-efficient cryptos, and the blockchain technology.’

More information

Would you like to know more about (the volatility of) digital currency please contact Thomas Walther: t.walther@uu.nl.