What is behind the recent surge in the price of bitcoin?

The latest iteration of a sustained surge in bitcoin price has seen the cryptocurrency rise by more than 300 percent during the past year. This is the third major cycle of price spikes involving bitcoin since 2013 — the previous two “bubbles” ended with a sharp fall of over 80 percent. Unlike a stock or a bond, it is hard to determine the fundamental value of bitcoin. Its value is entirely dependent on what people think it is worth. Some boosters have claimed that bitcoin could be worth as much as $400,000 while others foresee a spectacular price collapse.

Bitcoin came into existence in 2009 and its first-mover advantage has enabled it to achieve widespread recognition and notoriety. Bitcoin and other cryptocurrencies have essentially created a new form of payment system that is based on blockchain technology, which utilizes a distributed public ledger system that is validated by a decentralized user network and whose integrity is derived from the usage of sophisticated cryptographic algorithms.

At present, bitcoin fails to fully meet the requirements to be considered a traditional form of money. Money serves three basic functions in a modern economy: It is a medium of exchange, it acts as a store of value and it is used as a unit of account. Despite recent support from PayPalSquare and other platforms, cryptocurrencies like bitcoin remain a niche payment method. Given the limited opportunities for using bitcoin to undertake normal day-to-day transactions, it is hard to consider the cryptocurrency as a viable or practical medium of exchange.

Additionally, the extraordinary volatility in the price of bitcoin makes it a poor unit of account. A common unit of account simplifies measurement of relative prices and facilitates the efficient exchange of goods and services. Wild fluctuations in the price of bitcoin (as highlighted by the now legendary story of Laszlo Hanyecz), make it infeasible for denoting relative price levels. In fact, stablecoins exhibit more future potential to act as a medium of exchange and unit of account than first-generation cryptocurrencies such as bitcoin.

At present, it is bitcoin’s role as a store of value that has generated considerable interest and much debate. Bitcoin has no intrinsic value of its own — a feature that it shares with modern fiat currencies. However, unlike fiat currencies (whose supply, in theory, is unlimited), a major part of bitcoin’s appeal lies in the fact that its supply is constrained (by design, only 21 million bitcoins are expected to ever be mined). Critics, however, note that there is nothing preventing the creation of any number of new cryptocurrencies based on the same underlying blockchain technology.

Techno-libertarians, some of the earliest adopters, are attracted to bitcoin as it is highly decentralized and utilizes a blockchain-based distributed public ledger system to record transactions. This contrasts with fiat money (such as the U.S. dollar), which is not only issued by a government-controlled authority but also requires trusted intermediaries (like banks) to maintain private account ledgers to record holdings and transactions of each participant.

Recently, bitcoin has attracted the attention of asset managers and large financial institutions. Rich investors are adding bitcoin to their portfolios as some of the stigma attached to cryptocurrencies fade. There are emerging signs that bitcoin has attained mainstream status as an alternative asset class. Rising demand and limited availability of bitcoins has contributed to the price surge.

Despite favorable recent developments, it is still extremely hard to…

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