Bitcoin: The Future of Decentralized Finance?

**Note**
This article was originally written for and published in the first edition of The Consulate, an up and coming magazine focusing on the analysis of macro-scale international occurrences.
The magazine is the brainchild of a fellow USIU-A alumni.
Click here to visit their webpage.
**End Note**

Decentralized Finance (commonly known as DeFi) is a hot trend, fuelled by the skyrocketing growth of cryptocurrency such as Bitcoin and Ethereum. 

DeFi encompasses several technologies that have one main commonality – they do not give one central entity the power to control transactions. 

For contrast, think of transactions made using platforms like Visa or PayPal. Such transactions have that specific company acting as an authority, middleman, and gatekeeper for each transaction. When you send someone money over PayPal, the company guarantees that you have sent the money and that the other person will receive it. 

In return, you lose some percentage of your transaction in the form of transaction fees. 

Zooming into Bitcoin, this cryptocurrency is a decentralised digital currency – it avoids centralised administrators or banks. Payments in Bitcoin happen peer-to-peer (from one individual directly to another) and do not require any intermediaries. 

Centralised currencies usually work in conjunction with a bank or other financial institution to provide a central point of control over the currency. With Bitcoin, decisions regarding money supply are agreed upon democratically. 

Transactions performed using Bitcoin are verified cryptographically by nodes on the network. These transactions are stored in a ledger that is available to all nodes on the network. This ledger, which is public and distributed, is what is known as the blockchain. 

Moving on to our next point of focus, let’s look at some macroeconomic trends of the year 2021, specifically concentrating on Bitcoin-related movements.

The 2020-2021 period has been a turbulent one for the economy. Experts have claimed (several times) that we are in an asset bubble, with both US stock prices* and crypto prices soaring beyond belief or understanding. What’s even more interesting is that we can’t see any end in sight, with governments pumping billions (or trillions) into the economy via stimulus packages.

In the US, retail traders are making themselves known as a force to reckon with. Excess liquidity due to a pandemic-related drop in consumption and government-sponsored stimulus checks allowed retail traders to make waves in the stock market, notably with the attempted stock squeeze on Gamestop and AMC (which, according to users on the Reddit forum r/wallstreetbets, might still not be over). 

Citadel securities estimate that retail trades made up over 20% of all trades in 2020, double the 2019 volume. While we do not have exact numbers for 2021, it is not unreasonable to assume that increased social media-driven interest in retail trading has driven that number up to at least 25%.

We are, as cliche as the word has become, in unprecedented macroeconomic waters. 

To hammer home this point, let’s look at the performance of BitCoin through 2021. 

In the first three months of 2021, bitcoin’s value jumped 70%. Its closest physical comparable, gold shed approximately 5% in the same timeframe. In comparison, the three main stock indices in the US (Dow Jones, S&P, Nasdaq) are all up between 4% and 5%**.

It is clear that Bitcoin, in the first 3 months of 2021, outperformed every traditional investment. 

I will not decompose the performances of all the different cryptocurrencies in this article due to time and space constraints, but I will point out that:

  • The broader crypto market has also seen massive gains, well in advance of 25% for many cryptocurrencies.
  • No major cryptocurrency has matched the massive growth exhibited by Bitcoin.

Returning to the topic at hand, we have to ask ourselves: why has Bitcoin’s value jumped so high? 

Speculation has fuelled growth to some extent, and another factor we should consider is the rise in institutional interest in and uptake of the cryptocurrency. Just this year, we have seen the following institutional moves related to Bitcoin:

  • Grayscale added over $2 billion worth of BTC to their holdings
  • Tesla bought $1.5 billion worth of BTC
  • The City of Miami announced the addition of BTC to their balance sheet
  • PayPal announced they would allow payments in BTC in 2021
  • Coinbase announces a proposed public listing, opening up billions of dollars in institutional investment to BTC and crypto in general. 

Our list is by no means comprehensive, but clearly puts across a salient point: Bitcoin’s powerful first-mover advantage and increased institutional inflows make it clear the cryptocurrency is here to stay. 

Footnotes

* focus is placed on the US stock market due to its disproportionate impact on world markets
** as of time of writing (08/03/2021)

Notes from the author

  • While it is my honest belief that cryptocurrency is an excellent investment vehicle, I strongly clarify that this is not investment advice. Cryptocurrency markets are amongst the most volatile in the world, so do your research before investing.
  • Once again, this is not investment advice.
  • To the moon and beyond, fellow HODLERS.