Without some form of higher government regulation, widespread bitcoin adoption could pose significant risks to financial stability and consumer protection. A man checks a bitcoin transaction during Adopting Bitcoin 2024 in Nuevo Cuscatlan, El Salvador, on Nov. 16.Jose Cabezas/Reuters
In the seven days after Donald Trump was declared the winner of the U.S. presidential election, bitcoin soared as much as 35 per cent to around $130,000. Given Mr. Trump’s re-election and the influx of cryptocurrency-friendly politicians in the U.S. Senate and the U.S. House of Representatives, bitcoin enthusiasts are buzzing with optimism.
They envision a future where bitcoin isn’t just a speculative asset but a mainstream medium of exchange. However, a recent study sheds light on a fundamental paradox that is tough to reconcile.
A research paper just published in the Journal of Behavioral and Experimental Economics looks into what makes bitcoin investors tick. It found that these investors aren’t just financially motivated, they’re driven by a strong desire for financial autonomy and a deep distrust of traditional institutions. They favour meritocratic over welfare-oriented systems.
In other words, they believe in a free-market system where income is distributed based on individual ability with less government intervention, as opposed to a more equitable distribution of wealth facilitated by social programs and policy. In essence, they’re rebels seeking to upend the status quo.
This mindset aligns with bitcoin’s original allure as a decentralized currency free from government control. It’s no surprise that bitcoin-heavy investors differ significantly from traditional stock investors who, comparatively, prioritize stability and are more accustomed to regulatory oversight. Bitcoiners tend to be risk-takers, often exhibiting higher levels of novelty-seeking and even gambling tendencies.
At least some crypto-enthusiasts could just be straight-up anarchists: Dogecoin, a cryptocurrency which was explicitly created as a joke, doubled in value since the election and spiked yet again after Mr. Trump announced a new Department Of Government Efficiency (DOGE) would be co-led by Elon Musk. Mr. Musk has a history of cryptic postings about dogecoin on X which are often followed by heavy price fluctuations.
But here’s the paradox: If bitcoin were to become widely used as a currency, it would inevitably require more government regulation. The very decentralization that attracts investors and speculators could lead to financial chaos if left unchecked. Without some form of higher regulation, widespread bitcoin adoption could pose significant risks to financial stability and consumer protection.
But the paradox doesn’t end there. If people believe bitcoin’s value will keep soaring, they have little incentive to spend it. Why use bitcoin to buy a coffee today if it might be worth double tomorrow? This speculative holding reduces bitcoin’s effectiveness as a currency. Currencies need to circulate to facilitate trade and economic activity.
If everyone holds on to their bitcoin, it can’t function as a medium of exchange.
So, we’re left with a conundrum. For bitcoin to achieve mainstream adoption, it would need to embrace the very regulations and oversight it was designed to avoid. This clashes directly with the beliefs of its core investors, who value decentralization and freedom from government intervention. Additionally, overcoming the hoarding mentality would require shifts in how investors perceive and use bitcoin.
Bitcoin stands at a crossroads. The very features that make it appealing are the same ones that hinder its ability to function as everyday money.
As individual investors, you can’t ignore these paradoxes when considering bitcoin as part of your investment portfolio. The allure of massive appreciation can be tempting, but it’s important to approach cryptocurrency with caution. Bitcoin’s volatility means its value can swing dramatically in short periods, which can have a significant impact on your financial well-being if you’re overexposed.
Financial advisers often recommend that high-risk assets like bitcoin should make up only a small portion of a diversified portfolio, some going as far to cap their recommendations at 1 per cent of a portfolio. Regularly rebalancing your investments also ensures that no single asset class becomes disproportionately large, which could expose you to undue risk. By keeping your bitcoin holdings to a reasonable percentage, you can participate in potential gains while mitigating potential losses.
In the end, whether bitcoin can overcome its inherent paradoxes and evolve into a mainstream currency remains uncertain. Its future needs some sort of balance between the ideals of decentralization and the practicalities of regulation and everyday use. In the meantime, keep your investments grounded, your portfolio diversified, and remember that sometimes, the smartest move is balancing innovation with caution.
Preet Banerjee is a consultant to the wealth management industry with a focus on commercial applications of behavioural finance research.
