In December of 2016, the cryptocurrency bitcoin wasvalued at a little over $600. Today it has reached nearly$18,000. So what's fueling bitcoin's increase in value? And with a1,000-fold increase in bitcoin value over the past five years, arewe staring down the barrel of a massive "bubble," similar to whathappened with Tulips in the 1600s, the dot-com implosion,and the 2008 financial crisis?

An investment in bitcoin differs from traditional stocks andbonds because it does not pay revenue to the owner, such as a stockpaying dividends. Bitcoin is very similar to gold in this regard.According to an article in Ars Technica: "Gold's valuedefies conventional market analysis in much the same way bitcoin'svalue does. Gold doesn't pay a dividend and only about 60 percentof the world's gold supply is devoted to jewelry or industrialuse."

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In addition to financial institutions being unwilling to upholdgold's value, a number of people believe the value comes from goldbeing held off the market.

A dark horse no more

Recently, financial entities have begun to give bitcoin theirstamp of approval. In November, CME Group announced it would begin tooffer bitcoin futures contracts, which is essentially, pendingregulatory approval, a wager on the bitcoin market. Likewise,NASDAQ and others have announced plans forbitcoin futures and derivatives in the first half of 2018.

While digital currency has created new millionaires in 2017,real world applications remain limited. Startups and traditionalbusinesses are looking for uses of blockchain technology andcryptocurrencies with varying levels of success. Initial Coin Offerings (ICOs) are another factorfueling digital currency growth. Similar to an IPO from atraditional company, ICOs allow users to buy a stake in a newdigital currency — the next bitcoin — with the hopes of makingmoney once the value increases.

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While much of this sounds exciting, bitcoin has historicallyshown itself to be very volatile, already having three majorbubbles with ensuing plunges in value. Bitcoin has defied critics,however, by recovering and then increasing to new heights. Becauseof this, some are issuing warnings due to market unpredictabilityand immaturity. Security and Exchange Commission (SEC) Chairman JayClayton urged both main street investors and marketprofessionals to, "please exercise extreme caution and be aware ofthe risk that your investment may be lost."

This hasn't stopped some people like Joseph Borg, president of the North AmericanSecurities Administrators Association, who recentsaid: "We've seen mortgages being taken out to buybitcoin."

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Buyer beware

Consumers also need to be aware of bitcoin's rapidly increasingtransaction fees. In the first week of December, a bitcointransaction cost $6. Now, this cost ranges between $20 and $26.This is problematic because it doesn't make financial sense to usebitcoin for smaller transactions.

The transaction fees are somewhat complicated to explain. Butwhen the number of demanded transactions exceeds the network'scapacity, users have the ability to attach an additionaltransaction fee allowing the expedition of their transaction. Thoseunwilling to pay this additional fee may wait hours or days fortheir transaction to occur.

In addition to urgency requested and network capacity, the mostimportant factor in transaction fee pricing is the size (in bytes)of the transaction. The size is dictated by the number of input andoutput coins in the transaction. In a simple example, inputs aresimilar to the amount of money you would have before making apurchase, and the outputs are the change that is made from thetransaction.

Another word of caution

Over the years, there have been a number of high-profile attacksaiming to steal bitcoins. From phishing to social engineering tomalware, attackers have continued to find ways to steal digitalcurrency. Security researchers have discovered more than 100variants of malware targeting bitcoins. "In August2016, the bitcoin exchange Bitfinex announced that hackers hadstolen $77 million worth of bitcoins. The company foisted thesecosts on to users, forcing them to take a 36-percent reduction inthe value of their deposits." It is important to note that theseattacks have been on exchanges, digital wallet software and humanerror. Bitcoin's underlying technology has so far provensecure.

Lastly, it's worth mentioning that the amount of electricalenergy that the bitcoin network is consuming annually is massive,currently quoted at 32TWh — equivalent to the usage of country ofDenmark. According to a December article in ArsTechnica, Eric Holthaus, a writer for Grist, projects that, ifthe bitcoin network continues to grow at its current rate, by 2020,the energy consumption of the network will be equivalent to thecurrent (2017) usage of the entire world.

But there is reason to believe that the bitcoin network will notcontinue to increase at the same rate. Bitcoin energy consumptionis not tied to the number of transactions processed, but, morelikely, to the effort put into bitcoin mining.

Thankfully, the creator of bitcoin has stated only 21 millionbitcoins will ever be created, and the reward (number of bitcoins)miners get for their work will continue to decrease, having fallen from 50 bitcoins in 2009, to 25 in 2012, to 12.5 in2016 and set to fall to 6.25 in 2020. With this knowledge, wecan remain hopeful that the bitcoin network will eventually find asustainable amount of electrical consumption.

Nick Graf serves as Consulting Director ofInformation Security for CNA's Risk Control unit. He can be reachedby sending email to [email protected].

See also:

Ransomware and the perils of shoddy attribution

Ransomware: What to do when it happens toyou

Cyber (in)security: Can insurance solutions keeppace with threats