While 2022 was a down year for cryptocurrencies, with Bitcoin (BTC 0.24%), the most valuable asset in the industry, losing 65%, things are taking a positive turn in 2023. As of Jan. 21, Bitcoin is up 36% so far on the year, and bullish supporters are hoping this is a microcosm of what’s in store over the next 12 months.
Building for speed and scalability
Since its first verified transaction in January 2009 until now, Bitcoin has primarily only been used as a store of value. Bitcoin’s defining characteristic, which is that there will only ever be 21 million coins created, makes many believe that as demand to own it increases over time, the fixed supply translates to a higher price. The comparison you’ve most likely heard is that Bitcoin is like a digital version of gold, a novel way to store wealth in a world that is only becoming more digital.
Moreover, Bitcoin was created with decentralization and security as non-negotiable traits. Not only are there thousands of miners across the world that help verify new transactions on the blockchain, but Bitcoin’s proof-of-work consensus mechanism makes it almost impossible for the network to be attacked. This is a great setup to have.
However, Bitcoin’s lack of scalability is an issue, as it can only process 3.5 transactions per second, according to bitinfocharts.com. In order for Bitcoin to evolve from a store of value to a medium of exchange, it needs to become faster at settling transactions.
Luckily, a layer 2 solution, known as the lightning network, is in the works. The lightning network is built on top of the main Bitcoin blockchain, and it essentially creates channels between different parties who want to transact frequently with each other. For example, I might open a channel with my local coffee shop or gym. Any time I buy a cup of coffee or pay my monthly membership fee, balances are updated on the lightning network. These channels can be closed at any time, at which point the transaction is sent to the Bitcoin layer for final settlement.
The benefit of lightning is that it reduces the data load on the primary Bitcoin blockchain, as transactions are settled far less frequently. Lightning solves the problem of speed, scalability, and costs.
A major fintech company like Block has already enabled free payments for its 49 million monthly Cash App users by connecting with the lightning network. Any additional news about the ongoing development and adoption of the lightning network should be closely followed in 2023, as this key feature’s progress could catapult Bitcoin’s price in short order.
Macro factors matter
Bitcoin’s price has skyrocketed quickly before. It was up 1,300% in 2017, 85% in 2019, 309% in 2020, and 1,120% in 2021, so it’s not completely out of the question for it to go parabolic in 2023. With Bitcoin’s price rising rapidly so far this year, “hodlers” are certainly hoping for the momentum to continue for the foreseeable future.
However, it’s hard to overstate how important macroeconomic factors are to the price action of risky assets, a category where Bitcoin firmly belongs. The Federal Reserve started adopting a policy of monetary tightening in March last year, actions taken to curb soaring inflation that took hold of the economy. Immediately, we saw growth tech stocks, as well as cryptocurrencies, plummet.
I’m always skeptical of any explanations that so-called financial experts provide as to why a particular asset moved up or down in a short period of time. But I think Bitcoin’s rally to start the year has something to do with inflation cooling down in recent months. And this has many hoping that the Fed will pause its rate hikes, or maybe even reverse course, sometime in 2023.
An accommodative central bank, a growing economy, and positive investor sentiment are critical ingredients for Bitcoin to continue its climb throughout the year. While progress with the lightning network is definitely something to keep an eye on, at least for now, Bitcoin’s price is fully dependent on investor enthusiasm in the near term.