The Bitcoin and the cryptocurrency camps are still divided. Bitcoin supporters advocate investors embrace the digital currency mainly due to its decentralized nature. Critics point out that these currencies are like dust in the wind with no intrinsic value and only fueled by vague speculation. Moreover, the nature of its code dictates that only a finite supply of 21 million of them may ever be “mined.” Should you invest in Bitcoin? That’s what we’re going to discuss.
First, there’s a lot of muddled information out there about Bitcoin and other cryptocurrencies. Let’s start at the beginning and try to demystify what digital currencies are all about. Second, there won’t be a definite yes or no to the title of this article. But this information will give us a better understanding of if and how to invest, should we choose to do so.
What is Bitcoin?
Bitcoin is a digital currency created in 2009 by a shadowy person or group who went by the pseudonym Satoshi Nakamoto. The purpose of creating an online currency was to create a new decentralized, electronic cash system. It was designed to be completely independent of country, bank or other regulatory body.
Owners are always anonymous. Instead of names, IDs or social security numbers, sellers and buyers are only identified by their encryption keys. Unlike traditional currencies, digital currencies are mined. What that means is that when Bitcoin is sent from one person to another, a network records the transaction, including all others made over time, in a “block”.
Computers “mine” these transactions using advanced math. All transactions are inscribed in a limitless and immutable digital ledger made up of many blocks. This is what’s known as a blockchain. It’s a publicly accessible record of all transactions that have ever been made.
Subsequently, the mined blocks are converted to “hash,” or complex sequences of code, which fit into the blockchain. Now imagine thousands of miners doing this simultaneously on increasingly advanced computers running optimized software to decrease the mining time, with the winner taking it all. Once a hash is generated it is placed at the end of the blockchain. The user is then awarded 12.5 Bitcoins.
Bitcoin Price Fluctuations
The current value of one Bitcoin as of June 21 is roughly $6,755, with 12.5 of them netting approximately $84,437. Not bad, right? Well, yes and no. While $80k is a good return for a computer doing all the work, CNET remarks that the value of a Bitcoin is determined by what people will pay for it. It’s highly speculative and volatile, with values fluctuating wildly from day to day or even hour to hour.
Considering that in December 2017 one Bitcoin was worth $20,000. It then dipped below $8,000 less than two months later. Based on that volatility, it might not make a sound investment. That dip cost the global cryptocurrency market over $100 billion. It’s not just this kind of volatility that Bitcoin investors need to worry about, but also hackers.
How Secure is Bitcoin?
Bitcoin transactions and the blockchain are highly secure with the probability of transactions being hacked or duplicated extremely low (nothing is impossible just mathematically improbable). But due to the random nature of blockchain code, digital wallets and Bitcoin exchanges on the other hand can be.
Hackers stole 40 million dollars worth of cryptocurrency from an exchange in South Korea. That once again spurred a pattern of even higher volatility. Financial site Nadex reported that South Korea is the world’s third largest crypto market behind the US and Japan. Bad news, therefore, can cause quite a stir in market sentiment and drive down value while driving volatility up.
The “Official” View on Bitcoin
So, what do financial experts say? Back in November when Bitcoin’s value was on the up and up, Deutsche Bank’s chief strategist Ulrich Stephan cautioned investors about the dangers of investing in the cryptocurrency, citing warnings of a Bitcoin bubble. JPMorgan Chase & Co. CEO, Jamie Dimon also called Bitcoin a fraud, earlier last year.
Yet, others are more optimistic; UBS Chairman Axel Weber, although urging caution, indicated that there is more potential for the underlying technology inherent in cryptocurrencies. As recently as the end of May, Bank of England governor Mark Carney changed his mind and is now more open-minded about the digital currency, most likely due to the prospect of the Central Bank implementing a digital coin of its own to rival Bitcoin.
The generally negative sentiment towards Bitcoin and other digital currencies, expressed by banks and financial establishments, can be understood from the point of view that it threatens the very existence of their business model. Bitcoin and blockchain technology represent a highly disruptive and decentralized threat to a very structured and centralized establishment.
As such, through distributed and encrypted systems, smart-contracts and other automated financial transactions, blockchain can eliminate middle-men and provide more enhanced security than traditional electronic transactions. But, how does Bitcoin compare to traditional investments?
Should You Invest in Bitcoin?
Investors buy bonds and stocks because they have the potential to bring in cash flows and capital gains from possible future increases in the price. While Bitcoin may seem like it operates on the same principal of capital gains, the difference is that stocks are backed by a company’s profits and its potential to grow. Companies have cash flows from sales, investments, etc., while Bitcoin has nothing. It operates on the idea that someone may be willing to pay more for it in the future.
Other factors to keep in mind are tax-implications in the United States. The IRS views cryptocurrency as property, rather than a currency, which can have costly tax implications for merchants and traders. Even if the value plummets right after a transaction, a Bitcoin holder is liable for the tax on the amount for which it was originally purchased.
For all it may have going against it, in all fairness it has produced millionaires and billionaires. The Winklevoss twins used their $65 million Facebook payout to invest early in Bitcoin, and as a result are now billionaires. For the average investor it becomes a question of how much they can afford to lose. With trends going the way they are, however, more people are embracing cryptocurrencies and Bitcoin due to its high potential return. We also mentioned previously on Out of Your Rut how these cryptocurrencies are growing rapidly despite government and institutional resistance.
Final Thoughts on Bitcoin
Remember, however, that unlike cash or investments, Bitcoin aren’t guaranteed or protected by any institutions. If your wallet is hacked, your coins are lost forever. Whoever holds them, owns them. There are physical ways of safeguarding your digital wallet, with one of the safest, ironically, being to store it in a safety deposit box in an old fashioned bank. If you’re still on the fence about investing in Bitcoin, start by treating it as any other investment; never invest an amount of money that you can’t afford to lose.
Do you own Bitcoin, or are you thinking of investing in it?