A Primer on Bitcoin Investment

By , On , In General, Investment

The hottest financial commodities in existence are the various cryptocurrencies, the most popular of which is Bitcoin. Stories about Bitcoin’s meteoric rise to prominence can make it seem like a very appealing investment, especially for inexperienced investors. After all, early adopters have seen their wealth grow exponentially. Recently, the Winklevoss twins, famed Harvard rowers and supposed ‘true’ inventors of Facebook, spun $11 million of their $20 million settlement from Facebook into over a billion dollars in less than four years.

If you’re doing the math at home (their estimated wealth to-date is $1.3bn USD), that’s a more than 118-fold return on investment. Seems pretty tempting, right? After all, everyone’s predicted Bitcoin will crash, and it always does — temporarily. Then it bounces back, bigger than ever. It’s been years of these ups and downs, but the lows are never as low, and the highs only seem to creep higher. Then there’s the other side of the — well, coin. It’s the currency of the future! Secure and untethered to any particular government or bank, it’s untraceable and only getting easier to acquire and use. So, it acts as both an investment vehicle and a new currency with several big upsides. Should you be getting in on the Bitcoin boom?

Hold up. While Bitcoin has helped some early adopters strike it rich, it may not be all it’s cracked up to be. Bitcoin’s volatility is its most obvious drawback, as well as its greatest strength. It’s also in a transitional phase, caught somewhere between a commodity and a true currency, and it faces a number of competitors. Before you consider investing in Bitcoin, learn a little more about the technology and its drawbacks.

Bitcoin Mining — Where Do Bitcoins Come From?

Contrary to what you might believe, Bitcoins aren’t just produced by adding a line of code to an app or website. The technology behind Bitcoin only allows for a certain number of coins to be ‘mined’ and circulated. Mining involves the use of powerful computers that facilitate secure transfers and operate the Bitcoin infrastructure that maintains records for all Bitcoin users. For completing these tasks, the bitcoin miners are paid out in new coins, which can then be circulated in the Bitcoin economy. There are hard limits to the number of Bitcoins in circulation, and mining takes a massive amount of time and computing power for each coin, meaning only dedicated miners can expect to profit off this system. What this hard limit and requisite investment of resources does is create meaningful scarcity, imparting genuine value on each coin. As more investors race to purchase Bitcoins, their value in comparison to traditional currencies inflates, while the gradual production of more coins deflates the value, much like a traditional currency.

How Do I Buy Bitcoin?

One of the initial drawbacks to Bitcoin was how difficult it was to purchase. While any investment vehicle requires some degree of knowledge to make use of, Bitcoin was once one of the least user-friendly and complicated of them all. Understanding what Bitcoin is can be challenging enough, but purchasing and exchanging it used to require a lot of technical knowledge. Fortunately for more casual investors, services like Coinbase or Circle facilitate smaller-scale investment with minimal technical know-how. These services may require initial fees to convert your traditional currency to a cryptocurrency (and another to transfer it back, should you wish to cash out) but otherwise make the process relatively simple. If you can navigate an ecommerce store or access and use your online banking app, you can invest in Bitcoin.

Bitcoin’s Competitors

It should come as no surprise that Bitcoin isn’t the only cryptocurrency on the market. The technology isn’t proprietary or limited to one currency. As such, many newer currencies have popped up in the last few years, with varying degrees of success. Some, such as the arguably satirical dogecoin are little more than a novelty, with a single coin often bottoming out at far less than $0.01 USD. Others are much more legit — arguably moreso than Bitcoin itself. Currencies like Litecoin and Ethereum offer the same advantages (or, at least, potential advantages) as Bitcoin with faster verification times for transactions. Bitcoin can take 10 minutes or longer to complete a single transaction, due to the decentralized and encrypted nature of the currency. Litecoin in particular optimizes this verification process, often taking only 2 1/2 minutes to complete a transaction. Furthermore, Litecoin and Ethereum are actually worth something, unlike joke currencies like dogecoin. As of today, a Litecoin is worth about $275 USD, with approximately 55 million coins in circulation for a market cap around $14 billion. Meanwhile, a single Bitcoin is worth about $14,000, with a total market cap of nearly $250 billion. It’s worth noting the extreme volatility of both currencies, particularly Bitcoin. Just last week, a Bitcoin was worth just shy of $20,000 USD.

The Drawbacks of Cryptocurrency Investment

Is it a true currency?

While there are certainly reasons to consider cryptocurrency as an up-and-coming investment vehicle, there’s a lot of potentially unwarranted hype surrounding this misunderstood technology. Blockchain technology (the system through which cryptocurrencies are produced and secured) may well be the future of commerce, but it isn’t there yet. There’s some argument over whether Bitcoin and its competitors are true currencies, the way the US or Canadian Dollar are. In order for Bitcoin to be a true currency, it must meet at least two standards: one of liquidity, and one of utility. That is to say, for Bitcoin to be a currency, you must be able to transfer it to another form of wealth with ease, and be able to spend it on goods and services. Bitcoin only partially meets these requirements.
In terms of liquidity, Bitcoin gets part marks. While the Winklevoss twins are indeed Bitcoin billionaires, they can’t just cash out their Bitcoin in exchange for $1.3bn USD. Only small amounts of Bitcoin may be cashed out for traditional currency at a time; to move large quantities, one must find a buyer willing to pay market price for their coins. That presents a challenge for all the early adopters of Bitcoin, who now have a great deal of wealth in a highly unstable, comparatively difficult to trade asset.
In terms of utility, or purchasing power, it is certainly true that Bitcoins can be used to purchase goods and services through online marketplaces such as Overstock, it is not widely accepted. You cannot walk down to your grocery store and buy food with Bitcoin. It’s highly unlikely you can pay rent with Bitcoin, and you certainly can’t pay your taxes or mortgage payments with it. As such, Bitcoin is a hybrid currency and commodity. This isn’t necessarily a drawback: one must simply understand the limitations of the medium, especially its general lack of liquidity.

Will it be worth anything next year?

Another vital question. What will Bitcoin be worth in 2018? If you invest in a typical commodity, you can find reliable projections on the expected value of that commodity over the short, medium, and long term. These projections aren’t always accurate, but can be trusted to a certain degree, much like the weather forecast. Cryptocurrencies are simply an unknown. They’ve only existed for a few years, and in that time they’ve exploded and collapsed on numerous occasions. If cryptocurrency projections were weather forecasts, the expected daytime high would range from 40 degrees C to -40. No matter what anyone tells you, cryptocurrency is unstable. Whether this is just growing pains for the next innovation in commerce, or a sign of structural problems with decentralized currencies is unclear.

The Bottom Line

Bitcoin and its cryptocurrency brethren are shaking up the investment market, garnering interest from novice investors and experienced pros alike. Its meteoric ascents and incredible success stories give it a certain ‘wild west’ appeal; these are new, unforeseen frontiers for commerce. However, it’s not a safe investment by any stretch. Bitcoin cannot easily be converted to traditional currency, cannot purchase real-world necessities or interact meaningfully with other investment vehicles, and fluctuates so wildly in price that one may find themselves gaining and losing thousands of dollars in investments each day. Finally, nobody can predict whether Bitcoin will continue on its generally upward trajectory, or if it’s due for a correction to more reasonable values.
If you’re interested in investing, consider this: while all investments include some risk, cryptocurrency investment is closer to gambling. Invest cautiously and with money you can afford to lose, should the worst happen and the bottom falls out. Bitcoin belongs in your investment portfolio only as a particularly high-risk item; be sure to round it out with traditional, lower risk investment vehicles.

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