It's no secret, Bitcoin is the latest craze.
What is bitcoin?
Bitcoin is a digital payment system with no intermediaries or banks;
it was invented by a person or group using the alias Satoshi Nakamoto,
and released as open-source software in 2009. The U.S. Treasury has
categorized it as a decentralized virtual currency though some believe
it is best described as a "cryptocurrency."
- "a digital currency in which encryption techniques are used to
regulate the generation of units of currency and verify the transfer of
funds, operating independently of a central bank."
Bitcoin uses blockchain technology
to record its transactions. It's a publicly
distributed ledger for certain financial transactions. It is currently
mostly used for bitcoin, but many believe it could be used in a wide
variety of financial applications in the future.
The benefits of
this system are that it is transparent, secure, and streamlined, so that
there are less parties involved in facilitating each and every
transaction. Even as the existing payments system becomes
ever more convenient and secure, the space is still littered with middle
parties taking a small amount from each transaction. These players
include payment processors, payment networks, issuing banks, and
acquiring banks. The dream of bitcoin and other monetary systems based
on blockchain technology is for payers to be free of these inherent
costs of exchanging currency for goods.
The potential problems with investing in bitcoin
First, it is not backed or regulated by
the government or other entity. This stands in stark
contrast to all other forms of currency used
around the globe. So, many people view bitcoin as something akin to
Monopoly money, because it is neither a fiat currency
nor is it based on something of tangible value like gold. In other
words, a bitcoin is worth exactly what people perceive its worth to be.
While, in a sense, this is true of any currency, the value of a bitcoin
is much more fickle than other forms of currency because of its
unregulated nature.
Second, bitcoins are not traded on Wall Street. They cannot be bought
or sold through a brokerage. Instead, one must set up a bitcoin
"wallet," something like a bank account exclusively for bitcoins.
Once this account is set up, its holder can link to a traditional
banking account and use those funds in local currency to buy and sell
bitcoins.This means bitcoin is
much less liquid than traditional equities, creating more volatility
and wild swings. For instance, in the past month alone, the value of one
bitcoin fell from prices over $2,500 to under $2,000 before regaining
all-time highs over $3,400. Those are incredibly volatile swings within
one month -- something virtually unheard of with any other type of
currency!
Finally, the unique way of buying and selling bitcoins not only
contributes to its less liquid nature, but has also contributed to higher
rates of fraud and theft through uninsured bitcoin exchanges. Also, one should note that none of the bitcoin exchanges have yet established a
long business track record.
Where do the price and value of bitcoin go from here?
Unfortunately, no one knows. Many believe,
bitcoin could fall anywhere -- from being known as a worthless
experiment, to being the greatest disruptive force the financial
industry has ever seen.
If friends wanted to purchase a small, speculative
position in bitcoin, I wouldn't try to talk them out of it. However --
and I cannot stress this enough -- nothing should be invested in bitcoin
currency that an investor isn't comfortable losing.
