Unless you’ve been living on a deserted island, it is pretty safe to assume you’re aware of the mass hysteria surrounding digital currency Bitcoin (you may even own that island if you’ve already invested in the currency).
Having gone from being priced at less than $1000 per coin at the start of the year, the digital currency has experienced unprecedented growth throughout 2017 and is now valued at about $17,000 per one Bitcoin.
And it seems that as each day passes, more Bitcoin billionaires are crowned, leaving the rest of us scratching our heads and thinking, ‘is it too late to invest?’
Whether to invest in anything is never an easy question as you’re essentially making an educated assessment on an outcome you have limited control over. And with many commentators predicting the Bitcoin bubble will burst, it adds another layer of uncertainty.
However, if a bubble is forming, there is still no predicting how high it will go before that happens. So the question remains, should you get in and buy Bitcoin while the going is good? And if so, are you confident that you can get out before the bubble pops?
What is Bitcoin and how does it work?
To answer the question of whether you should invest, it’s worth taking a step back and understanding what Bitcoin is and how it works.
Bitcoin is an electronic currency that isn’t controlled by a central bank or single administrator. Bitcoins aren’t printed like traditional currency, but can be used to buy things electronically.
It was conceived in 2008 as a peer-to-peer solution to traditional payment methods, with the fully electronic nature of the currency theoretically offering advantages such as purchases not being taxed and low transaction fees.
While buying things using Bitcoin transactions can be slightly tricky to understand (an explanation can be found here), it is important to understand from the perspective of assessing whether there is potential for mainstream application of the currency, which will make it more likely to be a sustainable investment.
If you are interested in Bitcoin as an investment, the easiest way to buy Bitcoin and sell it is by using an exchange service, of which there are numerous in the market. An indicative demonstration of how to do it can be found here.
To give you an indication of the meteoric rise of Bitcoin, back in 2010 the currency was priced at 1.5 US cents per Bitcoin. In 2017 alone, the currency has experienced almost a 2000% rise.
This unprecedented increase has led some, such as New Zealand’s acting Reserve Bank Governor Grant Spencer, to label the scenario as the ‘classic’ bubble.
While we’re on the topic, spare a thought for the person who literally threw away millions of dollars in Bitcoin stored on a hard drive.
The billion dollar question
So back to the billion dollar question of whether you should buy Bitcoin. One of the advantages of investing in Bitcoin is there is a controlled supply, with a maximum amount of about 21 million. The peer-to-peer nature of Bitcoin means that unlike with traditional currencies, a central bank can’t create more of it when the need arises.
The capped nature of the currency means that there is an argument for still investing in Bitcoin, as the currency is less likely to be devalued by more being produced in future.
But there are risks as well, with one of them being if a major government puts regulations around the currency, or decides to issue its own cryptocurrency.
The other disadvantage of Bitcoin is the use of it as a currency to make purchases is limited, meaning it fills a niche position in the market, and one that it is hard to see ever becoming mainstream. For this reason, it is hard to see it being anything more than a passing fancy, and certainly not a sustainable asset for an investment portfolio.
Another big risk is the exchanges where you pay for digital currency are not subject to prudential regulation, meaning it is difficult to determine who is behind them. Information such as who the exchange is operated by, where it is registered and who the directors are can be hard to determine. There is a long-list of questions that you may not be able to answer once you dig beyond the surface – how liquid is the exchange and how long does it take to settle a transaction? Once you’ve received your currency can you verify it is valid and no-one else has the same code? Is it a front for money laundering?
While it is tempting to jump on the money train and buy Bitcoin, for me, there are still too many questions surrounding it to sink a substantial amount of money into Bitcoin or other cryptocurrencies.
And this is a view echoed by some of the world’s best financial minds. Chair of the US Federal Reserve Board, Janet Yellen, has expressed a view that Bitcoin is a ‘highly speculative asset’ and that it is ‘not a stable store of value. The Governor of Australia’s Reserve Bank, Philip Lowe, also stated in a recent speech that ‘the value of Bitcoin is very volatile, the number of payments that can currently be handled is very low, there are governance problems, the transaction cost involved in making a payment with Bitcoin is very high and the estimates of the electricity used in the process of mining the coins are staggering’.
He finished with the statement that ‘the current fascination with these (crypto) currencies feels more like a speculative mania than it has to do with their use as an efficient and convenient form of electronic payment’.
These are words that are worth putting a good amount of weighting on given the mouths they’ve come from.
The future and the alternatives
Bitcoin and cryptocurrencies are efforts to make payment systems more efficient and versatile. This is not a new idea, but it is difficult to implement and to get broad adoption. With a new payment system merchants will be reluctant to invest in the technology to accept payments unless they can be assured that there will customers making payments; and customers will be reluctant to adopt the system when there are limited merchants accepting payments. It is a massive hurdle to overcome – even for better technologies.
One system that has successfully overcome this hurdle is the Hong Kong Octopus system – almost everyone in Hong Kong has an Octopus card, as you need one to travel on public transport. There is now a whole ecosystem of vending machines, kiosks and convenience stores that accept payment by Octopus cards. Consumers carry the cards and use them, and merchants willingly accept payment using them – any cryptocurrency achieving this same adoption will undoubtedly be a success.
At the moment I don’t see this adoption of cryptocurrencies, but there is starting to be adoption of the underlying ideas behind Bitcoin, most notably the ‘Blockchain’. One exciting application of Blockchain is tracking goods through the supply chain so that consumers can have confidence and trust in representations made by companies around their products (for example, that they are sourced ethically, sustainably, or made of specific components). If that system was widely adopted it would prevent (or at least expose) scandals such as horse meat being sold as beef (Europe 2013), the illegal mining of tantalum in the Congo, or the use of slave or forced labour in making clothes. The use of Blockchain technologies in the supply chain could also improve the final market value of premium products, such as Tasmanian wild-caught abalone, if consumers are able to easily verify when and where the fish was caught, and how it has been handled and processed in its journey from the sea to the plate in a fine-dining restaurant.
But back to Bitcoin and other cryptocurrencies – the big question has to be ‘what is going to drive adoption?’ Venezuela is planning on creating their own cryptocurrency, the ‘petro’, which will be backed by Venezuelan oil, gas and other mineral reserves; and even the Bank of England has toyed with the idea of releasing their own digital currency. But will you be able to pay your taxes and settle your debts with these digital currencies? If you can’t do these thing with a digital currency, even one supported by a central bank, then it is unlikely in my view that there will be wide adoption.
It is also important to recognise that Bitcoin isn’t the only cryptocurrency available. Driven by the Bitcoin surge, two of these rivals – Ethereum and Litecoin – have also experienced astonishing rises in recent weeks, but are still priced well below the current Bitcoin level.
While some of the currencies are based on interesting ideas, many of the same risks that are associated with Bitcoin also apply.
Disclaimer: Please note that the information provided in this article is of a general nature and does not constitute financial advice. The facts of every situation differ and should be discussed with a qualified advisor if advice is required.