The cryptocurrency craze is here as Bitcoin is one of the hottest investments of 2017.
Demand has driven the value of the approximately 16.7 million bitcoins in circulation to almost $290 billion as of December 11, 2017. That is 18 times the value at the start of the year!
The allure of potential riches, the extreme price movement, and the extensive media coverage has left many on the sidelines with a fear of missing out. Others are worried that the skyrocketing bitcoin value will disintegrate much like the dot-com boom or the housing price bubble and are staying away.
It is important to understand what bitcoin and other cryptocurrency competitors are, as well as the risks involved in owning “coins.” The biggest difference between cryptocurrencies and traditional currencies is the lack of a physical version; no physical “coins” exist. Bitcoin and other cryptocurrencies exist solely on the internet.
Bitcoin is not issued or backed by any government or central bank. Its value is based purely on its going market price. The same could be said about investing in gold or precious gems – they may have a physical presence but their value is based on what people will pay for them and theoretically could fall to zero. Also similarly, Bitcoins do not offer interest, dividends or insurance protection for owners.
How bitcoin works
The bitcoin, a digital form of cash flow, debuted in 2009. It took a while to catch on, but the trendsetter’s eventual success bred hundreds of competitors. Bitcoin continues to lead the pack of virtual cash alternatives in market capitalization and adoption.
The new currencies use blockchain technology as their backbone. The technology works like a digital public ledger that processes transactions (completed blocks) without a bank or clearinghouse. The buyer and seller interact directly, with both accessing the technology to facilitate the transaction.
Access to one’s bitcoins requires use of a private key, kept in a digital wallet, to sign in. When someone creates a new transaction, the computer asks the wallet to sign it and then sends the information to the blockchain. The private key was developed to keep bitcoins safe, even if a computer is hacked. Other key facts about bitcoins and its peers:
- Cryptocurrencies may limit the amounts available. For example, bitcoin established a controlled supply of only 21 million bitcoins. This differs from traditional currencies that can be devalued by governments printing more. However, competition from other digital currencies can lead to devaluation of the initial ones, such as bitcoins.
- Governments could add regulation and even decide to limit the currencies’ use. For example, China banned initial coin offerings and trading in cryptocurrencies in September. Other governments could take similar actions facing lack of control over the flow of funds, tax issues or claims of protecting investors.
- Cryptocurrencies are now being targeted by hackers. Earlier this month, NiceHash, one of the largest marketplaces for mining digital currencies, had 4,700 bitcoins stolen (valued at approximately $75 million as of December 8, 2017).
- Even more startling is the notion that back in October, an estimated 25% of bitcoins that were in circulation may be unrecoverable due to lost private keys.
Experts weigh in
Fluctuation in prices of bitcoin (sometimes 10-20% daily) have raised red flags for some investors. In addition, many are concerned as the listed value in USD for one bitcoin can vary drastically from exchange to exchange at any one time, with a difference of even $2,000 observed at one point.
In the financial services industry, opinions are mixed. Bitcoin is essentially “digital gold” for millennials, Wall Street strategist Tom Lee said on CNBC late in November.
Jamie Dimon, the head of JPMorgan Chase & Co., has referred to bitcoin as “a fraud” creating a worse speculative bubble than tulip bulbs, a reference to the infamous 17th century Dutch market bubble.
Conversely, Morgan Stanley Chief Executive Officer James Gorman believes bitcoin is something more than just a fad. He said, “The concept of anonymous currency is a very interesting concept – interesting for the privacy protections it gives people, interesting because what it says to the central banking system about controlling that.”
Just last Sunday, Bitcoin futures began trading on the Chicago Board Options Exchange (CBOE). This is the first opportunity for institutional investors to be able to trade Bitcoin. Moving forward, we may see a Bitcoin exchange-traded fund (ETF) or other investment vehicles. In the interim, Bitcoin must be purchased through a website like Coinbase – you can’t yet make a purchase in your brokerage account.
Cryptocurrencies including Bitcoin remain in their infancy and the future is unknown. Most importantly, investors considering the purchase of coins need to be aware of the risks and only invest dollars earmarked for speculation which they can afford to lose.
Growth in the number of cryptocurrencies, regulation, rising transactions costs, demand volatility and more could eventually crush bitcoin prices. Or as some point in the future, we may see the need for a digital currency replace what we have today. After all, metal was the first currency. Then literacy and the printing press led to paper currency. Only time will tell if Bitcoin or another cryptocurrency will replace paper currency as the primary exchange of value in the future.
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