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What is Bitcoin? Should I Invest?

by Adam Oerther, CFP®

If you watch or read the news on an even semi-regular basis, chances are you have come across the term Bitcoin at least once or twice. Considering the price of Bitcoin has skyrocketed this year, with the year-to-date return at over 1000% as of December 8th, it’s no wonder the mass media has increased its coverage of the so-called “cryptocurrency” and that interest in Bitcoin has also increased significantly. Another fascinating aspect to Bitcoin is the wide spectrum of acceptance surrounding it, from JPMorgan CEO Jamie Dimon calling it a fraud, to investing guru Warren Buffet seeing a Bitcoin bubble, to Microsoft’s legendary co-founder Bill Gates saying Bitcoin is better than currency. However, my personal favorite tidbit is without a doubt the fact we don’t even know who created Bitcoin in the first place! In fact, many people who have suddenly gained interest in Bitcoin appear to be interested solely because of the sudden media coverage and various predictions that Bitcoin will be worth millions some day, rather than because of a solid understanding of what it is in the first place and whether or not it makes sense to “invest” in it. We explore these topics and more below.

What is Bitcoin?

Bitcoin is the most popular version of thousands of aptly named “cryptocurrencies,” which are essentially sets of software protocols that track transactions which are recorded in an anonymous, decentralized online ledger, or blockchain, which other software systems verify to ensure tokens are not counterfeited or re-used. This complicated algorithmic process, called “mining,” produces the digital tokens, or “coins”, which can then be used by the “miner” to facilitate trade with other coin owners or purchase goods and services.

Created by a person (or group of people) using a pseudonym, Satoshi Nakamoto, the only value these cryptocurrencies have are the value placed upon them by their users. They are not produced or regulated by any government agencies, and in fact were used primarily in their early years by criminals, due to the relative anonymity of the digital currency, to buy and sell drugs online. Since that time, interest in the blockchain technology backing cryptocurrency operations has increased in multiple sectors of the economy, including retail, finance, and even central banking.

Should I Invest?

We’ve been asked this question a lot lately, especially as the price has skyrocketed. In fact, as I was writing this article, one of our clients stopped by the office specifically to ask about Bitcoin. As we’ve pointed out previously, an investment typically involves buying and holding assets with some fundamental value attached to them. When you buy shares of Coca-Cola, you own a piece of its business, and the value of those shares is derived from Coca-Cola’s ability to use its own assets to sell its beverage products and earn a profit, part of which is rewarded to shareholders in the form of dividends.

This is not the case with Bitcoin or any other digital currency, because the only value these cryptocurrencies have is the willingness of other users to pay for them at the going price. They do not have assets, produce or sell any products, or pay dividends. While this is the case for many currencies, the difference here is the level at which the currencies are accepted among not only the users but also businesses and the government agencies that back other currencies. The exchanges on which they are listed also appear to be susceptible to hacking, with one cryptocurrency exchange recently being scammed out of close to $64 million in Bitcoins, and another back in 2014 getting taken for a whopping $460 million.

All things considered, at this juncture, we would consider buying Bitcoin or any other of the thousands of cryptocurrencies a speculative trade at best. While it is certainly possible we may be witnessing a major disruption in the way currency and other transactions are processed, it is not clear whether Bitcoin or any other cryptocurrency will be accepted as a store of value as ubiquitously as other currencies, such as the U.S. dollar, or if inevitable government intervention and regulations may negatively impact the price. To be sure, it is certainly an interesting and exciting phenomenon to watch, but with all of the unknowns surrounding it, we suggest if you’re going to put money into it, treat it like a trip to Vegas—don’t put in more than you can afford to lose.

The information presented in this article is for educational purposes only and is not meant to provide individual advice to the reader. There is no guarantee the information provided above relates to your personal situation. All financial situations are unique and should be advised as such.