Should You Invest in Bitcoins?

Category: Finance

The banking crisis in Cyprus has some people pulling their cash out of banks and investing them in Bitcoins. Media coverage of this phenomenon leads a number of people to ask, 'What is a Bitcoin, and should I invest in some, too?' Here is my primer on the first subject, a link to in-depth info, and some opinion on the second. Read on to learn more about Bitcoins...

What is Bitcoin?

Bitcoin is a form of currency that relies on cryptography for authentication (verifying that the currency is legitimate and hasn’t been tampered with) and peer-to-peer networking technology for transaction processing and records archiving. A unit of currency, also called a Bitcoin, is created out of thin air and given to someone in exchange for his/her work: processing transactions for the Bitcoin community. That person may then exchange Bitcoins for other things.

Existing Bitcoins are used in trade just like traditional currencies, with records of transactions being kept by the Bitcoin community. In fact, the first thing a desktop or Android Bitcoin app (called a “wallet”) does is download every single transaction since the first Bitcoin was created. That takes more than a day, I can attest! (Future apps are supposed to eliminate the need for this.)

No government controls or manages the Bitcoin system; the community of Bitcoin users does so through open-source software that implements the Bitcoin protocol. The peer-to-peer network that supports the Bitcoin system is as elusive and resilient as the Bittorrent network that continually defies government interference with music and video trading. Government taxation, confiscation, and direct manipulation of the value of a Bitcoin are practically impossible; a good thing, in many opinions.
Stack of Bitcoins

On the other hand, no government can protect Bitcoin users from getting ripped off. If you pay with Bitcoins and don’t receive what was promised, you are on your own. No one has figured out how to break into the Bitcoin network and steal Bitcoins yet, but no computer system is invulnerable. If someone gets into the software “wallet” from which you manage your Bitcoins, they can spend all of your virtual money. There is no way to challenge unauthorized transactions; there is no one in charge to accept such a challenge.

Bitcoins vs. Real Money

If all of this seems preposterous, consider how you acquire and use “real” money. Government creates it by saying it’s created. It’s distributed to people who work for it, trade for it, or borrow it. A network of bank, credit card, and other financial institutions’ computers keeps records of who has how much money and their exchanges of it. Still, people can get ripped off for millions of dollars and they get no satisfaction from government.

The Bitcoin Wiki is a vast labyrinth of knowledge about how Bitcoin works and how to use Bitcoin as safely as possible. Comparing the Bitcoin system to traditional monetary systems can be educational and disquieting, no matter which system you use.

Speculators – pardon me, “investors” - have become interested in Bitcoin lately because the currency’s value in terms of other currencies has been rising rapidly. In March, 2013, the dollar value of a Bitcoin jumped 360 percent. But let’s look at what happened in just one day: April 3, 2013.

Somebody launched a DDoS (Distributed Denial of Service) attack against Mt.Gox, a currency exchange handling 70 percent of worldwide trade that uses Bitcoins. The ensuing panic caused people to sell their Bitcoins and the currency’s value dropped 20 percent overnight. This probably was not idle mischief. Someone made money by borrowing Bitcoins and selling them for $X before the attack, then buying devalued Bitcoins for $X – 20% to repay the loan. The same thing happens regularly, and it will work as long as people panic and DDoS attacks are possible.

Bitcoins are a very risky investment that carries a high potential reward. As Max Gunther, author of “The Zurich Axioms,” wrote, “Every occupation has its hazards. If you keep bees, you get stung. If you invest, you worry.” Putting into Bitcoins a portion of your retirement fund that you can afford to mostly lose is not crazy; pulling it out after every DDoS attack is. The long-term outlook for Bitcoins is rather good, in theory and by design.

Like gold, Bitcoin is a limited and rare resource. By design, there can never be more than 21 million Bitcoins. As of April 9th, there were about 11 million Bitcoins, worth about $2 billion after April 3’s devaluation. It is possible for the supply of Bitcoins to max out while demand grows much more. The value of Bitcoins would soar. There is evidence that some people are hoarding bitcoins, resulting in a rapid rise in the value of the currency. The graphs and factoids in this article show it rather well.

NEWS FLASH (11 APR 2013): In another indication of how volatile the Bitcoin market can be, there was a huge Bitcoin selloff on April 10th. The BBC reports that some Bitcoin holders panicked when Mt.Gox was unable to keep up with volume of trading yesterday. Will prices rebound today? Who knows?

Demand for Bitcoin depends heavily on its widespread acceptance as a form of payment, and the ease of converting it to local currencies. If a Bitcoin currency exchange can partner with a traditional bank, as Paypal did years ago, Bitcoin debit cards that work like any others would appear. Dollars could be transferred between bank accounts, as Paypal allows today. Semi-solid rumors abound that Bitcoin exchange Bitinstant is close to doing just that.

WARNING: as of this writing, any “Bitcoin debit card” being offered is a scam. Hold onto your dollars. Also, if you use Bitcoins, keep your security software up to date. There's already at least one instance of bitcoin mining malware spreading online.

Of course, the more integrated with traditional money systems Bitcoin becomes, the more vulnerable it becomes to government regulation. Witness Paypal’s recent collection of users’ Social Security Numbers and other identity info to comply with new banking laws, and its required reporting to the IRS of users who exchange more than $25,000 annually.

So Bitcoin is not to be dismissed as a crackpot utopian pipedream or a criminal enterprise. As an investment, it should be approached with due diligence and guarded optimism. If you’re going to bet on Bitcoins, bet enough to worry about but not enough to hurt you badly should you lose it all.

Your thoughts on the Bitcoin currency system are welcome! Post your comment or question below...

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Most recent comments on "Should You Invest in Bitcoins?"

Posted by:

Louis Winter
11 Apr 2013

Hello Bob,
Would not tangible gold and silver be safer real assets than Bitcoins?
Thanks for your daily emails!

Posted by:

11 Apr 2013

Here's an interesting article:

Posted by:

11 Apr 2013

Bitcoins do seem to function as currency, but they work more or less like and electronically traded fund [etf] on a stock exchange. ETFs exist which trade physical gold and silver, stock in gold and silver deposited with third parties, and stock in gold and silver mining adventures. One can also invest in or speculate in other currencies via foreign exchange transactions or via a broker in most major cities around the world.

Bitcoins are a thin and speculative market, unless you intend to buy them and use them as money. Then you face the same risks as one does in buying/selling any other currency. Of course, that risk may be lower than the negative appreciation currently enjoyed by those holding most of the world's "guaranteed" sovereign debt.

Posted by:

Igor F.Naftul'eff
11 Apr 2013

Honestly? --- I prefer good old traditional dollars and euros... - The name is Igor, and I reside in St.Petersburg, Russia. I believe that explains everything.

Posted by:

11 Apr 2013

This is still fiat money. The risks are high going this route. If you want an edge against government interference and a hedge on inflation, physical Gold and silver are still what I would choose.

I am not it the business. This is just my personal opinion.

Posted by:

11 Apr 2013

Precious metals and Bitcoins are useless when civilization melts down. Put your money in toilet paper.

Posted by:

11 Apr 2013

Bitcoins are subject to extreme manipulation. Traders can put in many small buys using various exchanges to drive the price up. The increase in price and easy outsized returns being made attract the uninformed novice to put some money in Bitcoins. Then when big demand generated by the public comes in, the traders sell into the strength a much larger position in Bitcoins. Demand is satisfied, price goes down and the novices will sell in a panic, rinse and repeat. There will always be some new sucker. This game is as old as trading.

Posted by:

11 Apr 2013

Bitcoins functions very poorly as a currency with double digit swings in value every day. One of the most important aspects of a functioning currency is stability. I don't need to buy something today buy I will need to buy it and pay for it tomorrow. What good are Bitcoins if the underlying price that I have to pay to obtain some consumer good or service is subject to wild changes every day? How does that work for budgeting?

Posted by:

11 Apr 2013

would you or have you invested bob ? thanks for your news letter very helpfull

Posted by:

28 Feb 2014

As of today 28th February,2014 - Mt Gox has collapsed leaving thousands of Bitcoin owners unable to cash in their wallets. China has banned the trading in Bitcoins and Mt. Gox will not tell anybody the truth but it would appear that hackers have struck it rich.

Cannot anybody see that this form of trading is planned as a monumental scam to benefit only those whose invention it was. Bob - shame on you your heading should have been a warning not to get involved in 36pt bold typeface and not in a 2013 article. This was more obvious than the South Sea Bubble !!!

EDITOR'S NOTE: The collapse of MtGox in no way demonstrates the Bitcoin is some sort of insider scam. MtGox is only one of many exchanges where users can buy and sell Bitcoin. It may be an indication that some regulation is needed in the future, but it's not the end of Bitcoin, nor is it a harbinger of impending doom for other Bitcoin exchanges. To wit, Bitcoin values have remained steady in the wake of the MtGox fiasco.

Posted by:

28 Feb 2014

Dear Bob, As I was not a member of your forum at the time of your original article I could not make any comments until now. But, having re-read the article a number of times it seems to me that you were emphasizing the pitfalls regarding owning Bitcoins. What has changed your stance - have you become an owner - I notice that you did not answer this point raised by a previous poster?

You virtually castigate me for my comments yet the three faults I raised SHOULD HAVE BEEN IMPOSSIBLE with unprotected stock.

Now you contradict yourself when saying, "it may be an indication that some regulation is needed in the future." The regulation you suggest is not possible - it is that lack of control that has stimulated this 'money game'.

MtGox is/was the largest exchange at the time the funds went missing and I am not surprised that the price has remained steady in the wake of the MtGox Fiasco (your word not mine) its just that the investors know just when to 'hold them and when to fold them' and most of them can afford the waiting game.

Millions stolen, governments concerned, an admitted fiasco, what actually gives you confidence that the Bitcoin will exist this time next year?

EDITOR'S NOTE: I don't own BitCoin. Nor have I any desire to do so, as I consider it an interesting experiment. I'm not a cheerleader or a detractor of the tech. If BitCoin collapses, I'm sure something else will come along to replace it. Here are several already vying in the wings:

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