Bitcoin has garnered a lot of attention recently, and this is no surprise given its return of about 1000% in the last year (and over 50,000% in the last five years). It is hard to blame someone for seeing returns like this and wanting to jump on the bandwagon, but is it a smart investment to include in your portfolio today?
First off, what is Bitcoin? It has been around since 2009, though many people are only just hearing about it now. Without getting too technical, Bitcoin is a digital currency and payment system. It is a cryptocurrency, which means rather than having a central authority verify and track transactions, these records are maintained by a network of computers owned by its users. This is made possible by technology known as blockchain, which is essentially a digital ledger of every transaction that is stored on each user’s computer. Transactions are all verified by the network of users, and because every user has a copy of the ledger, the data is much harder to corrupt and manipulate. This removes the need for a trusted central authority, such as a bank or government, to oversee transactions.
What are some of the risks?
Before putting your money in an investment you should be aware of the potential risks involved, and this is no different when deciding if you should buy a cryptocurrency like Bitcoin. One main risk for Bitcoin is the fact that its price activity shows signs of being a speculative bubble. Even many proponents of Bitcoin will admit that the rapid rise in price is a bubble, but argue that it is more similar to the dot-com bubble rather than the tulip mania of 1637, which is another common comparison. In the dot-com bubble we saw many internet companies experience a large drop-off in price after a momentous run-up (like Pets.com and Webvan), while some survived and remain prominent today (such as Amazon, eBay, and Priceline.com). One can make the case that Bitcoin is the most likely to be the Amazon of cryptocurrencies, though certain events could still have the potential to burst its bubble and lead to drastic price drops.
So what are some examples of these events? Increased government regulation or major hacks are a couple things that have the potential to burst the bubble, and these two things are not unprecedented. In January 2018, concern over South Korea possibly banning the trading of Bitcoin influenced a price drop of roughly 20% over the course of a few weeks. South Korea instead only ended up banning the use of anonymous accounts to trade the currency, though Bitcoin traders got a small taste of what could come with more significant regulations. In February 2014, the exchange responsible for handing over 70% of Bitcoin transactions at the time, known as Mt. Gox, was hacked and filed for bankruptcy as a result. This led to a price decline of over 70% in Bitcoin from the beginning of that February through the next year. Such an attack on one of today’s main Bitcoin exchanges could cause devastating effects to the price at today’s levels.
So buying Bitcoin has some risks, but is it a good investment?
The blockchain technology behind the currency undoubtedly has some practical uses, and we are starting to see its adoption in major industries. Bitcoin as investment, however, is not something we recommend today. It is difficult to place a fair value on something with a price that’s based on speculation and demand, though the recent returns we’ve seen from Bitcoin are not likely sustainable. Bitcoin’s price volatility makes it a poor store of value and medium of exchange, and these are issues that would need to be resolved before it can be widely accepted as a currency. These concerns and the various risks are going to keep us from hopping on the Bitcoin bandwagon.
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