So......What Should We Make of Bitcoin?

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If you’ve caught more than four seconds’ worth of financial media in the last 12 months, you’ve undoubtedly heard the “Bitcoin” mentioned at least a few times.  Bitcoin and other cryptocurrencies are receiving intense media coverage after skyrocketing in value in 2017.

So what should you make of it all?  Does bitcoin, ethereum, or another digital currency deserve a place in your portfolio?  First, let’s remember what bitcoins actually are.  Bitcoins, like all other digital currencies, are simply strings of computer code.  There’s no paper money or metal coins involved.  There’s no central bank issuing the currency, nor a regulator or nation that stands behind it. 

In the case of bitcoin, there is a finite supply, with about 16 million currently in circulation.  Bitcoin’s central algorithm releases a few extra bitcoins into circulation every ten minutes through a mining process.  Basically, newly released bitcoins are awarded to various groups using computing power to solve very complex math problems.  People from around the world combine their computing resources to compete in these mining contests to win bitcoins.

The mining contests will not continue forever, though.  There is a cap on total circulation of about 21 million bitcoins.  So even though the asset base is widening today, over 75% of all the bitcoins that will ever exist already do.

 

What's the Appeal of Bitcoin?

So why on earth are people buying them?  What can you actually do with them?  Digital currencies have a few different advantages over traditional fiat currencies like the U.S. dollar.  Because of that, they’re being adopted as a global currency around the world.  Transmitting funds, for example is very easy.  Bitcoins are held in digital wallets, and can be sent to anyone else around the world with a few keystrokes for free. If you were dealing in U.S. dollars, you’d need to pay international wire fees and deal in the foreign exchange markets to accomplish the same transaction. For ex-pats seeking to send money home to their family, bitcoins are a far better alternative.  The downside of this feature is that bitcoins are also often used in criminal activity.

 

The Bottom Line

Most of the frenzied buying pressure driving bitcoins’ surge beyond $15,000 is pure speculation.  And don’t kid yourselves people, bitcoin has all the classic signs of a bubble.  It’s an exciting development that could become widely adopted around the world.  But there’s also a decent chance that bitcoins are completely abandoned and go to $0. A security breach, other technological advancement, or regulation by countries around the world are a few of the potential risks.

And there inlies the reason I’m not recommending bitcoins to my clients.  Bitcoin is not an investment.  It’s a gamble.  I say this because its value is 100% tied to demand for bitcoins.  The only way an investment can provide positive returns is if someone else offers to buy your bitcoins for more than what you paid for them.  They’re not like stocks, that are shares of companies that work to produce profits.  Or bonds, that promise you pay you interest.  They’re just strings of computer code that sit in your digital wallet.  Buying them is pure speculation. 

For that reason, if you have a few extra bucks you’d be OK losing, by all means, pick up some bitcoins.  But by no means should they be added to your core portfolio.  I repeat.  Bitcoins are not an investment.  They’re a gamble.