There are lots of rumors surrounding the pretty recent technology of bitcoin. Some say it is a great get-rich-quick scheme; others argue vehemently on this. What is Bitcoin and its pros and cons? More importantly, is there a way to safely invest in it?
What is Bitcoin?
Bitcoin is a type of intangible digital currency. The clever technology underpinning Bitcoin, deeply rooted in modern supercomputing, has generated much hype. While we tend to think of money as pieces of paper and metal issued by governments, in reality, it may take many forms. By definition, currency is simply an accepted form of value and payment. Over the years this has included many things including gold or silver pieces, government-issued paper, shiny shells, or small desirable things like soap or cigarettes. Modern and esoteric forms of currency such as traveler’s checks, letters of credit, and even airline miles have no inherent value or governmental backing, but these are also currencies, used for purchases or exchange based on the guidelines of its issuers. However, what is truly novel about Bitcoin is its unique digital “mining” and communal “blockchain” accounting infrastructure.
Bitcoin’s inventor, the mysterious Satoshi Nakamoto, built original features into the DNA of his creation which has enabled it to grow quickly into a multibillion dollar asset base without oversight or promotion. “Mining” Bitcoins involves using supercomputers to solve increasingly difficult equations. Coins are awarded to miners at the conclusion of each equation, but each puzzle becomes exponentially harder. This system keeps the coin issuance to a controlled pace and is supposed to maintain the stability of the currency. Another Bitcoin innovation is that each transaction is tracked by chains of computer code, duplicated across blocks of computers all over the world, i.e., the blockchain. Because the tracking is decentralized across a network, it makes it almost impossible for anyone to counterfeit coins. This blockchain technology and its potential application in many new ways are considered quite revolutionary and potentially valuable.
Bitcoin… The Wild West of Currency
Nakamoto’s primary goal was to establish a financial system with very high security (based on the blockchain) which would enable the removal of all bank fees and other transaction costs. But although most of the available Bitcoins have already been mined, Bitcoin is not yet serving its purpose as a secure currency, and very few companies accept it as payment. Although the blockchain system itself has not been compromised, there have been many hacks on the owner’s Bitcoin “wallets,” that is the services which store and exchange the coins. In 2014, the largest Bitcoin exchange, Mt. Gox, shocked the e-currency world by announcing that it had been hacked and completely cleaned out of its 850,000 coins, some $480 million worth. Until a secure infrastructure of Bitcoin banks and brokers develops, it will remain on the fringes of the financial frontier.
Another problem with using Bitcoin as a currency is its volatile pricing. How can a company price anything in Bitcoin if its value keeps shifting drastically? Bitcoin’s lack of central management may mean that it will never provide the confidence required for widespread acceptance and it’s anyone’s guess where the upstart currency is headed. It may lose all credibility and value due to its lack of security, or it may become much more valuable as mined supply runs out and it lives up to its investors’ aspirations. Warren Buffett has scoffed at Bitcoin, calling it a mirage which may not even exist anymore in a decade. The technology world, on the other hand, has invested billions in “crypto-coin” infrastructure. Famed venture capitalist, Marc Andreessen, who has called Bitcoin technology the “new internet,” says that Buffett is out of his depth in this field.
“Investing” in Bitcoin
If you are deciding whether or not to invest in Bitcoin, you may feel that although you are betting against Buffett (usually not a good idea), at least you have Andreessen, a famous technology investor, on your side. However, Andreessen and his types agree with Buffett that new technologies often fade away, destroying the sums invested in them. But venture capitalists protect against these failures by dividing their funds among many “moonshots”: that is investments which can quickly multiply 10-fold (1000%) or even much more. They expect many investments to fail, but those that succeed have a good chance of shooting to the moon, recouping all the losses and then some. An example of this is Andreessen’s $250,000 investment in Instagram shooting to a $78 million valuation two years later!! However, investing only in Bitcoin, not in many ventures, is bet that an unproven and volatile technology will continue increasing in value and is simply a gamble. The Bitcoin “casino” is no place for you and your savings.