When bitcoin was born in 2009 after the financial crisis, the goal of early investors was simple — participate in a currency market that wasn’t beholden to the whims of central banks.
But in the intervening years, the boom in other digital “cryptocurrencies” like ethereum and litecoin has enticed day traders and momentum investors who simply want to buy something that’s going higher in a hurry.
While bitcoin BTCUSD, +12.15% has been around for a while, there is still plenty of confusion about what it is. That only increased this week after bitcoin “forked” into two different currencies as a result of disputes over transaction speed, security and other issues. Now there’s old bitcoin and Bitcoin Cash, which rocketed on its first day.
My colleague Brett Arends says cryptocurrencies are garbage and warns you to stay away. But just a few weeks ago, Twitter star and wealth manager Josh Brown admitted he was diving in to the cryptocurrency craze even as he admitted not fully understanding the currency’s use or where it will ultimately wind up.
And, of course, there’s the recent record highs of about $2,800 for the value of a single bitcoin — up dramatically from $100 in 2013 and a low of just $500 a year ago.
But will bitcoin — or any of its imitators — last? And should regular investors give this “asset” serious attention, or consider it a short-lived quirk of the market?
For the record, I don’t think bitcoin is a fad, even if it has its flaws. It’s dangerous to roll your eyes at a technological advance simply because it’s different and you don’t fully understand it — as is proven by this 1995 piece scoffing at the internet or this classic TechCrunch prediction that “the iPhone will bomb.”
But it’s fair to say that while there have been big strides for bitcoin over the last few years, the digital currency may be at an inflection point in 2017. Not only does it face competition from other cryptocurrencies, but it also seems to be a source of tension from within the bitcoin community itself.
So what’s up with bitcoin, and is it worth your money?
Both proponents and detractors are very strong in their opinions. But for those still in the dark about bitcoin, here are 10 things you need to know before you consider investing:
The good news about bitcoin
Bitcoin is a real currency. Those who think bitcoin can’t be used to buy anything real are either stuck in the past or just spreading misinformation. Many independent businesses accept bitcoin, but even some big brands are getting in on the act, including a Pennsylvania Subway restaurant and software giant Microsoft Corp. MSFT, +0.73% It simply isn’t true that you can’t use cryptocurrencies to buy actual stuff.
Bitcoin transfers are fast and flexible. While many financial institutions charge you or take days to process transactions, bitcoin allows transfers from one account to another almost for free and at will. You must have some technology, of course, and you must already have your money in bitcoin form. But there are no middlemen, and users are able to transfer value more quickly and without costly processing fees.
Digital currencies are here to stay. While bitcoin isn’t perfect, its potential has won over many of the biggest names of Silicon Valley and Wall Street. Icons from Bill Gates to Richard Branson to Mark Cuban see potential — at least in the concept and blockchain technology behind bitcoin. Even if volatility in bitcoin prices is the norm and competition is heating up, there clearly is a future for digital currencies in some form.
Yes, bitcoins leave a trail. While there is some level of anonymity in the world of bitcoin, some investors misunderstand how the currency works. That stems from the fact that the digital currency uses a widespread network of users who all keep transaction ledgers using blockchain technology, instead of a central institution of record. But the important thing to remember is that the long chain of transaction histories is shared, encrypted and independently verified by a disparate group of users — not simply made up out of thin air or subject to deletion at a whim. Yes, it is very different to collectively record who has how much currency and where it has been rather than relying on a verified financial institution. But to many bitcoin users, this decentralized system is a big part of the appeal, not a drawback.
Bitcoin has a long way to grow: While many techies are excited about the prospects of bitcoin, everyone admits the currency is in its infancy. Merchants are slowly learning the potential of connecting with bitcoin, and individual consumers are slowly becoming more comfortable with digital currencies; the learning curve is encouraging. What’s more, techies and other proponents of blockchain technology continue to look beyond bitcoin at the big-time potential behind the scenes. When you look at the amazing strides in mobile payments and e-commerce over the past 15 years, it’s awfully hard to write bitcoin off.
The bad news about bitcoin
Extreme volatility. The uncertainty bitcoin faces as a new technology is not unique. However, the fact that bitcoin is easily linked to the U.S. dollar means the ebb and flow of sentiment is painfully obvious — and may make volatility even worse. Remember, there are plenty of stocks like Twitter Inc. TWTR, +0.68% that are innovative and seem to have staying power … but have still lost investors a bundle. Don’t confuse the potential utility of bitcoin with a guarantee that its value needs to rise.
A fractured future. Adding to the volatility and the prospect of losses is the fact that even if digital currencies become mainstream, there’s no guarantee that bitcoin will, despite being a first mover. It’s not just competition from Ethereum and others, either; the bitcoin community itself is fractured about where to go from here and just saw a splinter group create a competing cryptocurrency known as Bitcoin Cash. After all, BlackBerry Ltd. may have kickstarted the smartphone revolution almost 20 years ago … but it isn’t exactly sitting pretty these days.
Bitcoin isn’t truly frictionless. While it’s true that bitcoin-to-bitcoin transfers are theoretically easy, it’s an error to think participation in the market is free or without frictions. For starters, users have to exchange real-world dollars or euros for the currency, and most third-party exchanges charge a fee for that. Furthermore, many merchants “accepting” bitcoin still don’t actually deposit bitcoin into their accounts — they use a similar third-party exchange to instantly convert bitcoins back to dollars, which often comes with a cost.
Perhaps most seriously, the different value of bitcoins on different exchanges shows that the market itself remains quite inefficient and bid-ask spreads remain problematic. All that may change over time, but for now the idea that there is no “cost” associated with bitcoin is not technically true.
High-tech high jinks are a risk. I don’t pretend to be a blockchain expert, but I do know that the tail of the chain — the most recent transactions — are a common playground for thieves. While bitcoin itself may be legitimate, there are plenty of bad actors looking to game the system – including one hacker who bilked $65 million from exchange Bitfinex a year ago. And of course, the deficit in public awareness has led to plenty of misbehavior, including fraudulent exchanges that take your money and never issue any bitcoin in return.
Again … bitcoin has a long way to grow. Some of the fraud risks and inefficiencies may resolve over time. Surely better systems and consumer education will help in the long run, but that begs the question of why you would want to buy now when the digital currency remains largely on the fringes of investing and commerce.
If you like taking massive risks on things like emerging-market penny stocks, I guess bitcoin is no big deal. But for the typical investor, there are many reasons why it makes sense to wait until the market is established and stable rather than chase potential reward at a massive potential risk.