The Wall Street Journal reported this morning that Bitcoin, the popular digital currency, reached a few hundred dollars shy of $10,000 yesterday. The year-to-date increase in the value of Bitcoin is 896%.
While we rarely receive inquiries from our clients about so-called cryptocurrencies like Bitcoin, we suspect that many of you are aware of them and, perhaps, wondering about them. What follows is a brief primer on cryptocurrency and our thoughts about them as an investment.
Bitcoin and other cryptocurrencies are money. So, let’s start with a basic definition of money. It is medium of exchange, a measure of value and a means of payment. Money has existed for as long as humans have interacted and exchanged with each other.
So, what is a cryptocurrency? It is digital money. It serves in the same manner as conventional currency (e.g. the US Dollar, Japanese Yen, British Pound). However, cryptocurrency is different from conventional currency in some very important ways.
Crypto is short for cryptography, which is the art of writing or solving codes. Cryptography is how cryptocurrencies like Bitcoin are created, and how transactions in the currency are verified, secured, and recorded.
There are currently hundreds of cryptocurrencies in existence, and more are being created. These currencies do not transact through banks. The transactions are stored in something called the Blockchain, which is an open (i.e. public) electronic database or book of records that can store any kind of data. Transactions in cryptocurrencies occur virtually instantaneously. There is no delayed settlement as there is with conventional money transactions in the traditional banking system. Cryptocurrency transactions are anonymous and private.
Cryptocurrencies are not currently regulated in the United States. There is no central monetary authority (e.g. Federal Reserve or European Central Bank) overseeing these currencies. However, China has begun to regulate Bitcoin and other cryptocurrencies. It is very likely that other governments will follow.
The first cryptocurrency, Bitcoin, was created in 2009 by Satoshi Nakamoto (an alias for an unknown individual). Bitcoin (also abbreviated BTC) was created with a finite limit of 21 million units. Bitcoin is created by “miners” who use computers to solve highly complex calculations that verify cryptocurrency transactions and link them to the Blockchain ledger. These miners receive Bitcoin as payment for their efforts. There are currently 16 million BTCs trading, making it the largest of the cryptocurrencies.
As the Blockchain grows, the computer calculations required to mine Bitcoin and add them to the Blockchain become more complex. So, it is increasingly difficult to create Bitcoins. Miners all over the world are using vast amounts of computing power – and energy – to create new Bitcoin.
Investors interested in Bitcoin can obtain them via transactions for the purchase and sale of goods and services, and on exchanges. Buyers and sellers can agree to settlement in Bitcoin (rather than other currencies like the US Dollar). Investors can purchase or sell Bitcoin on exchanges such as Gemini or itBit in the US. There are dozens of international exchanges for Bitcoin. There are stores that accept Bitcoin for payment and ATMs that issue the cryptocurrency.
Bitcoin is stored in electronic “wallets” that reside on the internet. They are accessible via desktop computer, laptop, and mobile phone. The owner of the wallet has a unique identifier that secures the wallet. Owners are anonymous, and transactions between parties require them to share their personal keys. These transactions are then posted for miners to verify and post on the Blockchain.
How do we at Springwater assess Bitcoin (and all cryptocurrencies) as an investment?
Currencies, including cryptocurrencies, have no intrinsic value. Unlike the US Dollar and other major currencies, there is no government backing. The value of these cryptocurrencies is driven by supply and demand.
The actual supply of cryptocurrencies is unknown. A central bank of a government can control its money supply. It is not clear who (or what) is really controlling the supply of cryptocurrencies.
The market for cryptocurrencies is not regulated. The markets are vulnerable to manipulation and fraud. There have already been numerous instances of such behavior.
Cryptocurrency markets have attracted speculators, and this has resulted in extreme volatility. The value of these currencies can vary dramatically in a single day.
While there has been some acceptance of Bitcoin (and a few other cryptocurrencies) in lieu of traditional currencies, widespread adoption appears years away.
If one of our clients wanted to invest in Bitcoin, we would suggest keeping the investment to no more than 1 percent of the total value of the client’s portfolio. We would also suggest that while Bitcoin may continue to soar in value, it is also possible that it could crash and become worthless.
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