As someone who only recently embraced Apple Pay, and who still carries real cash in his wallet, I must admit that I was skeptical when I first heard about “bitcoin”, the digital (or virtual) currency. It’s been around since 2009, which in itself sounds like an eternity in today’s world, but the idea of not having bills and coins in my pocket or paying with a debit or credit card is still hard to imagine.
Two years ago in the weekend edition of the Wall Street Journal (January 24-25, 2015 “Review” Section), Michael J. Casey and Paul Vigna wrote a very enlightening and informative article titled “The Revolutionary Power of Digital Currency”. In that piece they stated that “Despite bitcoin’s difficulties, it represents the future of money. Digital currencies will disrupt global finance, transform the way we pay for things and, just maybe, make the world a fairer place.”
Fast forward to 2017, and Vigna reports in the January 21-22 WSJ weekend edition that a filing has been made with the Securities and Exchange Commission to list Bitcoin Investment Trust on the New York Stock Exchange “as a traditional Exchange-Traded Fund (ETF)”, an obvious way to open up the market to investors.
As we write this, Business Insider reports (Feb. 6, 2017) that bitcoin “is on track for an eighth straight day of gains”, trading at $1,026. This after a 120% gain in 2016, and a “35% plunge over a matter of days” over worries that The People’s Bank of China had found irregularities in the trading of major bitcoin exchanges.
But let’s not jump too far ahead of ourselves. Exactly what is “bitcoin”, and for those consumers who must have the latest and greatest, should it be in your portfolio?
As I mentioned at the start of this article, bitcoin is a digital currency, and as such it can be used for online transactions between individuals and companies who are buying and selling goods and services. It is a form of encrypted currency that is not backed by any country’s central bank or government. No one owns it. There’s no central computer server. You “store” Bitcoin on your computer in a “wallet” and use it to pay someone. Beyond online purchases, Bitcoin is now being used for international business payments, person to person transactions, and donations – saving financial fees and the time involved in processing credit and debit card payments.
Bitcoin comes from an “open source computer mining system”, and the market consists of a fixed supply of 21,000,000, and to date, only approximately 66-70% of the fixed supply has been released. Written into bitcoin “protocol” (“protocol” being a system of rules for trading) is the release of 25 bitcoins every 10 minutes, meaning that by 2022-2023 90% will be released. So, because of this finite supply, the theory is that bitcoin becomes worth more as time goes on, hence the increasing interest in it.
How does an investor obtain bitcoin? You can receive Bitcoin for payment of a good or service. There are no size, time, or location restrictions, it’s confidential – and there are no transaction fees which proponents argue is one of the major advantages of a digital currency. Alternatively, as I mentioned above you will soon be able to have exposure to bitcoin by investing in an ETF holding it.
How are bitcoin transactions accounted for? In what is called a “blockchain” – a globally shared public accounting ledger, if you will — a network of confirmed transactions that are transparent. “
Is it safe, you say? “Cryptography” is used to secure transactions, but there’s no question that bitcoin as a new financial “currency” poses some potential challenges. Individual “wallets” may be open to cyber attacks. Since bitcoin is decentralized, it’s unclear as to who has jurisdication over it, and it’s likely an avenue for money laundering. Furthermore, bitcoin has been extremely volatile, and for this reason has been referred to as the “Gold” of the internet.
So whether you view Bitcoin as a medium of exchange, an asset, a hedge against inflation, or even a currency, we recommend that the average investor tread very, very lightly. Casey and Vigna state that “Warren Buffett’s advice about it (bitcoin) is an emphatic ‘Stay away’”. (WSJ article of Jan. 24-25, 2015 referred to above).
As with any other type of investment, our advice as Certified Financial Planner® Professionals is that if you don’t understand it, don’t invest in it. I can recall being on a panel at a Canadian MoneySaver conference many years ago, and my fellow panelists and I were asked what we thought of jojoba beans as a tax shelter. (This, in an era when everything from houseboats to RVs were being packaged as tax shelters). One panelist spoke up immediately and said that since he didn’t know what a jojoba bean was, he certainly wasn’t going to invest in a tax shelter holding them! Great advice.
And, don’t assume that your financial advisor understands bitcoin, simply because he/she is recommending it. Compensation drives behaviour, and unfortunately there will be those advisors who want to profit by it. Our guess is that most mainstream broker/dealers will be classifying a bitcoin ETF as a “high” risk, “speculative” investment, so if your risk profile isn’t in line with this, you probably won’t be able to buy it.
For more on how Bitcoin works, I’d recommend www.coindesk.com, and their post of January 9, 2014 by Nik Custodio, “Still don’t get Bitcoin? Here’s an Explanation Even a Five-Year-Old Will Understand”. It certainly helped me!
Choose to be Worry Free™.