It seems that there isn’t a day that has gone by in the last few weeks that we haven’t heard about Bitcoin. Whether it is an article on value, speculation, or a possible bubble it seems to be dominating the headlines and intriguing so many people. Bitcoin is one of well over 1,000 cryptocurrencies and in 2017 has increased in price by nearly 1,000 percent. But why the increase and should investors be looking to Bitcoin or
other cryptocurrencies to diversify their holdings?
There are differences between cryptocurrencies and traditional currencies. Traditional currencies are systems of money that serve as a medium of exchange for goods and services and are used as a basis of trade. They are typically tied to a country (or political union such at the European Union) and issued by a central bank and are convertible into other currencies. When traditional
currencies are used digitally there can be complications with the payment network, accounts, balances, and transactions. Essentially for a traditional currency to be used as a medium of exchange electronically, consensus needs to be achieved by multiple parties at multiple levels. Cryptocurrencies present a solution to this dilemma and Bitcoin was the first and seems to be the leader at this point.
Satuski Nakamoto, whose real identity
is unknown, invented Bitcoin in 2009, to facilitate peer-to-peer electronic exchange with out a central authority or those elements of consensus needed to be achieved. Some of the desirable aspects include the irreversible nature of it, it's pseudonymous, its fast and global, it's secure, and permissionless (no one can prevent you from using it). However, Bitcoin and other cryptocurrencies don’t have the backing of any government or commodities like gold and silver and the value is based on
speculation.
The boom in value lately is likely based on the mainstream starting to give attention to it and the increased usage. If all continues, investors will be able to trade futures in Bitcoin come late December 2017 and mainstream retailers are looking to accept it for payment. Financial experts are more cautious in their opinions and many are comparing it to the Tulip Mania during the Dutch Golden Age when the price of certain
tulip bulbs reached extraordinarily high levels and then dramatically collapsed in February of 1637 making it the first recorded speculative bubble. Still, some are projecting Bitcoin to continue to rise in 2018. As Tomas Carper, senior U.S. Senator (Delaware) said, “Virtual currencies, perhaps most notably Bitcoin, have captured the imagination of some, struck fear among others, and confused the heck out of the rest of us.” Perhaps that is at the heart of speculation. Ultimately a Bitcoin’s
value is based upon whatever a buyer and whatever a seller agree on.
The potential Bitcoin bubble is caused by investor remorse at not having purchased Bitcoins when they were at a lower price. The regret causes more people to buy in at higher prices, which causes the price to rise. The bubble then feeds on itself until it potentially bursts. Think of the tech bubble of the early 2000s when investors chased after tech stocks, their
prices rose dramatically and finally ended in massive bankruptcies.
So, what role does Bitcoin play as a diversifying element in your portfolio? Well, it is essential to know that the value of Bitcoin and other cryptocurrencies is based on speculation due to the high degree of risk discussed above. The extreme volatility and general security is definitely something to consider when looking at including it in your investment portfolio.
Ultimately it comes down to your comfort level with speculative investments and understanding the inherent risks associated with cryptocurrencies. As opposed to making it part of your portfolio we would recommend considering it only with money that you can afford to lose as a speculative investment.
As always, feel free to give us a call for a review of your investment account, general planning, or have
questions.
Hillary and Ryan
719.477.9883
