It’s all over the news. Everyone is talking about Bitcoin. What is it? Where does it come from? Why is it so popular? Your neighbor, mailman, priest, and mother are all buying into the cryptocurrency and talking to you about it every chance they get! Even some exchanges are starting to allow bitcoin trading and futures contracts. But why? Some think it is a complete fad and will blow over. It’s time to break down what it is, why its popular, as well as some of the pros/cons.
Let’s talk a little history. Bitcoin came around in early 2009. It had no real value at this point as no one had made any transactions. That is until 2010 when the first Bitcoin transaction occurred, two pizzas for 10,000 Bitcoin. It quickly had a lot of ups and downs. Unfortunately, it was a great way for illegally traded goods to be bought and sold online. Why you might ask? Bitcoin transactions were virtually impossible to trace.
What is Bitcoin anyway? It’s a digital currency that can be used as a substitute for the dollar (or any other accepted currency) to purchase goods or services. They are created by a process called “mining” for a decentralized network. Basically, that means a system of computers process Bitcoin transactions by working algorithms, for which they receive a Bitcoin payment. This takes a lot of computing power, so there haven’t been a ton of miners available. Like any other currency, it has value because it has gained popularity and acceptance in exchange for goods. Gold being physical commodity gave it value through history. Until 1971, the US Dollar was backed by a gold standard, since then it has been backed by the “full faith and credit” of the US Government, giving it value. Unlike the dollar or gold, there is nothing ‘backing” Bitcoin; it is decentralized and limited, capping the total Bitcoin available. The government is still working through the best ways to track and tax Bitcoin transactions as well, making it more popular.
Are there pros to Bitcoin? There are. Since there are no personal information exchanged during a Bitcoin transaction, it becomes extremely difficult for identity theft to occur. Fees are low or non-existent in a Bitcoin transaction as well, easing international transactions across markets. It is also decentralized, meaning it isn’t controlled by the government, allowing for a more “free market” exchange of goods and services. Having a currently finite amount of Bitcoin available helps to regulate inflation as well.
There are some downsides to Bitcoin. The easiest to notice is the extreme volatility of the currency. Just recently, we have seen it hit new highs only to lose over 15% the next day. In it’s earlier days, it has lost nearly all its value in an incredibly short amount of time. On the flip side, it has made tremendous gains in a short amount of time as well. It is also susceptible to hacking. Not only have the main Bitcoin exchanges been hacked, your personal “wallet” can be hacked, allowing tech savvy criminals access to your money supply. Although every transaction is tracked, refunds of Bitcoin are difficult. Only the other person you made that transaction with can refund your specific bitcoins, opening the market for scams and frauds all over the world. As it gets more popular, it is inevitable that more government regulation will come. Once that occurs, people may lose all interest in Bitcoin, devaluing your stash. They could also outright deem it worthless and in an instant, the Bitcoin market can be gone. With more regulation, we could see high taxes or fees start to climb into the fray as well.
Right now, Bitcoin must be treated with caution. It’s still young and gaining traction with businesses and governments, but the extreme volatility doesn’t make it an ideal place to invest. We don’t know day to day, what the value will be and don’t have much in the way of predicting what will happen down the road. Just like the lottery or a casino, don’t rely on Bitcoin to be your only investment for the future. Contact a financial professional with questions about Bitcoin and if it could be a good fit for you.