A year ago I cautioned people about a new “investment” vehicle called a Bitcoin, and since then the plot has thickened. As a reminder, a Bitcoin is an on-line digital currency supposedly created by a Japanese computer programmer under the pseudonym Satoshi Nakamoto (although that too is a mystery). The idea is to replace government-issued currencies and the need to settle transactions through a central banking system. Its issuance is controlled by a network of computers by a sophisticated algorithm. As opposed to a government that can continue to print money endlessly thereby deflating its value, the network has a finite amount of tokens that can be issued of 21 million with approximately 13.6 million already issued.
To get a newly-minted Bitcoin requires one to solve a complex equation whose answer is a 64- digit number. The people who attempt to solve this are known as “miners” and likely need a huge computer network to be successful. The equation gets more and more complex over time with the amount of Bitcoins issued per year limited and decreasing each year with all issued by 2040. Or for us common folk, we can buy a Bitcoin just like buying gold or stock.
Bitcoins are accepted by some merchants as an alternative to cash. There was even a “Bitcoin college football bowl game” a few weeks ago. You can buy goods and services with them and several networks have developed to exchange them. The underworld loves them as they do not have to launder a Bitcoin as they do with regular cash.
The value of a Bitcoin, just like gold or shares of stock, is determined by supply and demand. However, they have been extremely volatile ranging from under $200 to over $1,300 in 2013 and were valued at around $750 when I wrote my blog in early 2014. On a daily basis the value often moves up or down by 10% or more. Since the beginning of 2015 Bitcoins have cratered in value and are off 40% and are now valued at around $200. The value has dropped due to a number of reasons including China potentially not allowing them, a number of computer hacks into the system, large on-line thefts, allegations of fraud by some of its largest supporters and the closure of the largest Bitcoin exchange.
So with this large drop in value are Bitcoins safe and something you should now jump into? In my opinion a strong NO to both. Bitcoins are not backed by anything or supported by any government. They exist only in cyberspace in a network whose issuance is controlled by a complex algorithm written by an unknown person. While you may say that there is nothing backing the dollar, I beg to differ. There is an established government that for over 225 years has made good on its debts. While there are no hard assets per se backing the dollar, the U.S. government still owns vast holdings including about 30% of all the land in the country. There is NOTHING backing a Bitcoin. Some point to the controlled network making Bitcoins “tamper-proof” with a limited supply as benefits. However, the network supporting them has been hacked several times in the past year causing a sharp drop in value. My advice is to sell off any Bitcoins you have and do not accept them in your business. If you are smart enough to be a miner – go ahead but don’t hold onto the tokens for too long. They have been a horrible investment over the past year and the situation could get even worse. This very much reminds me of the tulip mania in Holland in the 1600s and the dot-com bubble of the late 1990s and both ended badly.