What should I do about Bitcoin?
Through shortly after New Year’s Day, Bitcoin and other cryptocurrencies were HOT. Prices were hitting new highs almost daily and rose nearly 500% in the latter portion of 2017. Considering this meteoric rise, it is understandable that news coverage was incessant and people were asking for my thoughts. While I do not consider myself an expert on cryptocurrency or blockchain technology, it is my responsibility as a financial advisor to understand enough to offer an opinion on the subject.
Blockchain Technology: A simple description is that blockchain technology is an encrypted ledger that keeps track of all users’ historical account balances and transactions on the Internet. Here is an enjoyable video from Bettina Warburg and WIRED offering an explanation of blockchain technology https://www.wired.com/video/2017/11/expert-explains-one-concept-in-5-levels-of-difficulty-blockchain/. Cryptocurrencies use blockchain technology with Bitcoin being the most successful so far. Note that cryptocurrencies aren’t even new – they’ve been around since 2009.
Cryptocurrencies – My Thoughts: I find the concept of the cryptocurrencies dubious on many levels. You may not believe that a US Dollar has any value, but I prefer the backing of the US government to the backing of the Internet. Additionally, I’m nervous enough that my bank account will be hacked, but at least I’m not openly sharing my information with the world.
While many legitimate investors are trying to capitalize on the “craze”, who actually uses cryptocurrencies? I’ve yet to meet anyone that has used a cryptocurrency to purchase something. Maybe it’s different in other parts of the world, but I feel that in the US, it is mostly used by nefarious elements to convert illegal-gotten dollars into something else. Certainly part of the allure to its users is that Bitcoin offers anonymity and freedom from regulation. How will the system be affected if law enforcement or governments decide that Bitcoin is an integral facilitator of a certain criminal activity?
Additionally, will governments around the world allow cryptocurrencies to corrupt their own government-backed currencies? I suppose it may be intended as a universal currency that transcends borders, but I wonder how governments may crack down. Some countries where the cryptocurrencies are apparently even more popular than in the US, such as China and South Korea, have already started to implement regulations, which had negatively affected pricing.
There is also the topic of supply. It is presently understood that there is a finite number of Bitcoins to be circulated (with some yet to be “mined”), but the lack of regulation means there is nothing stopping that from changing. Any increase in supply can have devastating effects on the value of each Bitcoin and even a whiff of this potential can be enough to scare market participants into a selloff.
At this time, the cryptocurrencies are not acting like a usable currency either. A usable currency needs to be relatively stable and free from large losses. Despite its spectacular rise, Bitcoin still lost more than 1% on more than 100 days last year according to data from Investing.com. What has been dubbed a speculative bubble may also be bursting as Bitcoin is currently off about 45% from its peak.
I believe in prudently allocating investment dollars into enterprises whose expected profits are derived in understandable ways, and not based on speculation or hype. In my opinion, Bitcoin and the other cryptocurrencies resemble the latter at this stage of the game. I reserve the right to revise my position as new information becomes available.
How to Invest in Bitcoin: For those that need “a piece of the action,” please do not allocate more than you can stand to lose. Here’s my understanding of how to invest:
- Exchange dollars for Bitcoin on a digital currency exchange, such as http://www.coinbase.com. You create an account (often referred to as a digital wallet) and link it to your bank so you can electronically exchange dollars for Bitcoins. Coinbase claims to use bank-level security measures to keep your account safe, but I fear a sophisticated computer hacker will be able to defraud the system so you’ll find your wallet is empty and there is no one to help you. It already happened in 2014 when Mt. Gox, the exchange responsible for handing over 70% of Bitcoin transactions at the time was hacked and filed for bankruptcy as a result.
- Buy Bitcoin Investment Trust (GBTC) in your brokerage account. It is currently the only US-approved exchange-traded Bitcoin investment vehicle. Not only does it charge a high 2% management fee, but it trades at a ridiculously large premium to the underlying Bitcoin value (currently about 40%). In exchange for the management fee and premium, you don’t have to worry about trading/storing Bitcoins yourself and can trade/track it in your brokerage account. Keep in mind that I suspect the premium will drop significantly when GBTC eventually loses its monopoly status, but when that happens is up to the regulators.
- Bitcoin futures contracts just started trading in Dec. ’17. You cannot trade futures with a small amount of money so I tend to think such investments should be left to institutional investors, but the following video will give you an idea how it works https://www.cnbc.com/2017/12/14/three-things-to-know-before-you-trade-bitcoin-futures.html. Note that some brokerage firms, like Charles Schwab, are not even offering Bitcoin futures due to perceived risks https://www.schwab.com/resource-center/insights/content/how-risky-is-bitcoin.
One More Thing: I’ve mentioned before that I think fellow investor Vitaliy Katsenelson is an excellent writer and find his articles quite entertaining. Here is his take on Bitcoin https://www.zerohedge.com/news/2017-12-24/bitcoin-%E2%80%93-millennials-fake-gold