Should We Invest in Bitcoin?
Bitcoin has made the headlines in recent years, and in particular since it hit the historic value of almost $20,000 at the end of 2017, after a remarkable price run that started with the virtual currency being traded at below $1000 at the beginning of that year. This publicity went hand-in-hand with another feature of Bitcoin, which was (and is) the fact that the currency is still relatively badly understood outside of tech circles. So what is Bitcoin, and should you invest in it?
Before answering this question, it is worth reviewing a number of striking features that differentiate Bitcoin from standard (fiat) currencies. The first is that it is virtual, meaning that there is no physical version of the currency in the form of coins or notes. Everything is digital. The second feature, and perhaps the most important from an investment perspective, is that it has no central bank. All Bitcoin transactions are carried out and verified in the Bitcoin Blockchain, using what is called an elliptic curve digital signature algorithm. ‘Digital scarcity’ means that the number of Bitcoins is capped from inception at 21 million. Currently about 17 million have been produced. The production of Bitcoin (called mining) is reduced by half every 4 years.
Why are these details relevant? The fact that Bitcoin is subject to artificial scarcity has given rise to a criticism that it has a deflation problem. The argument essentially goes as follows: due to the fixed number of Bitcoin, people will hoard them, rather than spend them, in the expectation that they will be worth more in the future. This digital hoarding will prevent people from spending, and hence it can only be used as a speculative tool. This represents rich pickings for predatory speculators, using nominally fraudulent activities such as ‘pump and dump’ schemes, which cryptocurrencies are susceptible to owing to the the lack of current regulatory oversight. For individual investors, this represents significant risk.
The argument is sound if you think that Bitcoin will supplant fiat currencies in the near future (which is unlikely). If you think of Bitcoin as a way of making transactions in a fiat currency (like PayPal), then the deflationary argument disappears. If you want to sell me something for €500, I could pay you in Bitcoin. How many Bitcoin to pay with is a function of fluctuating Bitcoin prices, but we are still using a Euro-priced transaction. The price is still €500. This makes it a somewhat more stable environment for investors. With a current market cap of $111bn, there is still plenty of room for growth and hence more investment opportunities.
Of course it is not all plain sailing. China has recently taken steps to crackdown on Bitcoin trading. Other countries have done the same.. This represents a potentially serious problem for any long term investment opportunities in the currency. At the end of the day, the decision to invest depends on whether you think it will become a long term trusted store of value. For this to happen it needs to trade at around $2,000,000 a coin, much higher than it is at present. This makes investing a risky enterprise that people should undertake with a the knowledge that there is a good chance that they will make a loss. Hence only invest what you can afford to lose.
Written by Adam Watson for Together Abroad