Should I be Investing in Bitcoin?

With all the recent buzz surrounding Bitcoin, it’s hard not to get excited about this relatively new currency. If you run in circles like mine, you’re likely reading, and hearing about it everywhere. For instance, just last week while on the train my phone started buzzing rapidly as a few tech buddies began filling our group chat with messages about how much money they were making as Bitcoin continued to soar to new heights. As the train pulled into the next stop, I looked up from my app and saw a man board the car in the typical tech regalia, his head donned with a snap-back cap proudly bearing none other than a Bitcoin symbol. Combined with several other encounters, this series of events was enough to convince me to investigate the craze further. After all, Bitcoin has already made a few “paper billionaires” and it seems that everyone from techies and bankers, to your dentist and even grandma is invested in this thing, so begs the question should you be too? Let’s dig in and see what all the hype is about!    

WTH is a Bitcoin, Anyway!?

Before we get into whether you should consider investing your hard-earned money in Bitcoin, let’s take a look at what Bitcoin actually is, how it came about, and just why it is so compelling to so many people.

Bitcoin is one of over a thousand cryptocurrencies currently in existence as of the time of this writing. Bitcoin, and cryptocurrencies, in general, are merely digital assets that store value and that can be used to purchase things just like using your credit card or cash. As you can imagine, the feasibility of not only Bitcoin but any currency is strongly linked to whether others are willing to accept it as a form of payment. Intriguingly, in the case of Bitcoin, many major retailers and Fortune 500 companies have announced plans to, or are already accepting Bitcoin despite the lack of an underlying asset with tangible value. What’s more is that it isn’t just small tech companies that are accepting it. The list of those accepting the currency includes household names like Microsoft, Dell, and Overstock.com, and the list will only continue to grow as the currency gains popularity.

As with just about any other major currency, Bitcoin derives its value from several factors, but chief among them is supply and demand. While demand for the cryptocurrency continues to increase due in part to its perceived anonymous nature, the supply is actually rather static. In the case of major currencies, a central bank like The Federal Reserve Bank or “The Fed” for short, in the United States can increase the supply of money rather easily by “printing” more (the Treasury actually prints money, but the Fed controls the supply of money through interest rates and reserve requirements). Bitcoin, however, must be “mined” through a complex process that limits the number of Bitcoins that will ever exist. Thus, as demand for the digital coin continues to increase faster than hackers can mine it, its value skyrockets. At any time you can check out the value of Bitcoin and other currencies on various exchanges, just like you would a stock, or currency like the Euro. Bitcoin price quotes can be easily viewed by typing the ticker “BTC” into the search bar on popular sites like Google Finance, Coinbase, and others. As of this writing, one Bitcoin is worth $11,800.

Should I Buy Bitcoin?

Now that we know a little more about Bitcoin we can explore whether we should buy into the hype. Bitcoin’s value has been increasing at an astronomical rate. To get an idea of just how fast the value has increased, take a look at the chart below, which compares Bitcoin’s change in value to that of each of the FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google) since January of this year.

As you can see, Bitcoin’s growth makes that of the FAANG stocks look non-existent. Fortunately for the many investors holding these stocks, they too have had a great year, further illustrating the point and adding to the Bitcoin hype. You can see each of the FAANG stocks’ growth below. I have removed Bitcoin for illustration.

Each of the FAANG stocks has increased its value at a faster rate than the combined markets they are typically compared to, with Facebook (FB) and Apple (AAPL) leading the way with +50% growth this year.

Up to this point, I have illustrated just how compelling the Bitcoin growth story has been this year (and if not, consider that a $10,000 investment in January of this year would be worth about $113,000 today!). Many traditional asset managers have added fuel to the fire, by publicly stating that they feel Bitcoin is far from reaching its peak value mainly because the currency isn’t mainstream yet. They believe that as this becomes less the case, much more money will pour into the currency, increasing its value even further (as high as $100,000 by some expert estimates). But while there is certainly a wealth of reasons to get excited, there may be even more reasons to be cautious. Before you hit confirm on that purchase order, let’s take a look at the proverbial other side of the coin.

What Goes Up, Must Come Down

So, we’ve all heard… This conventional thought combined with the recent run-up in price have led many to believe that Bitcoin has created an asset bubble (a situation where the asset is being valued by the public well above what it should be, often due to unfounded exuberance and other factors that do not directly increase the asset’s value), and that those that are late to the party stand to lose significantly once the music stops playing and the bubble finally bursts. One such individual is Jamie Dimon, the well-respected, and long-time CEO of JP Morgan who recently stated, “I could care less what bitcoin trades for, how it trades, why it trades, [or] who trades it,” followed by “If you’re stupid enough to buy it, you’ll pay the price for it one day.” As well respected as he is, this is still just one man’s opinion on the future, but that doesn’t mean he is wrong either. Compare the rise in Bitcoin’s value over the last year to that of the NASDAQ (the exchange/index that holds many of the world’s largest and most popular tech stocks) between 1999 and the height of the “dot-com bubble” in March of 2000.

Some have compared the recent run-up in Bitcoin’s value to that of silver between 1970 and 1980 as well.

While the charts all look similar, note that Bitcoin has increased its value by over 1000% which far exceeds the run-up in both silver in the ’70s and ’80s and the NASDAQ during the dot-com bubble. Combined with the fact that there hasn’t been anything substantive or tangible driving this increase in value, the recent explosion in value screams bubble. Now, that doesn’t mean that you can’t make money speculating in Bitcoin, rather you need to make sure that you aren’t the last one standing once the music stops playing.

So, should you invest? That depends on your personal objectives. If you are already well invested in other assets (stocks, real estate, etc.) and have spare change lying around, sure try your luck! It’s fun to speculate and it will give you something to talk about this holiday season as you gather with friends and family. Who knows, you might even make some money in the process. That said, I would not recommend seriously investing in Bitcoin as there is too much risk involved (both transaction and valuation risk). Any single misstep, be it regulatory, the prominence of another cryptocurrency, or something completely unrelated, is likely to burst the bubble and send Bitcoin crashing violently back to reality.

Armed with the above information, hopefully, you are better informed whether you decide to invest or not. If you do decide to jump in, check out this recent post by one of my favorite personal finance blogs at financialsamurai.com

At the time of this writing, I do not own any Bitcoin but may establish a position within the next 72 hours. 

*Note that Netflix was excluded from the FAANG charts, but has had a phenomenal year, increasing its value by ~48% year to date.

Sources:

https://www.cnbc.com/2017/10/27/bitcoins-origin-story-remains-shrouded-in-mystery-heres-why-it-matters.html

https://www.benzinga.com/general/education/17/08/9893336/on-the-breadth-of-cryptocurrency-how-many-different-kinds-of-digital

https://www.coindesk.com/information/what-can-you-buy-with-bitcoins/

https://www.coindesk.com/information/how-bitcoin-mining-works/

https://bitcoin.stackexchange.com/questions/161/how-many-bitcoins-will-there-eventually-be

https://finance.google.com/finance?q=CURRENCY%3ABTC&ei=jOMmWoiUMMWKe9WshIAP

https://www.bloomberg.com/gadfly/articles/2017-11-22/bitcoin-s-growing-on-jamie-dimon