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What is bitcoin?

One of the most significant innovations of the last decade, bitcoin has had a revolutionary impact on the traditional financial industry and can boast of turning investors into multi-millionaires. Those looking for big returns have come looking for profit, but how much do investors really know about the digital currency?

Imagine that the cash in your pocket and money in your bank exists only as a piece of code written on a server. This code acts as a virtual coin that you can buy items with, but can only access online and exists only in this matrix. This is asset is known as cryptocurrency.

Eight years old, the digital currency market is already worth over $97 billion¹; how can something virtual and intangible be worth that much?

It’s important to remember that value isn’t an intrinsic quality of an object, but merely a reflection of what people are willing to pay for it. Cryptocurrencies like bitcoin have the same characteristics as your average investment which means here in the UK, crypto are taxed as well; when supply is large but demand small, the product is sold for cheap. When supply is small and demand big, prices can rocket – which is exactly what has happened to bitcoin, the first and biggest cryptocurrency. 

A winning idea

The invention of cryptocurrency is a fascinating story to tell.  Bitcoin first surfaced in an online forum of computer enthusiasts in 2009, and was the brainchild of a user working under the pseudonym Satoshi Nakamoto. Bitcoin uses blockchain technology to make and record all payments and transactions in real time, without the currency holders being forced to reveal their identity.

Initially, bitcoin remained in small online forums and was exchanged between those sharing political ideals. But the efficiency of the technology behind it and its ability to be exchanged without leaving a trail caught the eyes of magpie investors who wanted to make a profit.

This flurry of demand pushed bitcoin’s value from nothing to over $2,000 a unit, turning those initial investors into multimillionaires. This bull run continued and bitcoin nearly reached $12,000, prompting fears of a bubble. 

The UK and other EU governments are planning to crackdown on bitcoin, as concerns grow that it’s being used for tax evasion and money laundering. Whilst Deputy Governor of the Bank of England Sir Jon Cunliffe doesn’t reckon bitcoin is big enough to threaten the global economy, he does warn investors to do their homework before they invest in bitcoin.

Bitcoin as an investment

If you’re looking for a passport to get rich quick, you’re probably looking in the wrong place. As with any other investment, you need to do your thorough research before you part with any money to ensure you know the characteristics of the investment, understand market trends and are aware of any risks involved. Finding rare millionaire-making gems tends to rely on being in the right place at the right time, and you’ll likely be taking on a lot of risk to get there.  

Cryptocurrencies, bitcoin in particular, still deserve your respect as an asset class. Bitcoin’s volatility doesn’t make it a great contender for investment portfolios with long time horizons, however.  If you do want to trade bitcoin over the short-term, you can manage this risk through diversification. By spreading your money across investments, asset classes and geographies, you aim to offset any short-term losses with gains made elsewhere. 

As an asset class, digital currencies should arguably be viewed as a commodity rather than a currency. Whilst currency like the US dollar and sterling are controlled by Central Banks and exist outside of their line of code, cryptocurrencies aren’t yet commonly used to exchange goods and services.

There is not one unique body that monitors bitcoin or ensures its functionality, instead, a group of blockchain users carry out the support in exchange for new bitcoin as they are released. Of course, a rush of supply could flood the market, which will weigh on the value, so new releases are carefully managed.

Investing in digital currency is risky business due to the highly volatile nature of the markets. The price swings like any other commodity, and just because it’s been pushed higher of late, doesn’t mean this momentum will continue.

Revolutionising the traditional financial system

Investors should also be aware that the technical reliability of the investment may one day be a cause for concern. Whilst the system is currently robust, a small issue could cause the price to plummet as investors rush to protect their money. The price recently weakened on news that the UK government is planning to tighten its regulation. What if governments decide to make cryptocurrency illegal because they’re unable to trace its movements?

You can speculate over the current and future value of these currencies, which will shape whether you invest in them or not, but it’s difficult to ignore the revolutionary impact this digitally innovative solution has had on the traditional financial system.

1. Guardian, 04/12/2017, Bitcoin: UK and EU plan crackdown amid crime and tax evasion fears

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