There is no doubt that 2017 was bitcoin’s year. The digital currency had a phenomenal ride that had investors chomping at the bit trying to replicate the easy returns that have turned some fortunate investors into billionaires in under 12 months.
As you watch your friends and colleagues make an easy 1,550% from the sidelines, there’s probably some part of you that’s itching to be part of the action.
With savers having to put up with low returns on their savings accounts for nearly a decade now, and stock markets already close to record highs, it’s easy to see why these returns are tempting.
Before you get swept up in the frenzy, ask yourself the important question; is bitcoin for you?
What is bitcoin?
Rule number one when it comes to investing; only invest in what you know and truly understand.
Bitcoin is a digital currency that exists only as a piece of code written on a server, utilising blockchain technology to make and record all transactions in real time, without the currency holders having to reveal their identity.
Whilst bitcoin relies on blockchain, the technology can exist independent from the digital currency. Blockchain is now being used to support a wide range of services, including supply chain tracking and peer-to-peer payment services.
The brainchild of a user working under the pseudonym Satoshi Nakamoto, bitcoin remained in small online forums and was only traded between those sharing the same philosophical ideals.
There are now a number of different cryptocurrencies, including Ethereum, Litecoin, Dogecoin and Bytecoin.
There are a number of differences between bitcoin and other currencies, namely that you can’t physically touch the cryptocurrency. Unlike the dollar and sterling, it’s not overseen by a central bank, either.
The Bank of England, for example, looks over sterling and adapts the money supply to try and keep the value of sterling steady.
Bitcoin has no central bank and isn’t regulated. It’s a decentralised system, outlined with rules but not rulers. One of these rules is that there can never be more than 21 million bitcoin. The only way you can increase the supply of bitcoin is by mining it – where a user solves a difficult mathematical problem and gets a fraction of a bitcoin as a reward.
Remember you need to have the key to your wallet. If you lose the blockchain or if an exchange is hacked, you could be nursing a severe loss.
Bitcoin has the same fundamental dynamics of any other investment; the price increases when demand is high and supply is low.
The bitcoin frenzy has fuelled a 1,550% rally in the cryptocurrency over the last year, although this had dropped to 1,528% in a matter of hours on the day this post was written.
Which brings us neatly to volatility. Bitcoin is incredibly turbulent. The market dynamics that have allowed investors to generate blockbuster returns can also push the asset over a cliff edge the next hour – meaning investors can lose double-digit percentage points in hours.
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Recent moves to ban bitcoin in some countries like South Korea have caused bitcoin to tumble, along with rumours of regulators wanting to clamp-down on cryptocurrencies due to their popularity with money launderers and criminals.
The problem is that no one knows how to value bitcoin in a traditional sense. There’s no question that bitcoin and blockchain have revolutionised the financial industry, but you apply the same value metrics as you would with another investment.
Many commentators have drawn comparisons to tulip-mania in the 17th century, which saw the price of the bulb soar before crashing back down.
Very few investment experts are willing to say how much they reckon bitcoin is worth. The opinion from those that do varies wildly; whilst some reckon it could go to $40,000 or even $1 million, others reckon it’s on the edge of collapse. One thing’s for certain, there will be no warning signs when the time is up.
The wrong investment could be incredibly costly for you and your family. The worst thing is that no one is held accountable. Investors can regularly see from wild swings in performance, suffering double-digit blows to their portfolio value.
When you invest with a discretionary wealth manager like Moneyfarm, if your portfolio falls 10% in value, your provider has 24 hours to write explaining why.
How can you invest in bitcoin?
Whilst bitcoin is particularly popular with millenials that have no recollection of the dot-com boom and are probably suffering from FOMO, there are a number of ways you can invest in bitcoin.
You mine for bitcoin yourself, trade it through an investment platform, or buy a stake in a fund that has invested in the cryptocurrency.
As bitcoin moves to the mainstream, a number of hedge funds specialising in cryptocurrencies have recently launched, with bitcoin futures being offered by some exchanges.
However, there have been some teething problems with the platforms that allow you to trade the cryptocurrency.
What would you do if you saw the value of your bitcoin investments start to tank, but weren’t able to withdraw your money? Many platforms don’t have the capabilities to deal with the demand for bitcoin from regular investors, which has left many stranded when they need to urgently manage their money.
Time not timing
To benefit from the bitcoin boom, investors need to be able to time the market – which is incredibly difficult to do when you have no way in gauging how much an asset is worth.
Investors are relying on their ability to play the market, and judge when to get out before the bubble bursts. This can be tricky in the heat of the moment and can leave many fingers burnt.
Many investors like the adrenalin of trading a volatile asset, but only when they have an appropriate level of risk.
If you have put all your savings into bitcoin to help you afford a deposit for a house you want to buy in 18 months, you’re going to have sleepless nights. It will be painful to lose everything you’ve worked your whole life for. Still, if you’ve got some play money that needs to stretch its legs, make it work for you. But be careful and know your exit plan. Organised fun can be more exciting than many think.