Bitcoin (BTC) is a new type of digital currency, with cryptographic keys, that is decentralized on a network of computers used by users and miners from all over the world and is not controlled by a single organization or government. It is the first digital cryptocurrency that has caught the attention of the public and is accepted by a growing number of merchants. Like other currencies, users can use the digital currency to purchase goods and services online, as well as in some physical stores that accept it as a form of payment. Forex traders can also trade Bitcoins on Bitcoin exchanges.
There are several important differences between Bitcoin and traditional currencies (for example, the US dollar):
- Bitcoin does not have a centralized authority or clearing house (for example, the government, the central bank, MasterCard, or the Visa network). The peer-to-peer payment network is managed by users and miners from all over the world. Currency is transferred anonymously directly between users over the Internet without going through a clearinghouse. This means that the transaction fees are much lower.
- Bitcoin is created through a process called “Bitcoin mining.” Miners around the world use mining computers and software to solve complex bitcoin algorithms and approve bitcoin transactions. They are given transaction fees and new Bitcoins generated by solving Bitcoin algorithms.
- There is a limited amount of Bitcoins in circulation. According to Blockchain, there were about 12.1 million in circulation as of December 20, 2013. The difficulty of mining Bitcoins (solving algorithms) gets harder as more Bitcoins are generated, and the maximum amount in circulation is capped at 21 million. The limit will not be reached until around the year 2140. This makes Bitcoins more valuable as more people use them.
- A public ledger called ‘Blockchain’ records all Bitcoin transactions and shows the respective holdings of each Bitcoin owner. Anyone can access the public ledger to verify transactions. This makes the digital currency more transparent and predictable. More importantly, transparency prevents fraud and double spending of the same Bitcoins.
- The digital currency can be acquired through Bitcoin mining or Bitcoin exchanges.
- The digital currency is accepted by a limited number of merchants on the web and at some physical retailers.
- Bitcoin wallets (similar to PayPal accounts) are used to store Bitcoins, private keys and public addresses, as well as to transfer Bitcoins anonymously between users.
- Bitcoins are not insured or protected by government agencies. Therefore, they cannot be recovered if the secret keys are stolen by a hacker or lost due to a failing hard drive, or due to the closure of a Bitcoin exchange. If the secret keys are lost, the associated Bitcoins cannot be recovered and would go out of circulation. Visit this link to see frequently asked questions about Bitcoins.
I think Bitcoin will gain more public acceptance because users can remain anonymous while buying goods and services online, transaction fees are much lower than credit card payment networks; anyone can access the public ledger, which can be used to prevent fraud; the currency supply is capped at 21 million, and the payment network is operated by users and miners rather than a central authority.
However, I don’t think it’s a great investment vehicle because it’s extremely volatile and not very stable. For example, the price of bitcoin grew from around $14 to a high of $1,200 USD this year before falling to $632 per BTC at the time of writing.
Bitcoin surged this year as investors speculated that the coin would gain wider acceptance and its price would rise. The coin plunged 50% in December because BTC China (China’s largest Bitcoin trader) announced that it could no longer accept new deposits due to government regulations. And according to Bloomberg, the Chinese central bank has banned financial institutions and payment companies from handling bitcoin transactions.
Bitcoin is likely to gain greater public acceptance over time, but its price is extremely volatile and highly sensitive to news, such as government regulations and restrictions, which could negatively affect the currency.
Therefore, I do not suggest that investors invest in Bitcoins unless they have been purchased at less than $10 USD per BTC because this would allow a much higher safety margin.
Otherwise, I think you’re much better off investing in stocks that have strong fundamentals as well as great business prospects and management teams because the underlying companies have intrinsic values and are more predictable.
Disclosure: Victor Liang has no positions in Bitcoins and has no plans to change his position in the next 72 hours.
