Bitcoin has gotten lots of attention over the past year, as its price has skyrocketed. This post is intended as an introduction to Bitcoin and cryptocurrencies. This is not intended to be a recommendation or advice regarding purchasing Bitcoin or other cryptocurrencies, as they are highly speculative and extremely volatile.
Bitcoin was introduced in 2009 and intended to be a new form of currency, in the way dollars or gold can be used as a form of payment or exchange. Bitcoin is a worldwide currency and digital payment system. Its value changes 24/7, not like stocks, which generally trade only during specific stock market hours during the day, in each country or region. Bitcoin and other cryptocurrencies are not physical. You can not hold or touch a Bitcoin.
Four years ago, Bitcoin traded around $125. Last December and early January, 2017, the price was in the $900-$1,500 range. By August, the price first crossed $3,500. Since mid-November, Bitcoin skyrocketed from the $6-7,000 to a range of $16-17,000 in the past week.
Bitcoin is traded all over the world and is not currently regulated by governmental agencies in the US and most other countries. It has been widely used for black market transactions, money laundering, or other illegal activities. This does not imply it is only for illicit purposes. However, if it becomes more regulated, demand for Bitcoin may decline, which would cause the value to decline. Per the WSJ, as of the end of November, Japan, South Korea and Vietnam accounted for over 80% of the 2017 global trading activity. In the past few weeks, the US share of trading activity has increased.**
I have followed this more closely since the summer, when a relative told me he had purchased some Bitcoin and another cryptocurrency starting in 2015. He has done this independently of me and is not a client of WWM.
What originated as a new method of currency has evolved into a hot investment. However, most currencies are not this volatile or speculative. Note that Bitcoin is only one of many cryptocurrencies.
We cannot emphasize enough how different Bitcoin is from stocks, bonds, gold or other investments. There is nothing backing it at all. There is no basis for any valuation methodology, like an individual stock can be evaluated relative to its future earnings expectations or underlying assets. Bitcoin is not an asset in that respect and has no earnings or dividend paying ability. There is supposedly a limited supply of Bitcoin, although more can be “mined” in the future. It has increased in value due to a huge spike in demand and media attention.
What no one knows is whether this will continue to appreciate or whether this is a huge bubble waiting to burst. We would offer the following advice to anyone who has held this and has significant “paper” profits: Sell some percentage of your Bitcoin holdings (like 15-20%) and take your profits in real cash. Sell off at least your original investment. By doing this, you will have realized some actual profit and still hold the remainder, if the price goes up in the near or long-term. As we do with stock investments we recommend, we would advise anyone with these types of holdings to gradually take profits if the value increases.
As of now, we cannot assist anyone in purchasing Bitcoin or other cryptocurrencies, as none of the major financial institutions, which function as custodians, have developed a method for holding it, let alone trading it.
From what I have read and heard, buying, selling and holding it can be somewhat complicated and costly on a percentage basis (significant bid/ask spreads), at least compared to buying and selling stocks, bonds or mutual funds. There have been reports that exchanges have not been able to process trade orders on a timely basis in recent days and weeks, as volume has surged.
Bitcoin is what is referred to as a “bearer security,” meaning you have the key/individual data for what you own….and if you lose that key, then you lose your investment, as no one else has that data. It is comparable to owning stock and the only proof of ownership is the actual stock certificate. If you lose your bitcoin blockchain data (your key), you would not be able to sell your bitcoin. For a humorous look at this situation, and a primer on Bitcoin, see “The Bitcoin Engagement” episode of The Big Bang Theory on CBS, which first aired on November 30, 2017.
There are different exchanges or places to purchase and sell Bitcoin, and as of now, the prices can vary significantly between exchanges, as CNBC has recently shown. This would be like Amazon’s stock selling for three different prices at the exact same time (say $1,000, $1,050 and $1,100)…which does not occur for a stock in today’s financial markets.
Some of these issues will likely get addressed in the future. Although this is not a brand new investment/currency, with its recent publicity, the controls and exchanges should improve. But that may take months or years. Bitcoin is considered an asset for tax purposes, so any sales are reportable as capital assets for US tax purposes. Thus, you are responsible for keeping track and reporting your financial data, such as purchase and sale dates and amounts.
Summary thoughts for now: I would not call this an investment, as we generally think of that term for our clients. Due to the incredible increase in price and very volatile trading, it is a highly speculative and risky bet.
As I have told my relative and others who have asked, I have never seen any form of investment increase in value like what has occurred in the past year, during my lifetime. And I doubt I will again. If I had purchased some years ago or even prior to October, I would certainly be taking some profits, with absolutely no regrets, even if it continues to increase. Nothing goes up forever. So the real question is, how high is up? No one knows. When it goes down from a peak, how fast will it go down and will it recover? Will you have sold or taken some chips off the table? Don’t be too greedy.
If someone wanted to speculate (note, I intentionally didn’t say invest) in Bitcoin, you should be prepared to lose a very large percentage of it. Bitcoin and other cryptocurrencies may be in their infancy, but as there is no real economic valuation to evaluate Bitcoin, other than demand, this is total speculation.
If you are interested, I highly recommend that you carefully read the following materials, especially the first two:
Bitcoin: Investment or Bubble? Larry Swedroe, Director of Research, Buckingham Strategic Wealth and the BAM Alliance (Our back office firm). This article was a reference source for some of this blog post.