Why All the Excitement Over Bitcoins?
Bitcoins are maybe the most unique and potentially revolutionary financial instrument to come along in a very long time. While to many people they are an esoteric, extremely complex instrument they have only barely heard of and don’t understand, millions of people around the world have opened accounts recently to buy and sell them and the price has skyrocketed in 2017, up 16 times since January.
Coinbase, www.coinbase.com, a large bitcoin exchange that only began in 2012, this week had 13.3 million users according to CNBC, an increase of 300,000 users in the last week alone. That 13.3 million users compares to 10.6 million active brokerage accounts at Charles Schwab, one of the leading U.S. investment firms https://www.cnbc.com/2017/11/27/bitcoin-exchange-coinbase-has-more-users-than-stock-brokerage-schwab.html. This year, the price of a bitcoin is up from just under $1000 in January to just under $17,000, prompting a lot of recent news. The Wall St. Journal and Barron’s have run recent large articles, even front-page articles last week. This might be a little more than a fad.
Private Currencies – Really?
What is a bitcoin? Is it currency? Is it an investment? It is both. Where does it gets its wildly fluctuating value, up 16X since January? Well, that raises the basic question of what a currency is and how its value is set.
In the U.S. any person other than a bank can create a currency. Yes, Virginia, it’s true, the government need not issue a currency, approve it or regulate it, though it can regulate or outlaw it. In fact, according to Wikipedia, there are currently over 4,000 currencies in use in 35 countries. The value of the currency depends on what people would exchange for it. Two people could agree to use Monopoly money as currency between them if they wanted to.
The price would be literally whatever the people who accept it as payment say it is. Does that really mean that I can arbitrarily say your dollar is only worth 50 cents? Yes, it does, but since other people would likely trade more than I would for it, you’ll deal with them instead and my 50 cents offer won’t be accepted. The value will be what you can get, and because there are so many buyers and sellers, the value of a dollar is very closely agreed upon today.
That’s how bitcoin and other electronic or “cryptocurrencies” work. The available supply of bitcoins is set by a promise not to issue any more and the price is what anyone accepting it agrees it is. The more people that want to buy it, the higher the price, and people have been lining up by the millions around the world.
Bitcoin exchanges, of which there are a great number, keep track of transactions, which are all electronic and whatever the last trade was at is the price. Exchanges are set up to facilitate buying and selling because most buyers and sellers do not know each other. That is the idea of a stock exchange too, but those are heavily regulated, much more centralized, pricing is much simpler, and no one is doing any “mining,” a complex process I don’t have space to cover here.
Because buyers can shop many different places and the transactions are actually between individuals, not so much institutions as yet, the price varies, sometimes significantly, especially between countries. However, as volume has exploded, the variations are becoming smaller. There is no official price or index, but some larger exchanges, of which Kraken is the largest, are being quoted. Any that price goes up or down as more or less people demand it. After all, the supply is fixed. You can see a list of larger U.S. exchanges at https://www.bitcoin.com/buy-bitcoin
You cannot buy bitcoins at Schwab or Merrill Lynch or any bank, only through an exchange like the ones listed here https://www.bestbitcoinexchange.io/. The vast majority of this is done online. While it can be done in person, I would be very careful there, the commissions are 5% or more and these are transactions between individuals, not a store you walk into. Think Craigslist, but with trading currencies you barely understand.
Having said that, there are now bitcoin ATMs. To find one, see https://coinatmradar.com/state/34/bitcoin-atm-north-carolina/
You can even buy the bitcoins in your IRA at https://bitcoinira.com/ although I almost hate to write that because I think this is much too speculative for retirement savings.
Please note that nothing in this article is a solicitation for you to buy or sell bitcoins or any other cryptocurrency or invest in any exchange or related business. I have no financial or other interest in bitcoin exchanges or any company or product related to them and I have not exchanged any bitcoins as of this date (December 13, 2017).
So, what do you actually have when you exchange dollars for bitcoins?
Well, “on 6 August 2013, Federal Judge Amos Mazzant of the Eastern District of Texas of the Fifth Circuit ruled that bitcoins are “a currency or a form of money” (specifically securities as defined by Federal Securities Laws), and as such were subject to the court’s jurisdiction. In August 2013, the German Finance Ministry characterized Bitcoin as a unit of account, usable in multilateral clearing circles and subject to capital gains tax if held less than one year” (Wikipedia https://en.wikipedia.org/wiki/Private_currency accessed 12/13/2017).
I was surprised to learn that you can buy regular products with bitcoins at Microsoft, Expedia, Overstock and you even buy gift certificates to Amazon, Kohl’s, Home Depot at https://www.egifter.com/bitcoin/ and the list is exploding.
Security is Critical
Bitcoins are digital money only. kept it in your digital wallet, either online, on your phone, computer or offline hard drive. They can be hacked or stolen or lost if you forget the password to locate it but there are security measures you can take such as encryption, multi-factor ID and storing it offline on your hard drive. If you buy bitcoins, talk to the exchange about security measures and read up and keep up.
If the idea of purely electronic currency seems ridiculous, remember that you probably spend 99% of your dollars electronically with a debit or credit card or online payment and that your paycheck or other payment may be done via auto-deposit. Your stocks and bonds are bookkeeping entries, not paper certificates and your interest is credited as an entry in your account bookkeeping. Not much in the way of money today is carried in physical form. I rarely carry more than $50, though with an ATM I can turn electronic entries into paper bills.
Futures Contracts on Bitcoins
Bitcoin valuation seems to be a matter of rapidly increasing demand which is driven partly by increasing acceptance of it as payment and by the perceived endorsement of it by financial institutions that have started to look at ways to make money on this. It is very noteworthy that two futures exchanges, the CBE and CBOE are just now starting to trade futures contracts on bitcoins, which is the eyes of some, legitimizes bitcoins and to others gives them the ability to hedge their bitcoin investments by using futures contracts. It also opens the door to products like ETFs that can be bought and sold in traditional investment accounts, although the SEC has not to this point approved any product applications.
Reasons for Demand Growth
Why would anyone give anything for a bitcoin? For several reasons.
- Because others will, and that is the most basic reason why any currency has value.
- As a speculative investment. In other words, when they see that its price has skyrocketed, they are buying, hoping it goes up more. After all, not many people knew about it until recently, the supply is fixed, and millions of people are opening accounts and buying it.
- Mainstream retailers are starting to accept bitcoins as payment
- Futures are now available on the futures exchanges like CME and CBOE. This helps to legitimize it and also might make it more stable as the capability grows to hedge trading positions.
- Large financial institutions like Morgan Stanley are starting to invest
- The amount issued is fixed by a promise never to make any more available than are currently out there. People like that because they’ve seen the consistent decline in value caused by governments issuing more of their currency, making it less valuable. That has been the appeal of gold over the years and really for any physical asset like a particular painting or even real estate. They’re not making any more of it. People call that a store of value.
- It is decentralized, owned and traded by people all over world and not issued or controlled by any government, though several outlaw its purchase or use for purchases.
- It is hard for governments to trace transactions. That makes it ideal for money laundering which has triggered regulation to fight that, but many people that are not drug dealers or arms merchants like this feature too. For this reason, some governments have outlawed cryptocurrency trading.
- People in some countries have trouble with their government limiting available investments or how much currency they transfer outside the country. The anonymity and difficulty of tracing transactions helps get around this. This is why it is so popular in China.
- The idea that this is the future of monetary transactions using blockchains, the vehicle by which cryptocurrencies are linked, secured and verified, will become a widespread platform for how currencies and trading are handled
- Excitement around something so revolutionary and yet so basic and the amount of money that some have made
I actually have serious concerns about the security of digital currencies and the ability to just simply lose your money because for example you forgot the password to your digital account on your hard drive.
Can the value of cryptocurrencies like bitcoin also go down? Absolutely. It fluctuates in value continually.
So, Is it the newest version of a speculative investment bubble like the infamous South Sea tulips? Is this 2008 on steroids?
Actually, I think this is potentially much more like the tech bubble in 1999. That’s the last time I saw rocket launch-type price charts like Bitcoin’s. Back then, if you remember, everyone was talking about and making money on tech stocks. People were quitting their jobs to be day traders. The multiple of earnings for which NASDAQ companies sold went from 20X earnings to 190X. That did not end well, as many tech stocks lost 70-80% of their value over the next few years. In fact, I’ve never seen a chart like bitcoin’s that did not have its mirror image on right side, with very steep losses, though I have to admit that I’ve never seem a chart as dramatic as bitcoin in 2017.
When prices go nearly straight up, buyers are buying with little to no understanding or commitment, they are just buying because a lot of money has been made in a short time and they want in on it. If the price rolls over and heads down, they sell for the same reason, it is just going down and they are losing money fast.
That’s the risk now. It is impossible to know how many of those 300,000 new accounts last week were “fast money” as opposed to people who were buying the concept of a digital currency for the reasons I listed above. I have to think it is the majority, maybe the vast majority. Do we really need a digital currency, and if so, will the demand be so strong that the price going from $961.79 to $16,590 today is reasonable? I don’t think so.
Long term, there may be enough gathering critical mass, regulations and hedging using futures that cryptocurrencies have staying power. It is not out of the question that we could actually be watching a revolution in the world’s financing of trade. Bitcoin, or something related, may be the next step in the evolution of currency, the ultimate means of exchange and investment.
There has been talk for a long time of an alternative to the U.S. dollar as the world’s reserve currency. The idea of a basket of currencies has often come up and the main appeal is diversification, the lowering of risk by getting away from the fortunes of any one issuer having a dramatic effect on pricing. A widely accepted cryptocurrency could accomplish that.
At the same time, it could become the ultimate financial threat, an electronic currency so pervasive that if you are not digitally connected, you cannot buy or sell. Those familiar with the biblical prophecy that no one could sell or buy without a certain mark on the hand or forehead might easily see the connection between the necessity to be digitally connected to access their money and authoritarian control of that permission. In fact, it doesn’t take biblical prophecy to see that.
This is the high tech, digital, rapidly evolving Wild, Wild West of money and “investing,” a West that is being settled at an amazing pace, one that could only exist in the time in which we live. Of my clients, I would guess that most, especially older clients, will not buy cryptocurrencies and that the whole idea mystifies and scares them.
Right now, you’re on your own if you want to buy them. Do a lot of research and be careful. Ask lots of questions, read up and keep up. Software and websites are changing at a lightning pace and the nuts and bolts of how things are tracked and valued using blockchains and mining is much more complicated than what I have had space to go into here.
Again, please note that this article is descriptive and educational only. It is not a solicitation to buy or sell bitcoin or any other cryptocurrency and I have no financial interest in any bitcoin exchange or product at this time, nor do I own any cryptocurrencies as of December 13, 2017, although I do not rule out that at some point I might buy bitcoins for myself. At this time, I have no immediate plans to do so.