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Bitcoin – What is it and should I be investing in it?

Posted on 20 December 2017

Warren Buffett, one of the most well-known and successful investors in history, once said, “Never invest in a business you don’t understand”.

Very few people really understand cryptocurrencies, but because of Bitcoin’s meteoric rise in recent years, many people are asking themselves, what is Bitcoin and should I be investing in it?

The qualities of cryptocurrencies mirror those of normal currencies in 2 key features:

  • they are difficult to counterfeit, and
  • you can’t spend the same currency twice

In addition to Bitcoin being a cryptocurrency it is a worldwide payment system. It is the first decentralised digital currency. The reason for this being that the system works without a central bank or single administrator. It involves a network of peer to peer transactions that take place between users directly using cryptography, without an intermediary. The transactions are verified by nodes and recorded in a public distributed ledger called a blockchain.

In 2010, one Bitcoin was worth less than one hundredth of an Australian cent. Each Bitcoin is now supposedly worth more than $20,000. But why?

The market capitalisation of Bitcoin is now well over $160 billion, which is larger than the GDP of many small countries. And all of this unrealised wealth is built on promises.

A promise that one day it will be a recognised fiat currency – that is, one that can be taxed by governments and used for official transactions, and to buy the full range of goods and services.

The value is built on the fact that there will only ever be 21 million Bitcoins ‘minted’ and there are currently 16 million of them. This makes them a store of value, similar to gold, but it also means that the people who got in early when the minting was easy will make a fortune if Bitcoins are legitimised at the cost of those who come in late.

Bitcoins are totally untraceable, which makes them very attractive to someone with a criminal bent.

According to research from UTS Business School, nearly half (around 43 to 49 per cent) of bitcoin transactions are related to buying and selling illegal goods such as drugs, weapons and pirated software.

UTS finance professor and research study co-author Talis Putnins, PhD student Jonathan Karlsen, and Sydney University senior lecturer Sean Foley tracked illegal bitcoin use across the globe from 2009 to 2017, a statement from UTS read.

“The aim of our research is to help regulators understand the size of the task they face in attempting to monitor and regulate bitcoin, particularly as it becomes mainstream – for example listing on futures exchanges,” Mr Putnins said.

“The blockchain technology that underpins bitcoin holds significant promise for revolutionising many industries, but this sort of illegal activity risks stunting the adoption of this technology and limiting the potential benefits to society.”

Results from the team’s research paper, Sex, Drugs and Bitcoin, revealed that one-third (32 to 34 per cent) of bitcoin users were using the cryptocurrency for illegal activities, with half of all bitcoin transactions for the purposes of trading illegal goods.

“The paper describes how bitcoin has become the PayPal of the dark web, which is estimated to contain approximately 30,000 domains,” the statement said.

“Users involved in illegal activity are very active in terms of buying, selling and trading, whereas legal users are largely buying and holding the cryptocurrency,” Mr Putnins said, pointing to the FBI’s seizure of over $4 million bitcoin from the online drug marketplace The Silk Road in 2013.

The research team uncovered illegal bitcoin transactions by tracing the activity of bitcoin users who had been caught for engaging in online criminal activity through two methods: information from the ‘dark web’ and identifying common characteristics of illegal bitcoin user activity.

Other reasons to be sceptical of Bitcoin:

  • the supposed ‘network effect’ which is one of the primary factors that crypto-enthusiasts discuss when making the case for Bitcoin. While it may well be the best-known cryptocurrency, it doesn’t change the fact that as monetary assets, both the US Dollar, and gold, have far superior network effects, which Bitcoin is not even close to replicating.
  • are investors confusing Bitcoin’s potential as a payment mechanism, versus its potential as money itself, something akin to mistaking the “pipelines for the oil”?
  • with over 96% of all Bitcoin held by just over 4% of Bitcoin wallets is the concentration of ownership not an issue that should be cause for concern?
  • Bitcoin forks should also be a concern for investors – they bring in to question the ‘consistency’ of Bitcoin. Any monetary instrument that lacks consistency is surely doomed to fail, as this is a fundamental prerequisite for a sound and widely acceptable monetary instrument.

While we are supportive of free markets and competition, the whole idea of a world of competing cryptocurrencies is a little “out there” for us, at least at this stage anyway.

Before investing in Bitcoin be sure to do your research, be wary of the people who may or may not be trading legally and remember the words of the wise Warren Buffett – don’t invest in something you don’t understand.

Vue Financial

The author is an employee of Vue Financial Pty Ltd, Authorised Representative of Count Financial Limited, AFSL 227232.

Important information:

The information in this article is provided for illustrative purposes only and does not take into consideration your personal circumstances. You are encouraged to seek financial advice suitable to your circumstances to avoid a decision that is not appropriate. Any reference to your actual circumstances is coincidental. Count Financial Limited and its representatives receive fees and brokerage from the provision of financial advice or placement of financial products.

 

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