This is a brief summary of my thoughts on cryptocurrencies specifically Bitcoin as an investment. Going forward I will add more about different aspects of the currency and surrounding products/markets as well as alternatives.
I am buying Bitcoin now at regular intervals because I believe that the price two years from now will be higher than it is now. If the price four weeks from now is down ninety percent I will not be bothered. It dropped ninety percent between June and December 2011 and seventy five percent between November 2013 and August 2015. Aside from those notable drops it also saw fifty, forty and thirty percent declines many times. If you are going to buy Bitcoin be prepared for drops like these.
So why buy when the price plummets like Humpty Dumpty? Well in my opinion only because Bitcoin has always put himself back together again and in the process accumulated more users, new use cases and higher demand. Over the few years that Bitcoin has been available and trading the rate of returns is significantly higher than most if not all other options.
Why I think Bitcoin is going up:
1) It provides strong utility that will likely be useful in a wide variety of areas including: international settlement, peer to peer payments, trust-less money transfer contracts between remote parties, store of wealth, etc. Before Bitcoin there was no method of distributed transactions that did not require a third party that I am aware of. Given the current trend, more people will use and adopt Bitcoin in the future and with a fixed supply the value of units should be bid higher. I will expand on use cases and potential opportunities in the future.
2) User adoption numbers are going up. Google trends results for people searching for ‘Bitcoin’ is increasing 400% per year, ‘what is bitcoin’ 150% and ‘buy bitcoin’ also at 150%. Each year more exchanges open with better infrastructure funding options and trading services. Stores and payment processors are also opening slowly allowing people to buy and earn Bitcoin from their work.
The experience of most new users is good, while some leave and some stay, the ones that stay are usually hooked. Some or a lot of people obviously bought at the peak times and then watch the price plummet and want to get out. Based on number of users active and signing up for exchanges, wallets web and forums, the user base is growing year over year.
3) Legality. In the early years of Bitcoin there was a lot of uncertainty that it was legal. The closest thing to Bitcoin, E gold and others were shutdown for violating money transmission laws in the US. Because Bitcoin doesn’t fit any traditional definition of money creation and transmission it was uncertain that it would be legal to use, own, trade, earn or buy using Bitcoin. Since then many countries have issued statements and guidance as to how they will allow and regulate the markets adding some level of certainty to investors and users.
Bitcoin is illegal in some countries however so you should check with your local authorities to ensure you are compliant with the law.
Criticisms of Bitcoin:
1) Deflation is Bad.
The issuance of Bitcoin is set at a fixed rate that is cut in half every four years until 2140 when it will stop and the only source of the currency will be that of existing owners. In the next ten years the rate of inflation will drop from 4.2% to 0.8%.
The concern is that during increased demand for currency, its availability will shrink because of a perceived higher future value. People will hold off purchases because they expect to get more bang for their buck by waiting. This will cause economic velocity to go down and prevent new lending and future growth.
This is what happens to dollar based economies. The comparison doesn’t hold though because a dollar economy is based on fractional reserve lending that has a different dynamic applied to the supply that is not applicable to Bitcoin. All dollars are created by banks as debt with interest attached but the interest that needs to be paid was never created. There is an ever expanding amount of debt attached to all actors in the dollar system. In the event of deflationary changes in the dollar economy all available liquid cash would not be enough to even pay the interest on debts let alone living expenses like food, rent, clothing. This causes all available supply of currency to quickly go to zero. Banks cant lend because they don’t have enough reserves and individuals can’t lend because they have to pay everything they have to cover existing interest payments.
This wouldn’t happen in a Bitcoin based economy to nearly the same degree. Granted during an uptrend most people would presume a higher future value of the currency but the supply would likely only contract in a linear fashion. People will still buy things, just at an adjusted value, probably.
2) It’s Too Volatile.
Bitcoin is volatile so be careful. If you are not comfortable losing your investment in Bitcoin do not buy any. If you can set aside some funds to buy without any exception on timeline for withdrawal, Bitcoins historical high rate of return and potential future expansion could outweigh the risks provided you can commit to a plan. The plan should help you avoid the case where you feel tempted to panic sell after a price drop.
Volatility in the several markets are a really good aspect to Bitcoin in my opinion. It means that users have the ability to buy and sell at prices they choose any time they decide.
There are strategies for mitigating market volatility like dollar cost average purchases and sales over time so that highs balance out lows.
3) Criminals and Drugs.
A lot of people only associate Bitcoin with drug dealers on the dark web committing crimes. They don’t want any part of something associated with criminals.
The bottom line is that a currency for everyone has to work for everyone or it wouldn’t be valuable. Regardless of how you feel about it, you can’t control what others do. I believe Bitcoin is helping people and will continue to do so in new ways. Obviously using it is a form of support and you are entitled to choose not to use it if you feel that is the right choice for you.
4) Not a Real Currency and People are just Speculating.
Some say buying Bitcoin is not an investment it is gambling because you are betting that the price will go up just because it has gone up in the past. You shouldn’t assume that past performance is an indicator of future returns. Sure but the distinction between investment and gambling is a grey area of one slippery sliding slope. Based on someones opinion all investments have some level of risk of collapse and assumption of growth based on past performance. Most people just don’t think about the risks because they may happen infrequently. Most people recommend buying stocks and government bonds because stocks are often evaluated based on past performance and bonds are still subject to default or devaluation risks.
The fact is people are using Bitcoin as a currency. People are right now earning income in Bitcoin, buying everyday things with it and trading it with others.
Some people say that Bitcoin has no intrinsic value. My thought is that nothing has intrinsic value. Everything is relative and depends on relationships with everything else. The network that connects Bitcoin users really is the essence of its value.
Detrimental factors affecting the price:
1) Inflation Rate
New currency is issued with each new block on ten minute intervals. This new currency is issued to miners and results in an increase to the total supply of Bitcoin. When the new currency is sold on exchanges it creates additional downward pressure on the price. Every four years the number of Bitcoin issued for each block creation is cut in half, reducing this downward pressure.
Back in 2013 at the peak around $1000 there were 25 BTC issued every ten minutes. The price dropped after that peak but for comparison the value of currency created each day was $3,600,000. When I started this article in July the daily created value was $4,860,000 and by the time I finished it the price had risen resulting in a daily value of $6,120,000.
While this value is high the currency is traded world wide so dividing this dollar amount by the increased number of participating traders makes this a more optimistic metric.
The most interesting observation about the amount of this newly created currency will be to compare it to the inflow of currency which I am sourcing now.
2) Technical Risks.
Bitcoin could fail catastrophically for unforeseen technical reasons. Or something new could come out tomorrow that makes it irrelevant. My estimation of this actually happening is very low because the mechanics of the currency are used in a lot of diverse and time tested systems.
3) Crime and Safety
Holding cryptocurrency involves a certain level of risk as criminals could steal your holdings using malware. It is important to understand the risks and proper use of cryptocurrency to ensure you keep it safe.
4) Regulatory Legal Risk.
While this is a much lower concern now than it was years ago, in the future government agencies may place restrictions on your ability to buy, hold and sell cryptocurrencies. As adoption grows and government agencies from around the world make their position known it is becoming clear that road blocks of this type are minimal.
My strategy in the past has been to buy when the price is historically low and going up then sell when the price is historically high and going down. This allows me to accumulate during periods of undervaluation and take some profit during periods of overvaluation.
Currently I am buying small amounts every pay cheque to accumulate an amount over a fixed period because I believe there with be growth over the next year.
I have built and use a web service that tracks top cryptocurrencies and reports on different metrics. I also have a trading bot that I can test against historical data. Despite my best efforts so far the best strategy is still to buy and hold when you have capital and to buy regular amounts over time if you have income.
As a final thought. Personally I find crypto currencies very interesting but if you want to invest there is a lot you need to know to use it properly and even with precautions it is very risky. This is not financial advice and I do not recommend that you invest with money you are not willing to lose.