Bitcoin. You’ve probably heard one or two of your tech friends talk about it. Or you scrolled through your news feed and saw the headline, “Meet The Man Traveling the World On $25 Million Of Bitcoin Profits.” Buying Bitcoin seems like a no-brainer and you have serious FOMO because just about everyone you talk made money off of it. It’s only natural that you want in, too! But before you go head first buying Bitcoin, I want to give you a quick overview of Bitcoin and it’s history plus a few cautionary warnings to consider before risking your hard earned money on Bitcoin.
WTF is Bitcoin and How Does it Work?
Bitcoin s a digital currency unaffiliated with any government regulator or country. On it’s most basic level, a Bitcoin is a computer file, stored in a ‘digital wallet‘ app on a smartphone or computer. Individuals can send Bitcoins (or fractions of Bitcoins) to other individuals that are willing to accept Bitcoin to purchase goods, or an individual can purchase Bitcoin as an ‘investment’, with the belief that the value of Bitcoin will go up and he or she will make money when they eventually sell it.
What Determines Bitcoin’s Price Fluctuation?
Unlike traditional currencies like the US Dollar, Bitcoin is not issued by a central bank (the Federal Reserve) or backed by a government. So typical factors that influence the US Dollar like strength of the US economy, inflation, and interest rates do not apply. Instead, the main determinant of Bitcoin price is supply and demand:
- Supply: The bitcoin protocol allows for new Bitcoins to be created through a process called “mining”. Think of this as the equivelant of minting new Bitcoin but the difference is that instead of one central entity like the Federal Reserve creating new money, any individual with the technical expertise and computer horsepower can mine new Bitcoin through a fairly rigorous and energy intensive process. It’s been noted that the Bitcoin network is consuming power at an annual rate of 32TWh—about as much as Denmark mainly due to highly energy dependent effort to power the supercomputers to mine Bitcoin. The technical expertise, cost of supercomputers to mine Bitcoin, and limits outlined in the Bitcoin protocol, create limits that limit the supply of Bitcoin.
- Demand: Like any other currency, the existinace of many buyers interested in purchasing Bitcoin boosts demand and the price that any individual is willing to pay. In early 2011 one Bitcoin was worth less than one US dollar, in 2015 one Bitcoin was worth $500 US dollars and today one bitcoin is worth $6,600. Why? Because individuals are willing to pay that much for it.
Investing or Speculating?
There is an important distinction oft forgotten between investing and trading. Investing investment means long-term ownership whereas speculation is purchasing in the hopes profiting off of short-term price fluctuations. I think there is a high willingness to invest in Bitcoin because many individuals under 35 years old were disillusioned by the stock market crash in 2008 and saw Bitcoin as an anti-establishment alternative investment arena where there is significant money to be made (quickly).
Bitcoin has experienced no shortage of price fluctuations and opportunities to make money. In yo-yo fashion, Bitcoin reached $20,000 in December 2017, only to see the price drop to $7,000 in February, then surged back up to $11,500 in March, and then ultimately drop even further to $6,600 in April. Quite the rollercoaster ride and for individuals savvy enough to day trade and gamble, there was (and still is) money to be made. But for the vast majority of us, Bitcoin has not been a particularly lucrative investment.
So should I invest in Bitcoin?
Remember that scene from the movie Rounders when Matt Damon walks out of his apartment in the middle of the night to go play poker: “Listen, here’s the thing. If you can’t spot the sucker in the first half hour at the table, then you ARE the sucker.” That’s a pretty fitting description of investing in Bitcoin
All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of MoneyIQ
