Should you invest in Bitcoin?

Should you invest in Bitcoin?

Is Bitcoin a good investment?

Bitcoin is the world’s most popular cryptocurrency. Bitcoin is popular because it has a lot of built-in advantages. Some of these traits are shared with other cryptocurrencies, like Ethereum, while others are attributable to Bitcoin’s market-leading status.

Bitcoin also has some important downsides that should give would-be investors and everyday users reason to pause. Like the broader pros and cons of cryptocurrency, these Bitcoin-specific drawbacks — and advantages, to be sure — deserve careful consideration. Let’s take a closer look.

Advantages of holding and using Bitcoin

Bitcoin offers some distinct advantages both in relation to other cryptocurrencies and to fiat currencies. (Fiat money is government-issued currency that is not backed by a physical commodity, such as gold or silver, but rather by the government that issued it. Most modern paper currencies are fiat currencies, including the NZ dollar, the British Pound, Euro, Australian dollar, US and many others).

Most of Bitcoin’s advantages relate to its decentralized nature, inherent anonymity, and independence from political and corporate influence.

Increasing acceptance as a payment method

Hundreds of merchants accept Bitcoin payments. It’s possible to buy virtually any physical item using Bitcoin. If you’re serious about reducing your exposure to fiat currencies, Bitcoin’s growing mainstream acceptance is likely to be a big help.

Ease of international transactions, generally lower transaction fees

Bitcoin transactions that cross international borders are no different from Bitcoin transactions that stay in-country. There aren’t any international transaction fees or red tape to navigate, as is often the case with credit card payments, ATM cash withdrawals, and international money transfers.

Bitcoin usually comes with lower transaction fees compared to other digital payment methods, such as credit cards and PayPal. Although such fees are variable, it’s rare for a Bitcoin transaction to cost more than 1% of its value. Compare that to 2% to 3% for most other digital payments. With time, Bitcoin transaction costs are likely to drop a lot further too.

Independence from political agents and its creators

Unlike money issued by governments, Bitcoin has no reserve bank, no banks, and no physical notes.

Because Bitcoin isn’t created or controlled by any state entity, such as a central or reserve bank, it’s not subject to political influence and the power-plays that are involved with sovereign currencies. Because Bitcoin exists outside any political system, it’s also much harder for governments to freeze or seize Bitcoin units, whether in the course of legitimate criminal investigations or as retribution for political acts, as often occurs in repressive states in which one third of the total human population live. This also means Bitcoin could be removed from the changes in fiat currency values that can occur based on elections (such as Trump), political events such as Brexit, regional strife such as wars and natural disasters, and even other troublesome activities such as Eurozone-infighting.

Due to its completely decentralised nature, popularity, and liquidity, Bitcoin is not tied to it’s creators. Many less popular cryptocurrencies are characterised by concentrated holdings — the majority of existing units are held in a handful of accounts. This allows the currencies’ creators to manipulate supply and, to an extent, value relative to other cryptocurrencies, negatively impacting other holders.

In-build scarcity

Bitcoin’s built-in scarcity feature — only 21 million will ever exist — is likely to support its long-term value against traditional currencies, as well as non-scarce cryptocurrencies, a popular Bitcoin alternative. As of today, around 89% of all Bitcoin that will ever exist have been mined (including those that we read of in the news that have been lost on hardware wallets or where the password to wallets have been lost). Bitcoin’s fans point out that this scarcity gives the currency its intrinsic value — like gold and other precious metals.

Most traditional (fiat) currencies controlled by national governments are not scarce. Central banks can create new units of currency at will, and often do — for example, the U.S. Federal Reserve began a programme of quantitative easing (“money printing”) that created trillions of dollars in the aftermath of the late-2000s global financial crisis. Most governments, including our own, followed-suit and did the same in response to Covid-19. Although the long-term impacts of such policies are unclear, these policies make many economists uneasy, and (both in NZ and offshore) have been blamed for a range of issues including growing inequality and spiking house prices.

Privacy, perhaps

Holding NZ dollars or other fiat currencies in an online bank account or executing online credit card and PayPal transactions doesn’t protect your privacy any more than physically handing cash or a credit card across the shop counter. Although your online accounts are hopefully protected from all but the most sophisticated hack attacks, they’re clearly associated with you – meaning private merchants, your bank, credit card providers, and public authorities can track how you spend and receive your electronic funds.

By contrast, Bitcoin’s built-in privacy protections allow users to completely separate their Bitcoin accounts from their public personas if they so choose. Although it’s possible to track Bitcoin flows between users, it’s challenging to figure out who those users really are.

However, as all Bitcoin transactions are recorded on an open ledger they might not be quite as private as some people believe.

Is Bitcoin a good investment?

Disadvantages of holding and using Bitcoin

Bitcoin has some inherent weaknesses and risks that make it unsuitable for many investors and consumers. Many of the advantages explained in the paragraphs above are also weaknesses!

Decentralised currencies tend to attract unscrupulous actors who threaten — directly or indirectly — more honest participants, and Bitcoin’s price volatility is not for the faint of heart. Bitcoin also presents an ethical quandary for environmentalists due to its vast carbon footprint.

No intrinsic value

Bitcoin and other cryptocurrencies have no intrinsic value, in that they generate no income (such as a rental property or dividend-paying share) and are only worth what someone is prepared to pay for them.

This means that it’s a stretch to call Bitcoin an investment. Of course, the same criticism can also be levelled at; fiat currencies, gold (which has only limited practical uses and is mostly stored in bunkers or worn as jewelry), artwork, and many other things too.

This area might be changing though, as it is now possible for Bitcoin to generate income through lending in the same way that money saved in the bank can earn interest.

Black market activity may undermine Bitcoin’s reputation

Despite high-visibility prosecutions of some largescale offenders, Bitcoin remains attractive to criminals.

At least some of this is a perception issue: if you were a big-time criminal, would you want all your transactions openly displayed on a visible ledger? Even as far back as September 2015, the FBI Assistant General Counsel said “…investigators can follow the money…” regarding the strange new world of Bitcoin.

Still, if it is perceived that shady uses for Bitcoin outweigh legitimate uses by law-abiding citizens, then Bitcoin’s credibility could be undermined.

Regulation

Think about it: why do nearly all nations have their own currency? A lot of it comes down to power and control.

Bitcoin and cryptocurrencies in general challenge the financial status quo and show early signs of threatening to upend traditional power structures in banking and finance by decentralising payments and lending. The most profitable corporates in New Zealand and Australia are the big banks, and they won’t give this up without a fight and some significant lobbying – perhaps for anti-cryptocurrency regulation!

What might regulation look like? Well, up until the mid-1970’s it was a criminal offence for US citizens to own or trade gold anywhere in the world after it was compulsorily acquired by the US Government in the early 1930’s.

Bitcoin-specific scams, fraud, loss, and risk of theft

As the world’s most popular cryptocurrency, Bitcoin has seen more than its fair share of scams, fraud, and attacks.

Bitcoin users are also vulnerable to smaller-scale theft, including hustlers targeting individual users. One common type of Bitcoin theft is the unauthorised use of private keys. When stored in internet-connected Bitcoin exchanges or cloud storage drives, private keys can be hacked, stolen, and used to access and spend or transfer the key owners’ Bitcoin holdings — depriving them of the value stored within.

Some other cryptocurrencies don’t have the critical mass of users necessary to make such malfeasance profitable to criminals, and such activity is more likely to be prosecuted by law enforcement agencies when traditional currencies and payment platforms are involved.

Cryptocurrencies may be stored in places called vaults, but you can lose your password and never get access again or have your vault emptied by hackers. And if either happens, there is no regulator or supervisor to run to.

No chargebacks or refunds

One of Bitcoin’s biggest drawbacks is a lack of standardised policy for chargebacks or refunds, as all credit card companies, and traditional online payment processors have. Users affected by transaction fraud — for instance, they purchase goods that the seller never delivers — can’t request a refund through Bitcoin. In fact, Bitcoin’s decentralised structure makes it impossible for any single party to arbitrate disputes between users. While Bitcoin miners take responsibility for recording transactions on a publicly accessible ledger, these 'miners' not qualified to assess the legitimacy of each transaction.

Some newer cryptocurrencies have rudimentary chargeback and refund functions, but this feature is yet to be built into Bitcoin.

Potential to be replaced by superior cryptocurrency

Bitcoin spawned a host of successor cryptocurrencies. Although many are structurally quite similar to Bitcoin, others — such as Ethereum — make notable improvements.

Some newer cryptocurrencies make it even harder to track money flows or identify users. Others use “smart contract” systems that hold service providers accountable for their promises. Some even have in-house exchanges that let users exchange cryptocurrency units directly for fiat currency units, eliminating third-party exchanges and reducing associated fraud risks.

Over time, one or more of these alternatives could take over from Bitcoin as the world’s dominant cryptocurrency. That could negatively impact Bitcoin’s value, leaving long-term users holding the bag.

Environmental impact of Bitcoin mining

Bitcoin mining consumes vast amounts of electricity. According to Business Insider, some of the biggest Bitcoin mining companies are based in China, where most power comes from dirty coal plants.

Believe it or not, there is more than a little debate over this, with some highly-educated people suggesting that over the long-run Bitcoin mining could positively impact renewable energy sources and provide a more reliable power grid.

Volatility

Bitcoin is wildly volatile. That means it’s value changes so much and so regularly that it’s unsuitable for all but the most risk-tolerant investors and even then, probably only as a tiny portion of someone’s overall wealth. Sometimes the value of Bitcoin can spike or plunge just based on a Tweet from a celebrity!

These shifts in prices also mean it is impractical for use as a mainstream currency, though perhaps it’s price will stabilise over future years and eliminate this issue.

The bottom line – should you invest in Bitcoin?

As the world’s most popular and widely used cryptocurrency, Bitcoin has some advantages over competing cryptocurrencies and over traditional “fiat” currencies. But it is probably very early days for cryptocurrencies, and Bitcoin has some glaring downsides as well.

As a current or would-be Bitcoin user, it’s up to you to decide whether the advantages of the world’s most popular crypto coin outweigh the downsides. There’s no “right” or “wrong” answer here, only the answer that works best for your investing objectives, values, and tolerance for risk.

One thing is for sure, the following reasons mean it will be fascinating to see what currencies and the global monetary system look like in a few decades’ time:

  • The long-term impacts of money printing (quantitative easing),
  • A multi-decade trend of decreasing faith in governments across nearly all major countries, which may extend to reduced faith in government-backed fiat currencies,
  • Continued innovation with cryptocurrencies including Bitcoin,
  • Decentralised challenges to traditional financial players such as banks, brokers, and merchants, and
  • Decentralised challenges to central banks and fiat currencies.