Bitcoin (BTC) is a new digital currency with cryptographic keys that is decentralized on a network of computers used by users and miners around the world and is not controlled by a single organization or government. It is the first digital cryptocurrency to gain public attention and is accepted by more and more merchants. Like other currencies, users can use the digital currency to buy goods and services online, as well as in some physical stores that accept it as a form of payment. Currency traders can also trade Bitcoins on Bitcoin exchanges.
There are some major differences between Bitcoin and traditional currencies (such as the US dollar):
- Bitcoin has no centralized authority or clearing house (such as a government, central bank, MasterCard or Visa network). The peer-to-peer payment network is managed by users and miners worldwide. Currency is transferred anonymously between users directly over the Internet, without going through a clearing house. This means transaction fees are much lower.
- Bitcoin is created through a process called “Bitcoin mining”. Miners around the world use mining software and computers to solve complex bitcoin algorithms and accept Bitcoin transactions. They are rewarded with new Bitcoins created by solving transaction fees and the Bitcoin algorithm.
- There is a limited amount of Bitcoins in circulation. According to Blockchain, there were about 12.1 million in circulation as of December 20, 2013. The difficulty of mining Bitcoins (solving algorithms) becomes more difficult as more Bitcoins are created, and the maximum number in circulation is limited to 21 million. The limit will not be reached until approximately 2140. This makes Bitcoins more valuable as more people use them.
- A public ledger called the ‘Blockchain’ records all Bitcoin transactions and shows the holdings of each Bitcoin owner. Anyone can access the public ledger to verify transactions. This makes the digital currency more transparent and predictable. More importantly, transparency prevents fraud and double spending of the same Bitcoins.
- The digital currency can be obtained through Bitcoin mining or Bitcoin exchanges.
- Digital currency is accepted by a limited number of online merchants and some brick-and-mortar retailers.
- Bitcoin wallets (similar to Paypal accounts) are used to store Bitcoins, private keys and public addresses, as well as to anonymously transfer Bitcoins between users.
- Bitcoins are not insured and are not protected by government agencies. Therefore, secret keys cannot be recovered if they are stolen by a hacker or lost to a failed hard drive or due to the shutdown of a Bitcoin exchange. If the secret keys are lost, the associated Bitcoins cannot be recovered and would be out of circulation. Visit this link for a frequently asked question on Bitcoins.
I think Bitcoin will gain more public acceptance because users can be anonymous while buying goods and services online, transaction fees are much lower than credit card payment networks; the public ledger is accessible to anyone, which can be used to prevent fraud; the currency supply is limited to 21 million, and the payment network is managed by users and miners instead of a central authority.
However, I don’t think it’s a great investment tool because it’s very volatile and not very stable. For example, the bitcoin price grew from around $14 to a peak of $1,200 USD this year, before falling to $632 per BTC at the time of writing.
Bitcoin rallied this year as investors speculated that the currency would gain greater acceptance and rise in price. The currency fell 50% in December after BTC China (China’s largest Bitcoin operator) announced that it could no longer accept new deposits due to government regulations. And according to Bloomberg, China’s central bank banned financial institutions and payment companies from handling bitcoin transactions.
Bitcoin will gain more public acceptance over time, but its price is highly volatile and highly sensitive to news (such as government regulations and restrictions) that could negatively affect the currency.
Therefore, I do not suggest investors to invest in Bitcoins unless they have purchased less than $10 USD per BTC, as this would allow. a much larger margin of safety.
Otherwise, I think it is much better to invest in stocks with strong fundamentals, as well as excellent business opportunities and management teams, because the underlying companies have intrinsic values and are more predictable.
Disclosure: Victor Liang has no position in Bitcoins and has no plans to change his position in the next 72 hours.