Bitcoin (BTC) is a new type of digital currency (with cryptographic keys) decentralized to a network of computers used by users and miners around the world and is not controlled by any organization or government. It is the first digital cryptocurrency that has caught the attention of the public and is accepted by a growing number of merchants. Like other currencies, users can use 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 in Bitcoin exchanges.
There are several important differences between Bitcoin and traditional currencies (e.g., US dollar):
- Bitcoin does not have a centralized authority or clearinghouse (e.g., government, central bank, MasterCard, or Visa network). The peer-to-peer payment network is managed by users and miners around the world. The currency is transferred anonymously directly between users via the Internet without going through a clearing center. This means that transaction fees are much lower.
- Bitcoin is created through a process called “Bitcoin mining”. Miners around the world use computers and mining programs to solve complex bitcoin algorithms and to approve Bitcoin transactions. Transaction fees and new bitcoins generated from the resolution of Bitcoin algorithms are granted.
- 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 in extracting bitcoins (solving algorithms) becomes more difficult as more bitcoins are generated and the maximum amount in circulation is limited to 21 million. The limit will not be reached until about the year 2140. This makes bitcoins more valuable as more people use them.
- A ledger called “Blockchain” records all Bitcoin transactions and shows the respective funds of each Bitcoin owner. Anyone can access the general ledger to verify transactions. This makes digital currency more transparent and predictable. More importantly, transparency prevents fraud and double spending of bitcoins themselves.
- Digital currency can be acquired through Bitcoin mining or Bitcoin exchanges.
- A limited number of online merchants and some brick retailers accept digital currency.
- 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 or protected by government agencies. Therefore, they cannot be recovered if secret keys are stolen by a hacker or lost on a failed hard drive, or due to the closure 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 more frequently asked questions about Bitcoins.
I think Bitcoin will get more public acceptance because users can remain anonymous while buying goods and services online, transaction fees are much lower than credit card payment networks; everyone can access the public ledger, which can be used to prevent fraud; the foreign exchange supply has a maximum limit of 21 million and the payment network is operated by users and miners instead of a central authority.
Still, I don’t think it’s a great investment vehicle because it’s extremely volatile and unstable. For example, the price of bitcoin rose from about $ 14 to a high of $ 1,200 this year before dropping to $ 632 per BTC at the time of writing.
Bitcoin rose this year because investors speculated that the currency would gain wider acceptance and increase in price. The currency fell 50% in December because BTC China (China’s largest Bitcoin operator) announced that it could no longer accept new deposits due to government regulations. And, according to Bloomberg, the Chinese central bank banned financial institutions and payment companies from managing bitcoin transactions.
Bitcoin is likely to gain more public acceptance over time, but its price is extremely volatile and very sensitive to news, such as government regulations and restrictions, that could negatively affect the currency.
Therefore, I do not recommend investors to invest in bitcoins unless they are bought for less than US $ 10 per BTC because this would allow a much larger margin of safety.
Otherwise, I think it’s much better to invest in stocks that have a solid foundation, as well as great business prospects 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 position in the next 72 hours.