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Don’t invest in Bitcoin for essentials but maybe as a side bet

Bitcoin has turned into the story of 2017 as its price has gained more than 1,000 percent this year.
Bitcoin has turned into the story of 2017 as its price has gained more than 1,000 percent this year. TNS

Over three days the week of Thanksgiving, Coinbase, a digital currency exchange opened 300,000 accounts. Chasing the eye-bulging rise in the price of Bitcoin, Coinbase accounts now outnumber Charles Schwab brokerage accounts, according to Bespoke Investment Group.

Even more than strong global stock markets, Bitcoin has turned into the story of 2017 as its price has broken through several milestones with a gain of more than 1,000 percent this year.

A raging bull market has reached euphoria as new investors — from teenage computer whizzes to billion-dollar hedge funds —track Bitcoin prices in a never-resting, 24-hour, seven-day-a-week marketplace.

This type of euphoria draws a lot of talk of a wildly speculative bubble. Some prominent financial analysts and bank leaders have even called it likely fraudulent.

Certainly, many participants in this market are there only with hopes of getting rich quickly. But many very smart people are committed to digital currency markets and their assimilation into more commonplace usage.

While Bitcoin has been around since 2009 — and is just one of hundreds of forms of digital currency or “cryptocurrency” — the marketplace is still in its infancy and has some lawless characteristics.

Bitcoin is not regulated by government agencies. It is a decentralized currency not under the control of any central agency or bank. Even calling it a currency is questionable.

It can be used as a form of payment. Microsoft, Dell, Expedia and others accept payment in Bitcoin just the same as cash and credit. But the Internal Revenue Service does not consider it a currency, partly because few people are using it that way. The IRS treats Bitcoin as property subject to capital gains taxes on the growth in price over purchase cost.

Creating Bitcoin is difficult. It requires specialized computers, skilled programmers, exceptional math and advanced encryption techniques.

Bitcoin “miners” use software to solve sophisticated math puzzles, adding blocks to an existing blockchain that is the public ledger of Bitcoin creation and transactions. Based on rules of how blockchains are created and managed, there is limited supply of Bitcoin that can be added to the blockchain.

I’ve spent several hours learning about it and I’m still not certain I understand the technical complexities. At this point, I don’t consider it a necessary addition to a diversified investment portfolio.

That might come with time — and perhaps with a lot of opportunity cost for not having been in earlier — but at this point this marketplace is still too small and speculative for serious money needed to fund major life goals. As a play account on the side, go for it.

Later this month, futures contracts based on Bitcoin prices are expected to be available to trade on U.S. exchanges. This way, investors (traders really) can participate in the Bitcoin market without owning the underlying currency/investment.

Investors have made tremendous gains just in the past few months. The price per Bitcoin took 1,271 days to go from $1,000 to $2,000. It took seven weeks to go from $6,000 to $11,000 to end November. It touched $19,000 last week.

This is a remarkable trajectory for an investment that has no earnings and doesn’t pay dividends or interest. It’s like gold in that the price is whatever the next person is willing to pay and has no relationship to company profits, interest rates or other measures of value.

Assets like this are also prone to spectacular collapse.

The extraordinary liftoff of Bitcoin prices year-to-date has not been without momentary declines, but you have to step back deeper into Bitcoin’s short history to see how extremely fragile it can be.

In June 2011, the price declined 50 percent in just three days, then had a 90 percent bottoming in November 2011. In April 2013, it dropped 70 percent in a week.

When investment bubbles expand and collapse they often go farther in both directions than seems possible as investor psychology drives extremes.

As the user-base grows more diverse and price history builds, Bitcoin’s pricing should become more stable, but there is no certainty in that.

Many very bright people are working exclusively in this marketplace to not only capture investment potential but also to expand use and functionality of the underlying platform that digital currencies are built on – the blockchain.

The blockchain acts as a sort of DNA marker for every creation and transaction of cryptocurrencies. While the future has a wide range of potential outcomes for currency management, the blockchain could become valuable to other industries as well.

Fields such as medical records, identity management and other industries that require precise, secure communications and records retention could utilize a blockchain.

It is a rapidly advancing innovation that could change the way we transact and share information on a much broader scale than today.

Gary Brooks is a certified financial planner and the president of BHJ Wealth Advisors, a registered investment adviser in Gig Harbor. Reach him at gary@bhjadvisors.com.

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