What’s all the fuss about Bitcoin?

Many virtual currencies, such as Bitcoin, have emerged over the last 10 years but are they safe to invest in? We examine the risks to be aware of if you are considering buying, trading or investing in them.

What are virtual currencies?

Virtual currencies are digital currency or electronic money. They do not physically exist as coins or notes.  Many digital currencies (also called crypto currencies) started in online gaming communities or on social media.

Although they can be used as a form of payment if another person is willing to accept them, they are not legal tender. The value of virtual currency can fluctuate significantly, they may not be accepted in many places and they are not guaranteed by any bank or government.

Is Bitcoin money?

The price of a single Bitcoin has gone up at a faster pace than any other speculative vehicle in market history.  However, it seems unlikely it could ever be adopted as a global currency, partly for regulatory reasons and partly because creating a world currency from scratch isn’t easy (especially given the mandatory limitations on Bitcoin creation).

There have been only three reserve currencies in the history of the Western World: the British pound, the French franc (however briefly) and the U.S. dollar.  Today, the dollar accounts for roughly two-thirds of all financial and economic transactions globally. The daily value of foreign exchange trading tops $5 trillion, while Bitcoin does a mere fraction of that1.

Bitcoin also fails as a currency in several ways. Money is defined by three characteristics:

  1. A storehouse of value. It’s hard to determine if Bitcoin is a storehouse of value. Daily volatility tops 5-10% while its ‘value’ has skyrocketed. If it crashes, it will fail to meet this criterion.
  2. A unit of account. It is a unit of account, but for whom?
  3. A medium of exchange. It may be a medium of exchange, but for now it has very few users.  There is some confusions as to how to use Bitcoin to exchange, as some nations have banned Bitcoin exchanges.

What are the risks?

If you want to buy, trade or invest in virtual currencies the risks include:

Virtual currencies have less safeguards
The exchange platforms on which you buy and sell virtual currencies are generally not regulated, which means that if the platform fails or is hacked, you are not protected and have no statutory recourse. Virtual currency failures in the past have made investors lose significant amounts of real money. Some countries are moving towards regulating virtual currencies, however virtual currencies are not recognised as legal tender.

Values fluctuate
The value of a virtual currency can fluctuate wildly. The value is largely based on its popularity at a given time which will be influenced by factors such as the number of people using the currency and the ease with which it can be traded or used.

Your money could be stolen
Just as your real wallet can be stolen by a thief, the contents of your digital wallet can be stolen by a computer hacker.

Your digital wallet has a public key and a private key, like a password or a PIN number. However, virtual currency systems allow users to remain relatively anonymous and there is no central data bank. If hackers steal your digital currency you have little hope of getting it back.

You also have no protection against unauthorised or incorrect debits from your digital wallet.

Popular with criminals
The relatively anonymous nature of virtual currencies makes them attractive to criminals who may use them for money laundering and other illegal activities.

What do the experts say?

In November 2017, Forbes reported that hockey stick-shaped price action is one of the telltale signs of a bubble2 (see the ‘hockey stick-shape’ of the graph below).  Bitcoin’s sevenfold rally this year fits the bill. It started the year at $973 and rocketed north of $7,245 as of Friday 3rd, up 644% in 10 months.   In Zimbabwe (the currency crisis mecca) the cryptocurrency blasted to $12,400 on Halloween (31 Oct).

Bitcoin chart

Chart retrieved from https://coinmarketcap.com/currencies/Bitcoin/#charts

Since debuting nine years ago, Bitcoin has graduated from the wild west of fintech to the mainstream. The crowd is piling in. CME Group the past week announced it will create futures products based Bitcoin. New companies are popping up everywhere selling you on buying Bitcoin for your retirement. Newsletters tout their Bitcoin trading strategy could make $1.64 million in 72 hours. Stories of overnight cryptocurrency millionaires abound.

The brightest minds in business and economics are shouting from rooftops that Bitcoin is in a bubble: Mark CubanWarren BuffettRobert ShillerJamie Dimon.

These respected investment strategists and financial advisers are warning that Bitcoin is another bubble akin to the tech boom of the late 1990s to early 2000s, the housing crash of 2006-2007 and the commodities bust of 2008-2009.  They suggest investing in the Bitcoin bubble will only benefit those who got in on the action early (say 2013) and, more importantly, get out before the bubble bursts.

The important thing to remember is that if you decide to trade or use virtual currencies you may be taking on a lot of risk with no recourse if things go wrong.

Does Fortress recommend Bitcoin?

Absolutely not. We don’t recommend anything that is highly speculative with limited investment fundamentals and is highly unregulated. Whilst it may still run hard, the risks are too great for us to recommend Bitcoin.

People investing in Bitcoin must understand and feel comfortable that whilst there is a chance of huge gains, there is also a significant chance of complete capital loss.

Want more information?

A Senate Committee has completed an inquiry into digital currencies. The inquiry             report, Digital currency – game changer or bit player, highlights the opportunities that    these new technologies and payment methods are providing, but also acknowledges    the risks.

 

If you have investment questions and would like to speak to a financial adviser, pleasebook online or contact us on info@fortressfs.com.au

Fortress Financial Solutions founder Chris Black is an award-winning financial planner based in Toowoomba who specialises in superannuation, investing, business succession, cash flow management, retirement planning and personal insurances (including life insurance, income protection, total permanent disability and trauma insurance).

Complied by Emma Linton Doig, Practice Manager at Fortress Financial Solutions.

1 https://www.cnbc.com/2017/09/13/Bitcoin-is-in-a-bubble-and-heres-how-its-going-to-crash-ron-insana.html
2 https://www.forbes.com/sites/trangho/2017/11/04/beware-of-the-Bitcoin-bubble-investment-and-financial-advisors-warn/#640d333d3f8d

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Topics within this article first appeared on MoneySmart and Forbes Online.

Information on this site may be regarded as general advice. That is, your personal objectives, needs or financial situations were not taken into account when preparing this information. Accordingly, you should consider the appropriateness of any general advice we have given you, having regard to your own objectives, financial situation and needs before acting on it. Where the information relates to a particular financial product, you should obtain and consider the relevant product disclosure statement before making any decision to purchase that financial product.

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