4 Risks of Investing in Bitcoin

As the popularity of Bitcoin continues to grow across the world, you may be interested in buying Bitcoins as part of your portfolio. In the past year Bitcoin has increased in value by over 400%, which understandably has attracted further attention from those eager to realise big profits. However, I believe there are significant risks associated with investing in Bitcoin and other cryptocurrencies. I have briefly summarised 4 key risks that you should consider before making any decisions.

  1. No Intrinsic Value

If I purchase a stock, there is a tangible cash flow given to me in the form of a dividend. Alternatively, if no dividend is paid, the cash flow generated from the business should be reinvested or stored in a bank. As a result the price of the share rises to reflect the intrinsic value of the underlying business.

However, in the case of Bitcoin, it is simply a currency, with no cash flow. For this reason its value is purely speculative, based upon the amount that people are willing to pay for its intangible value. It is hard to argue that traditional foreign exchange trading is any more than speculation, and Bitcoin is no exception to this. From the lows of Bitcoin in January 2015 ($214), to recent highs in December 2016 ($959), it is hard to pinpoint what has fundamentally changed to warrant this price shift beyond the consensus of the crowd.

  1. Regulation

The Western World’s attitude towards Bitcoin and the underlying Blockchain technology is currently unclear. The SEC has taken a cautious approach, with a Bitcoin ETF application still outstanding – you can view the preliminary prospectus for their fund on the SEC website.

This fund would give access for pension funds, hedge funds and institutional investors to invest in Bitcoin unlike before – this should in theory drive up the value of Bitcoin considerably. Although this may be a huge opportunity, with so much riding on a single decision, the average investor could lose out considerably if the ETF fails to be approved by the SEC. As of December 2016, the decision by the SEC is still pending.

On the other side of the Atlantic, the European Central Bank has not expressed any sort of mainstream acceptance of Bitcoin or the supporting Blockchain technology. In a recent article published on the ECB website there is a clear statement that ‘legislative bodies should, however, take care not to appear to promote the use of privately established digital currencies’. This is far from an endorsement.

Perhaps the only certainty is that the future of Bitcoin will rest heavily in the hands of central banks and governments, the very institutions that it seeks to reduce our reliance upon. It would not come as a surprise if these institutions eventually try to delay or limit the adoption of Bitcoin and Blockchain related technologies.

  1. Competition

It would be appropriate to say that Bitcoin is revolutionary. Since its invention by Sakoshi Nakamoto in 2009, it has been adopted by at least 10.9m users, accumulated a market cap of over $15bn, and has attracted big name companies to accept the currency, such as Wikipedia and Subway. However, this great success has also attracted great interest from big players. Central banks in particular have been considering the use of a Central Bank Digital Currency (CBDC), which relies upon the same fundamental blockchain technology.

In practical terms, this will likely take years to adopt, and it’s hard to imagine a cashless society managed by a central bank ledger at this stage. However, it is a warning that the notion of Bitcoin becoming an everyday currency is perhaps not entirely accurate.

There is also competition from the private sector. Mainstream Bitcoin adoption would remove the need for many banking facilities as we know it. In the most extreme cases, what is left of highstreet banking could cease to exist. Therefore it is no surprise that many banks are looking into the prospect of using the underlying Blockchain technology themselves.

Finally, there is competition from other cryptocurrencies. Currently, Bitcoin’s market capitilization of $15bn is over 20 times that of Ethereum, the next most popular digital coin. However, there have been concerns raised over the scalability of Bitcoin, which can process a maximum of 7 transactions per second. In its current format it is nowhere near enough to scale efficiently if the adoption of Bitcoin increases. As with all technology, at some point in the future there will likely be new and improved cryptocurrencies that do everything Bitcoin can do but better.

  1. History

History doesn’t repeat itself but it rhymes. This is perhaps the most important quote to consider when investing. If we cast our minds back to the end of November 2013, the price of a single Bitcoin reached $1,000. At the beginning of the same month, it was $200. Arguably, the 500% spike in price over this period was fuelled by mainstream media attention and the fact many investors were beginning to realise the potential of the currency as a payment mechanism. During this time I observed many people who had never even heard of Bitcoin considering buying it – with the benefit of hindsight this was definitely a warning sign.

Many investors then lost out in a subsequent crash, and less than 6 months later the price had collapsed to lows of $210. Whether this was a case of market manipulation by big players, or a classic bubble driven by irrational expectations of investors, the risks of investing in Bitcoin is clear. Even today the symbolic $1,000 barrier has yet to be broken, and this classic boom and bust cycle should serve as an important lesson for those who seek to make a quick profit from Bitcoin.

Disclaimer

I am not to be held liable for any of your investment decisions, and I am not an investment adviser. Do your own research and make your own decisions before making any kind of financial commitment

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