With the end of a robust year in the financial markets behind us, investors are looking forward to what 2018 has to offer. One of the bigger stories of 2018 may be the continued fascination with Bitcoin. You may have heard friends talk about it at a holiday party or read articles about the huge price gains. This might have you wondering whether Bitcoin is a legitimate investment for your retirement money.
The short answer is no. The vast majority of professional investment advisers will likely tell you to avoid it. It’s speculative, hard to understand and difficult to accurately analyze. But you hear about people making lots of money buying it, so maybe professional advisers don’t know what they’re talking about. What’s the real deal?
First, some background on why Bitcoin was established. Bitcoin was created as a digital currency. But not a traditional currency. It’s a currency designed to be independent of government oversight and control. That’s what makes Bitcoin unique, and it’s an important part of understanding what it is.
At its core, a currency is just something that people in a community agree has value, and they use that item to facilitate exchanges of goods and services. While governments generally control currencies, that’s not always the case.
Imagine 20 kids at a playground and each kid is required to help clean up the playground every day. But little Johnny has a stash of candy bars, and no other kid has any candy bars. Johnny gives the candy bars out to kids who are willing to do his work for him. That gives Johnny the freedom to play all day instead of work. Then the kids who Johnny paid might trade those candy bars for other things, like having someone do their homework. In this case, candy bars serve as currency.
The creators of Bitcoin wondered if on their own (without a government) they could create a digital coin (basically an electronic entry, like the dollar signs in your bank account) that could be traded within a community for the exchange of goods and services. The coin had to be rare, and had to be accepted by others as something of value. So they created a digital coin that in essence is hard to copy or reproduce. Then some people within this community started using it to buy and sell things and it grew from there.
The difference between Bitcoin and say the U.S. dollar is that the U.S. dollar is controlled by the U.S. government. Our government decides how many dollars we have in circulation. Bitcoin believers don’t want a government associated with their currency because sometimes governments do things that devalue currency. So that’s the idea with Bitcoin. You might use it because you want an alternative to a government controlled currency.
But who needs an alternative currency? Well, if you live in a country like Venezuela, where the economy has collapsed, inflation is out of control and your money is worthless, you might rather own Bitcoin than Venezuelan currency. Or, if you live in a country where you are concerned that your government might someday confiscate your wealth, you might rather own a digital currency that is outside the reach of your government. The digital currency movement is really an outcropping of a distrust of governments, and government failure at times to offer citizens an ability to preserve wealth.
So should you exchange some of your U.S. currency for this digital currency? Well, that all depends on whether you think that a digital currency would hold its value better than U.S. currency.
For instance, assume you sold your house and got $400,000. Then the closing agent asks you how you want to be paid. If they pay you in U.S. currency and you put that money in the bank, you are basically assured it will be worth $400,000 next month. If you are paid in Bitcoin, it could be worth $600,000 or $200,000, or who knows, maybe $0. Thus, you don’t know if Bitcoin is a reasonable “store of value.”
At this stage, Bitcoin is more like a lottery ticket than a currency or an investment. The reality is some people win the lottery every week around the world, and those are the stories you hear; but millions lose. So you have to be willing to lose all the money you put into a digital currency.
As fast as digital currencies rise, they can fall or be replaced by other currencies. The systems also are subject to hacks by attackers who figure how to generate fake Bitcoin or steal your Bitcoin.
Also, don’t forget that if a digital currency became successful and moved a large portion of the economy outside of government control, governments could decide to crack down on something like Bitcoin and outlaw its use. The U.S. government basically outlawed individual ownership of gold in the 1930s, so this isn’t far-fetched.
Bitcoin is a remarkable story and the innovation of its creators is to be admired. It’s surprising it has gotten this far, and maybe has much farther to go as a means of payment. But as a place to store the value of your serious money, I am still fond of the U.S. dollar.
Charlie Farrell is chief executive of Northstar Investment Advisors LLC. He is the author of “Your Money Ratios: 8 Simple Tools for Financial Security.” This column is for information and education purposes only.
Blockchain – Crypto – Currency infomation