Hardly a day goes by that we don’t read about Bitcoin.
Despite its increasing coverage in the news, however, it’s likely that most people still don’t understand what it is.
Beyond that, what about the technology behind it? And what are the advantages and risks of investing in Bitcoins.
So here is a brief overview of Bitcoin, the technology that supports it, and its advantages and risks as an investment.
Simply put, Bitcoin is a form of digital currency, also known as cryptocurrency.
Unlike tangible currency such as a dollar bill, cryptocurrencies have no central issuing authority, such as the Treasury Department. They also don’t require a centralized intermediary, such as a bank, to make sure the same dollar isn’t spent twice.
So, in essence, these systems are based on trust.
Bitcoin works by using “tokens” that are transferred via a database. The transactions are verified using sophisticated software protocols called Blockchain technology, which is a kind of decentralized online ledger system. Joseph N. DiStefano, a writer for philly.com, called Blockchain a “supercharged version of Microsoft Excel.”
Since its inception in 2009, Bitcoin has grown in fits and starts, with many businesses attempting to make money by facilitating it, including as an investment asset.
<IMPORTANCE OF BITCOIN, BLOCKCHAIN TECHNOLOGY
As a business technology, Blockchain is being explored beyond its use to verify Bitcoin transactions. For example, it can be used to update prices and transactions.
For this reason, companies such as Wal-Mart are looking into its possible uses.
And, according to a recent report in the Philadelphia Inquirer, IBM Corp. and Comcast’s venture capital arm are looking to jointly finance a fund that invests in firms looking to sell Blockchain services to large corporations.
As an investment option, Bitcoin and other cryptocurrencies finally gained mainstream acceptance in 2017 when two of the world’s biggest exchanges – Chicago Board Options Exchange and CME Group Inc. – began trading Bitcoin futures. In addition, Bitcoin Electronic Transfer Funds are likely to be available this summer.
<SHOULD THE AVERAGE INVESTOR CARE?
Investors, no matter how big or small their holdings, should try to stay informed. This goes for their personal investments as well as market trends.
As Bitcoin and Blockchain technology grow – and some consider Blockchain the way of the future – it’s important to keep up with their uses and potential.
<ADVANTAGES, RISKS OF CRYPTOCURRENCIES FOR THE AVERAGE INVESTOR
Cryptocurrencies as an asset class have a low correlation to almost every other asset class available to the average investor. They could, however, be prudently added to a well-diversified portfolio with the possibility of increasing return for the amount of risk taken.
When stocks and bonds are down, cryptocurrencies have the possibility of being up. The inverse also can be true, because they tend not to move together.
According to modern portfolio theory, this may have the effect of reducing overall volatility. But it’s important to stress that while there may be advantages related to added diversification, very real risks also are posed.
For one thing, cryptocurrency prices themselves are incredibly volatile, and traditional methods of valuation have a hard time explaining why that is. Therefore, cryptocurrencies should occupy a prudent slice of a well-diversified portfolio if, and only if, the investor has done extensive due diligence on the currency of their choosing as well as the method by which they buy, sell and store it.
In addition, cryptocurrencies’ volatile nature makes them a poor medium of exchange. For this reason, investors should use them as a store of value, similar to what they would do with exotic investments such as art or wine.
These risks above are why some financial firms, such as Merrill Lynch, recently blocked clients and financial advisers from investing in Bitcoin.
<THE BOTTOM LINE
Despite the fact that cryptocurrencies operate in an unregulated environment, many people and businesses are attracted to the underlying Blockchain technology as a way to communicate value in countless applications. We’ll have to wait and see where Blockchain as a business technology goes.
As an investment, potential investors need to carefully consider the risks and where Bitcoin and its underlying technology are in terms of their evolution and application.
Chris Kim is chief investment officer of Tompkins Financial Advisors, based in Wyomissing. He is responsible for the administration and management of the company’s multibillion dollar wealth management portfolios and overall client investment program. He can be reached at email@example.com.