Everything You Need to Know About Investing in Bitcoin

investing in bitcoin

Since the beginning of the year, the price of Bitcoin has surged. At one point, a single bitcoin went for close to $3,000. Although the price has come down somewhat — as of this writing it’s right around $2,400 — its money-making potential attracts investors.

You might even be tempted to add bitcoins to your investing portfolio. But before you hop on the Bitcoin bandwagon, here’s what you need to know.

What is Bitcoin?

Before investing in Bitcoin, it’s useful to have a basic understanding of what it is and how it works.

Bitcoin is a digital currency. The units, bitcoins, are digital tokens that can be exchanged or bought. They are produced through a process called “mining.” Computers solve math problems and their owners are offered bitcoins in exchange.

An element of cryptography is used, so Bitcoin is also referred to as a cryptocurrency.

Bitcoin is not the only cryptocurrency. MarketWatch reported recently that cryptocurrencies have a combined market capitalization of $100 billion. Bitcoin accounts for almost half that amount alone. Investing in cryptocurrencies isn’t just about Bitcoin. There are other investment opportunities that are less expensive.

“Bitcoin uses blockchain technology, which acts as a decentralized public ledger for transactions,” said Ashe Whitener, a cryptocurrency enthusiast who formerly worked in business development for Euro Pacific Bank. “Blockchain technology can be used for many things because it’s secure and fast.”

According to Investopedia, blockchain protocol and Bitcoin were developed by a person or group of people using the name Satoshi Nakamoto. Timestamps for each transaction are added to the end of previous timestamps, creating a chain. This historical record cannot be changed, and the ledger is public, so everyone can see the transactions.

However, even though the ledger itself is public, the parties remain anonymous, protecting their privacy. On top of that, as the chain of transactions grows, it is harder to disrupt by hackers and other attackers.

Whitener pointed out that using blockchain technology cuts out the need for a third-party bank or payment processor. Plus, it’s not controlled by a government, and you don’t have to worry about exchange rates.

To Whitener, whose Liberty Entrepreneurs podcast focuses on how to achieve financial freedom outside the purview of the government, Bitcoin and other cryptocurrencies built on blockchain technology provide a way to live without borders.

More than a cryptocurrency exchange

The blockchain technology underpinning Bitcoin can be used for more than just cryptocurrency exchange. Transactions are recorded immediately and verifiable by everyone involved.

Already, financial institutions are building their own blockchain platforms to streamline the process of managing transactions with fewer people directly involved, according to a PricewaterhouseCoopers white paper.

Investment opportunities based on innovations using cryptocurrency technology are likely to develop in the coming years.

How to invest in Bitcoin

Investing in Bitcoin requires a bit of hoop-jumping to get started, said Whitener.

First, you need to download a wallet designed to “hold” cryptocurrencies. You can download a wallet on Bitcoin.org.

Whitener warned that it’s important to make sure you keep your wallet in a secure location and back it up. Just as with any digital good kept on a computer or other device, it can be wiped out by malware. Backing up your wallet is essential if you don’t want to risk losing your bitcoins and other cryptocurrencies.

Your wallet should be secured by encryption and a password (sometimes called “keys”). Whitener stressed the importance of knowing your Bitcoin keys. “If you forget your Bitcoin keys, the encryption is so good, you may have just lost your investment,” he said.

After your wallet is squared away, you need to open an account with a cryptocurrency exchange like Coinbase. “If you’re in the U.S., you just hook your bank account up to an exchange and use it to buy the amounts you want,” said Whitener. “It’s as easy as buying stock.”

Whitener prefers to move his bitcoins off the exchange and into a wallet as soon as he gets them.

“You can keep your bitcoins in an exchange-based account, but that defeats the purpose if you are trying to decentralize your investments,” he pointed out. “However, keeping it on an exchange means you don’t have to manage your keys. You just need to decide if a point of centralization is right for you.”

Once you have your bitcoins, you can use them to pay others for goods and services, or you can hold onto them, hoping they will appreciate in value. Later, you can sell them on an exchange or directly to someone else. Whitener said there are websites such as LocalBitcoins.com that allow you to trade bitcoins or sell them directly to others.

If the price of Bitcoin has risen since your purchase, you can come out ahead later. Of course, the downside is that Bitcoin might not see dramatic increases in the future. In that case, you stand to lose.

Pros and cons of investing in Bitcoin

Whitener mainly prefers Bitcoin and other cryptocurrencies for the potential as an exchange medium, but he sees the appeal as an investment as well.

“I think you can treat Bitcoin like a long-term investment, if you are careful to balance it with the rest of your portfolio and understand the risks,” he said.

Advantages of Bitcoin investment

“Cryptocurrencies represent an entirely new asset class and financial sector,” Whitener pointed out. “That comes with opportunities when you get in early.”

He said that institutional investors haven’t really started investing in Bitcoin. “When the big players step up, that will provide another price boost and also more stability,” Whitener said. “This is a financial space that is going to be growing in market capitalization as it becomes easier to access.”

Whitener also pointed out that it’s possible to subdivide bitcoins into smaller pieces. “If $2,000 or $3,000 for a bitcoin is too rich for your blood, you can buy a fraction of a bitcoin, much like buying fractional shares of stocks.”

Even though Bitcoin is the largest and best-known cryptocurrency, there are other cryptocurrency investment options. However, Whitener continued to say that Bitcoin has a cap on how many units will be produced.

By about 2140, 21 million bitcoins are expected to be in circulation, and no more will be issued after that. “This means they will likely hold their value better than other cryptocurrencies that have unlimited supply potential,” he said.

Disadvantages of Bitcoin investment

“The dangers of investing in Bitcoin aren’t that different from very small cap stocks,” said Whitener. “You can see big swings in a short period of time. There’s still a lot of price discovery going on.”

Another concern is the fact that Bitcoin and other cryptocurrencies might not catch on going forward. Although Whitener sees plenty of potential for future growth, he also acknowledged that if cryptocurrencies don’t capture a part of the mainstream market, they could also go bust.

Whitener said those who invest in Bitcoin at the early stages might also have to deal with regulatory risk down the road. “It’s an unknown right now,” he pointed out. “Even different parts of the government see cryptocurrencies differently. We don’t know what the regulations will be.”

Recently, the SEC rejected a proposal for a Bitcoin ETF. Bloomberg reported that the announcement resulted in a loss of 18 percent for the price of Bitcoin. The government is concerned about the unregulated nature of the cryptocurrency market.

“Dealing with these issues going forward could be a challenge for would-be Bitcoin investors,” said Whitener.

Finally, Whitener warned about scams. “You have to do your due diligence, just like with anything else,” he said. “There are coins that are scams and some exchanges that are scams.”

Should you invest in Bitcoin?

“[W]hether it makes sense for you to invest in Bitcoin depends on your situation and risk tolerance,” said Whitener. “It could be a great investment for some people and a bad idea for others.”

Whitener thinks Bitcoin makes the most sense for younger investors with a little extra cash to experiment with. However, he suggested limiting portfolio cryptocurrency exposure to between 2 and 3 percent.

In the end, Whitener sees a lot of opportunity in the blockchain and cryptocurrency space. “You do have to be careful out there,” he said. “But know there’s a bunch of amazing innovation for the smart investor to profit from.”

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Published in Financial Tips, Investing

  • Kathy Ramsey

    The IRS treatment of crypto currencies is a big issue. An article on this would be interesting.