If you're here then you probably already know something about the digital currency called Bitcoin which has grown in popularity over the last few years. Therefore, we won't discuss what they are, how they are obtained, or how they are mined. We will be attempting to answer a simple question: Should you invest in Bitcoin?
More precisely, the question should be: Should you PURCHASE Bitcoin? This is because Bitcoins can be either purchased or obtained through mining. I won't be discussing Bitcoin mining here because I have only done minimal research on the topic and your success depends greatly on how you approach the endeavor.
So, should you buy some Bitcoin? Should you spend your US Dollars (or whatever form of currency you use) to purchase this new and unregulated digital currency? In my opinion, the current answer has to be a weak no. Let's go over the main reasons why this is so and then we'll go over why you might want to purchase Bitcoin.
Currency is Generally Not a Good Investment for Most Investors
For the vast majority of investors, investing in currency or currency trading is a fool's game. There is a lot of risk and uncertainty and there are always people who are playing the same game but are more informed than you. What makes you think that you will be better able to predict the movements of the Yen or the Euro than another currency trader with more education, a faster computer, and better software? That's what you have to do to succeed in currency trading because the only way you make money in currency trading is when you make the right "bet." Bitcoin is just another type of currency. It's not government-issued or government-regulated, but it is a currency nonetheless. The same principle of currency investing that applies to the plethora of government-issued and government-backed currencies apply to this new digital currency called Bitcoin.
I did say you were making a "bet" when currency trading. You might say, "don't you make a bet on any investment, be it a stock, a bond, real estate, etc.?" The answer to that question is a resounding yes. However, when you purchase some investments, it's a different type of bet you're making.
As we discussed in our article on investing in precious metals, if your gold coin goes up in value it only goes up because of the forces of supply and demand. If my share of Tesla Motors goes up in value, it may be for the same reasons of supply and demand, but it also might be because the underlying value of the company increased. That's an important difference.
It's the same thing with currency. If the value of the Euro goes up, it's only because of the forces of supply and demand. Maybe more people want to hold Euros (eg. interest rates in the Eurozone increase) or the supply of Euros decreases (eg. The ECB decides to print fewer Euros). There can be many other events and factors that affect the supply of and demand for Euros. Either way, there is no underlying value to Euros besides the paper they are printed on. They are worth what we say they are worth. This is profoundly different than the underlying value of a company like General Electric, which makes all kinds of things that people want to buy. If you own a share of General Electric, you own a share of all of its business and you own a share of an income-generating organization.
Getting back to the main point of this subsection, currency trading is just like making a bet on what the future value of a currency will be. If you buy Bitcoins with US Dollars you hope that sometime in the future the Bitcoins will be worth more than they are today. You hope that your Bitcoins will be able to buy more dollars than a number of dollars you used to buy the Bitcoins.
Note: We're ignoring inflation above for simplicity purposes
Bitcoin Don't Generate Income
This was briefly addressed above. Bitcoins are just a "thing." You hope that "thing" will be will be worth more in the future. That's the nature of your Bitcoin investment.
I would contrast this with the nature of many other types of investments. If you purchase stocks, you are hoping that the underlying value of the company (based many factors) improves. If you purchase bonds, you are effectively making a loan to a government or a company and you are hoping that you are repaid an amount greater than your original investment adjusted for inflation. If you purchase real estate, you are hoping that the price of your real estate goes up. That real estate price is dependent on supply and demand for real estate in the community, but it's also dependent on the rental income your real estate can generate and the improvements you make to the property. In the above three examples, the investments are tied to some kind of cash flow: corporate profits or dividends, interest payments, or rent payments.
With investments in currency, there is no income and there is no cash flow. You will sit with that currency until you are ready to sell.That's why investors who aren't overly cocky about their abilities and who have a medium-term or long-term approach prefer to invest in equities, bonds, and real estate rather than currency. Bitcoins are just another type of currency and they have all of the same drawbacks when it comes to investing that any traditional government-issued or government-backed currency would have.
Bitcoin Will Add Major Uncertainty (Volatility) to a Portfolio
I believe the final reason why you should be very cautious in deciding whether to purchase Bitcoin is that there is a lot of uncertainty and most Bitcoin purchasers seem to have less information about what they are purchasing than a traditional investor in equities would have.
Before you purchase a stock you research the company. You look at their financials and their management. If you are a smart investor you look at the actual company itself. You might walk into a store, look at their product, and really think about what this company makes. You then make a decision based on this information about whether investing is a worthwhile risk.
With Bitcoin, you are investing in a digital currency. There's not store to walk into. You know that the supply is increasing (for now) and that the difficulty of creating new Bitcoin (mining) is correlated with the number of people attempting to create them (attempting to mine for them). You know that you need relatively powerful computers to mine Bitcoin. You hear the news stories about people making money by purchasing or mining Bitcoin. But, how much do people really know? To me, it seems like many people are engaging in classic speculation.
There's no way to know whether Bitcoin will collapse tomorrow or whether it will increase in value by ten thousand times. There's even no way to know if people will accept it in the stores you shop at. There's no way to know what the government will say about Bitcoin. There's no way to know if a competing digital currency that is better in every way will come out tomorrow and Bitcoin will become completely worthless.
Given the above, you still might want to consider adding some Bitcoin to your portfolio
Although I don't believe it's a good investment today, Bitcoin might become something you might want to purchase in the future, even if just for using it as a means of exchange. Bitcoin might or might not last, but it's likely that some kind of virtual currency (be it Bitcoin or another virtual currency that does or doesn't exist yet) will become widely used. Throughout history, currencies change and there's no guarantee that the US Dollar (or any other currency that's widely used) will remain popular. It might just be the case that virtual currency will be attractive and used as a possible means of exchange. It might just be that virtual currency will be like money in the future.
Therefore, we can't completely say that you should never hold Bitcoin or virtual currency. However, if we do hold it, we should hold it because it is a useful and efficient means of exchange, not because we are deluded enough to think that holding currency in general or virtual currency specifically is a wise investment compared to the plethora of other investment options available to investors novice or expert.
UPDATE: Click here for an a new article written in light of new information and study