Bitcoin -- a “digital currency” or “digital money” -- is receiving a lot of attention. Not surprising since the Bitcoin price increased 1700% this year, from $952 to $17,371 as of December 12. Definitely Impressive.
According to Investopedia, a digital currency is any form of payment that only exists in electronic form. It cannot be turned into physical money. Proponents hope that Bitcoin will someday have a stable value and replace other currencies as money.
Some stated advantages for Bitcoins as a currency include easier transfers of value between two parties, secrecy, easier to transport than physical currency or gold and no influence from central banks. Disadvantages include lack of backups and record of ownership, price volatility, theft, competition from over 1300 other digital currencies (source: CoinMarketCap.com) and dependence on the internet.
Buying Bitcoins means you trust a currency supported by unknown people and internet sites more than the US and other Governments. You trust a completely unregulated internet creation with a short history to a regulated currency with a long history.
I think that Bitcoin will not make a good currency. The production of Bitcoins will end once the total number equals approximately 21 million. Once the supply is fixed, it is more likely that Bitcoins will increase than decrease in value. Therefore, no one will want to pay for anything in Bitcoins, they will always prefer to pay with dollars (or some other currency), which are expected to decrease in value because of inflation.
Price volatility already limits Bitcoins use as a currency. Merchants are reluctant to accept Bitcoin as payment if it might sharply decline in value. Consumers should be reluctant to spend Bitcoins if they expect them to increase in value. That may prevent Bitcoin from becoming a currency. And If Bitcoin doesn’t work well as a currency, what is it good for?
Here is a cautionary tale from the December 22, 2013 New York Times: In 2010,” A software programmer named Laszlo Hanyecz … persuaded someone to accept 10,000 Bitcoins in exchange for two pizzas from Papa John’s…By Mr. Hanyecz’s reckoning, the Bitcoins he had been “mining” on his computer were worth about 0.003 cent apiece. He got his two pies for $30....”
Had Mr. Hanyecz paid with US dollars and kept the 10,000 Bitcoins, the Bitcoins would now be worth $170,000,000, or $85,000,000 per pizza! I hope his pizzas had all the toppings.
Another cautionary tale: according to Wikipedia “In early April 2013, the price per bitcoin dropped from $266 to around $50 and then rose to around $100. Over two weeks starting late June 2013, the price dropped steadily to $70. The price began to recover, peaking once again on 1 October at $140. On 2 October, … a flash crash to $110. The price quickly rebounded, returning to $200 several weeks later.”
Those price changes were -80%, +100%, -30%, +100%, -21% and +82% over a six-month period. How many people can accept that level of volatility? Lots of people when prices are bouncing up. But when pricing are bouncing down???
Sure, I wish I had sold the pizzas to Mr. Hanyecz for 10,000 Bitcoins. It would also have been great if I invested in Bitcoin when it cost $1 or even $10, $100 or $1000.
But I didn’t. And there is a reason. I prefer my long-term investments to be in Funds that own stocks. Stocks have real value. They represent ownership in companies that have factories, intellectual property, brand names, sales and usually profits.
Bitcoin pays no income and has no underlying value. At some point, it may turn out to be the Pet Rock or Beanie Baby of the second decade of this century. Speculators may make a profit but I am not a speculator.
It is the “greater fool” strategy. People buy because they think others will pay even more in the future.