What is Bitcoin?
Bitcoin is a ‘cryptocurrency’, and a ‘global payment system’. Don’t be alarmed by the complicated terms; a cryptocurrency is simply a digital currency that is not tied to a nation or central bank. Think of it as a global currency, so whereas the Great British Pound is associated with the UK economy and Bank of England, a Bitcoin is simply associated with any ‘market agent’ that wants to own it. The simple premise behind a Bitcoin is that if two people from different nations own a Bitcoin, then they don’t have to worry about the value of the goods and services in their respective currencies but just use Bitcoin instead, this is where the idea of a ‘global payments system comes from’.
So why has Bitcoins value increased (and decreased) dramatically?
When we buy another currency, we are actually entering an agreement with a ‘central bank’. A central bank is just like any other bank but it provides financial and banking services for the government and that entire country. They also provide support to commercial banks which are the ones that we deal with on a regular basis like Barclays or Natwest. The UK’s central bank is the Bank of England and the US’s the Federal Reserve. They are responsible for lots of things and one of their most important functions controls the money in their countries economy. Along with the economic forces, a central bank is key in deciding that one pound can buy you e.g. one pint of milk. Central banks can use different policies to make sure that the value of the currency doesn’t fall so dramatically (sometimes they get this wrong, but that’s another story!).
So, who is Bitcoins central bank?
This is the problem, Bitcoin doesn’t have a central bank, it’s not backed by anyone, and its prices are determined solely via the economic forces of the day. If someone has a Bitcoin and is willing to sell it, they provide a price, and other people in the market decide if it’s worth it or not. So when you hear that Bitcoin is a ‘decentralised cryptocurrency’ this simply means it hasn’t got a central bank to back it.
Is it a problem that Bitcoin is not backed by a Central Bank?
Well, the simple answer is Yes, definitely, but we need to explore this complicated asset more before we dismiss its value totally.
If the price of Bitcoin is solely determined by what people are willing to buy and sell it at, it is prone to rapid changes in value, this is why it has been so volatile since its creation, and why we see news articles every other day about giant gains or giant falls in its value.
One key argument is that as the value is determined solely by economic forces, certain commentators have argued that savvy market agents have created a hype or craze around Bitcoins leading to lots of individual investors wanting to invest in the currency. This will drive up its value, and then the savvy market agents will sell and make a profit.
We have to admit, this is a major problem, as really, we have no control over its value and there isn’t a central bank to back it up if it starts to fall in value rapidly.
But couldn’t other currencies like the £ or $ fall in value too?
Yes, they could, and they have in the past, take the UK’s referendum on EU membership as an example, the GBP fell by over 10% in one day. But, the central bank is ready to use its range of policies to increase its value if it falls too low over a particular time period. The Governor of the Bank of England confirmed that this was a possibility with the pound if it did fall low enough.
So far we have learned that due to the decentralisation of Bitcoin, it is riskier than major currencies.
But what other things do we know about this ‘cryptocurrency’?
The honest answer is not much, Bitcoin has been around since 2009, and it was allegedly created by a person called Satoshi Nakamoto, who nobody has so far been able to absolutely confirm, he is an unknown figure. The one major thing that the founder did do was to create a limited amount of Bitcoin, but whether this can change in the future is unknown.
How can I invest in Bitcoin?
The easiest way to invest in Bitcoin is to buy some of the currency, (by creating a Bitcoin Wallet) see our list of Bitcoin exchanges. Buying some Bitcoin is just like holding another currency if its value increases your Bitcoins increase in value.
Should I invest in Bitcoin?
This is the most important question in this entire article. Warren Buffets’ famous investment advice is that he only invests in businesses that he understands. His famous example is Wrigley’s chewing gum company, he says that Americans will never stop chewing gum. But with Bitcoin, will people actually use it. If they could, we wouldn’t immediately dismiss it from our investment portfolios. However, it’s currently pretty difficult and expensive to use for buying products and services. Although some of the biggest companies have started accepting Bitcoins as a valid payment method, some so far haven’t, e.g. right now as I write this article, you can buy the latest Surface Laptop from Microsoft, but you can’t use the same coins to buy the latest Apple Mac. However, so far, the craze around Bitcoin has been generated from an investor’s point of few, rather than purchasers. Consumers may be worried that if they start using Bitcoin as a form of payment, firstly, a lot of stores won’t accept the currency, and secondly, its relative price compared with the currency they have been used to, or are paid in can change dramatically between purchases. This volatility, and having to compare to another currency, means that I can’t see how Bitcoin is currently a viable global payment system, and therefore I can’t put my own money into it, but we can’t advise you not to purchase.
However, I’m not ruling it out, but I would like to see the value after the various governments start to regulate it in each of their currencies. Our policy at Invest in ETFs is not to give direct investment advice but simply display the information for you to make your own decision. The only advice we can give is to invest a sensible portion of your investment portfolio if you do decide to invest, investing more than 10%, in an asset with no true fundamental value is far too risky in our opinion. See Bitcoin as a risky (but potentially punt, rather than a rock-solid asset. For lower risk less volatile investment, see ETFs – the new way to invest, where we track the stock market as a whole and don’t rely on stock picks or new financial products, but simply trust the largest companies in the global economies.