What is Bitcoin?
Bitcoin is the most popular virtual currency to date. People use bitcoin as a digital representation of value, similar to how we use U.S. dollars as a medium of exchange. There are a couple differences between bitcoin and the U.S. dollar, however. The most obvious is that Bitcoin is entirely virtual and relies on the Blockchain for transactions. The Blockchain is a public ledger of all transactions involving Bitcoin and serves as its permanent database. Users of the Blockchain verify all of the transactions and once a transaction has taken place, a new “block” is created. Compare that to the U.S. dollar, which is printed by the U.S. Treasury and backed by the “full faith and credit” of the United States Government.
The U.S. dollar holds value because the U.S. Government says it does. With Bitcoin, it derives its value because there are people willing to use it as a medium of exchange. It is the law of supply and demand: the higher the demand, the higher the price, and vice versa. With the mainstream media picking up on Bitcoin over the last several months, the demand for Bitcoin has skyrocketed, thus substantially increasing its value.
How do you invest in Bitcoin?
The easiest way to invest in Bitcoin is by using an online broker exchange, such as Coinbase. Coinbase is a firm headquartered in Silicon Valley and is the most well-known Bitcoin exchange. You can create an account online and link it up to your bank account to make transfers more efficient. Coinbase also allows you to buy partial bitcoins rather than having to pony up a large dollar amount to buy a full coin.
One of the drawbacks of exchanges like Coinbase is that as traffic picks up, the sites have been known to crash. This poses an illiquidity risk if you are actively trying to get rid of or purchase bitcoins.
Should you invest in Bitcoin?
When you purchase stock in a company, you are purchasing a share of a company’s future earnings and stocks have a tangible value based on expected future earnings of a company. When you hold bonds, you receive interest payments that make bonds easy to value (assuming the debtor doesn’t go bankrupt). Unlike these traditional investments, the value of Bitcoin is not determined by any kind of cash flow; it is purely based on public sentiment and demand for the currency.
Investing is based on taking calculated risks to achieve a rate of return on your money. We invest in stocks and bonds because over long periods of time both asset classes have shown they can outperform inflation. Bitcoin is an asset that has experienced exponential growth in the past 12 months, and no one knows where the price will go from here.