Investment products come in a range of shapes and sizes, each with their own underlying ‘Risk vs Reward’ levels. Bitcoin – the digital currency, is most definitely a highly speculative asset class. As such, whilst the potential rewards are certainly high, as are the risks.
To give you an idea as to how quickly Bitcoin has grown, in 2009 the digital currency was worth just a fraction of $0.01. 8 years later? Bitcoin reached all-time highs of just under $20,000 in late 2017. As such, if you invested right at the very beginning of the digital currency’s journey, you would have experienced some highly significant growth levels.
On the other hand, Bitcoin has since lost value, amount to just under $4,000 at the time of writing. As a result, had you invested in 2017 when prices began to rocket, you’d certainly be sitting in the red.
In our ‘Should you Invest in Bitcoin’ guide, we’ll start by very quickly explaining what Bitcoin actually is. After that, we’ll take a look at some of the risks, as well as the potential long-term rewards.
Let’s start by exploring what Bitcoin is.
What is Bitcoin?
In a nutshell, Bitcoin is a digital currency that was created in 2009 by an anonymous developer called ‘Satoshi Nakamoto’. It is often referred to as a ‘Cryptocurrency’, not least because the underlying framework is based on a mathematical discipline called cryptography.
Without getting too technical, there are some significant differences between a cryptocurrency like Bitcoin, and traditional fiat money such as the Pound, Dollar or Yen.
Firstly, as a digital currency, Bitcoin does not exist in the physical form. Instead, it operates in a virtual manner, on top of a piece of technology called the ‘Blockchain’.
Furthermore, Bitcoin is not controlled or owned by any single authority, nor is it backed by any central bank or nation state. Instead, Bitcoin is subsequently controlled and maintained by the online community, and decisions are implemented only when consensus has been reached.
If you were to actually invest in Bitcoin, it is likely that you would need to obtain a wallet to store it. This operates in a similar way to a traditional bank account, insofar that a Bitcoin wallet is utilized to keep your funds safe.
However, unlike a traditional bank, if you lose your wallet password, or somebody manages to hack it, there is nobody to call to recover your money. This is why Bitcoin and its underlying blockchain is referred to as ‘Decentralized’, as the project is run without a centralized point of control.
Whilst there is so much more to Bitcoin and its supporting technology, you should now hopefully have a general understanding as to what the digital phenomenon actually is.
Now let’s explore how an investment into Bitcoin works.
How Does a Bitcoin Investment Work?
In effect, an investment in Bitcoin works in the very same way as an investment in any other financial asset. The reason for this is that you are essentially speculating on the value of Bitcoin rising, with the aim of selling it at a future price that is higher than when you bought it.
Much like in the traditional financial space, the value of Bitcoin is determined by market forces. In other words, if public sentiment is positive, buyers will outnumber sellers and thus, the price in theory should go up. On the contrary, if sentiment is adverse and as a result sellers dominate the market, then the value of Bitcoin will go down.
Just like in the stock market, sentiment can be determined by relevant real-world events. For example, if a third party Bitcoin platform gets hacked, then it can affect the price negatively.Alternatively, if a mainstream organization shows interest in Bitcoin, then the price is likely to go up.
Trying to figure out how much your Bitcoin investment is worth can also be a daunting task. The most common way for people to determine how much Bitcoin is actually worth is by comparing it with a major fiat currency such as the U.S. Dollar. This allows people to determine how much they want to buy or sell Bitcoin for in the real-world.
How do you Actually Invest in Bitcoin?
When it comes to making your first investment, there are a number of ways that you can do it. In the vast majority of cases you will need to use a third party exchange, especially if you want to use real-world money to buy Bitcoin.
Some websites such as U.S. based Coinbase are fully-geared for first time buyers, as they allow you to use your debit or credit card online, in exchange for Bitcoin. This does come at a fee however, with card payments costing in the region of 4%.
Many alternative avenues also exist. For example, there are now thousands of Bitcoin ATM machines dotted around, which allow you to insert local currency in exchange for Bitcoin.
Ultimately, if you are investing in Bitcoin, you will be responsible for storing the funds. As note above, the best way to do this is via a third party wallet application, which be downloaded onto your phone or laptop device.
It should also be noted that you can also invest in Bitcoin through a CFD (Contract For Difference) platform. Essentially, a CFD is a financial product that allows you to speculate on the future value of an asset, without actually owning or holding that asset.
There are now a range of fully regulated CFD platforms that will allow you to invest in Bitcoin with ease. However, do remember that you do not actually own the Bitcoin, rather you have purchased a contract on its future price.
What are the risks of investing in Bitcoin?
This is potentially the most important section of our ‘Should I Invest in Bitcoin’ guide, not least because it is crucial that you have a full grasp of the underlying risks.
In order to gain a better understanding as to how risky Bitcoin is, it is worth taking a look at the past couple of years. At the start of 2017, the real-world price of Bitcoin was about $1,000. At the end of the same year, Bitcoin increased its value by almost 2,000%, subsequently resulting in all-time highs of $20,000.
However, since December 2017, the value of Bitcoin has plummeted quite considerably. In fact, at the time of writing, the value of Bitcoin is worth sub-$4,000, meaning that had you invested during the crypto-craze of late 2017, then you would have lost a significant proportion of your portfolio value.
Bitcoin Price Chart, from CoinMarketCap
The overarching reasons for such a drastic movement in value is liquidity. In highly established markets such as the Dow Jones or FTSE, because there is so much trading activity, blue chip companies only experience ultra-small movements in price, meaning that gains or losses are often minute. This makes most blue chip stocks a low-risk asset class.
On the contrary, it is not uncommon for Bitcoin to make or lose over 10% in a single day. Whilst volatility levels are much lower than they once were, the Bitcoin space is still ultra-speculative.
Asides from volatility levels, other risks also exist. For example, as Bitcoin is a decentralized project, it means that no central authority exists, Whilst this is good for anti-establishment evangelists, what it also means is that should your Bitcoin funds get hacked, then essentially, there is nowhere to turn.
Moreover, you should also consider the risks associated with losing your private keys. A private key is similar to a password, and it ensures that you, and only you, have access to your Bitcoin funds. Once again, if you were to lose or misplace your Bitcoin private keys, then the funds would essentially remain redundant indefinitely.
Should I Invest in Bitcoin?
To summarize, if you are thinking about investing in Bitcoin, it is absolutely fundamental that you recognize that the space is highly speculative. Not only is there a chance that you could make double-digit losses, but you could also lose your investment in its entirety.
Fully in-line with these ultra-high risk levels is the potential to make significant gains. If you had invested £1,000 worth of Bitcoin in 2009 when it was priced at just $0.01, and you subsequently held on to your investment until late 2017 when it reached $20,000, your £1,000 investment would have made you a billionaire.
However, past performance is most definitely not an indicative guide of future results, nor is there any guarantee that Bitcoin will ever recover its previous all-time highs.
It is therefore wise to ask yourself whether or not you can afford to lose the amount of funds you plan to invest. If the answer to that question is yes, then a Bitcoin investment could be suitable.
An alternative investment strategy that some people like to implement is to get exposure to the world of Bitcoin is to instead investment small, but regular amounts. Not only does this allow you to invest in Bitcoin without risking your savings, but you can also smooth-out volatile price movements.