Bitcoin can be highly confusing to many people. Most of us are accustomed to thinking about money having a degree of physicality (e.g. bank notes) rather than being purely digitally based. Moreover, some may be intrigued by stories of how Bitcoin has risen dramatically in value since its inception, and wonder whether it should, therefore, hold a place in their portfolio.
Here at Vesta Wealth, our Financial Planners wanted to offer this short guide on Bitcoin to help inform your thinking on this topic. We hope you find this article useful and invite any questions you may have about how this could affect your financial plan, via:
t: 01228 210 137
e: [email protected]
What is Bitcoin?
It’s difficult to discuss the pros and cons of Bitcoin as an investment without first establishing an idea of what it is. This requires stepping back slightly to understand money more generally. Here it helps to recognise that money (e.g. coins) represents value. If you work for an employer then they exchange money for your time, which you can then later exchange for something else of value such as a new car. Yet there’s no reason dictating that coins must be used. For example, certain civilisations used gold, copper, silver and even seashells.
Bitcoin became possible when the link between paper money and gold (i.e. the Gold Standard) was broken in the 20th Century. This led to the creation of ‘fiat money’, where money came to hold value because a government said it did. Society, in other words, moved from trusting something to hold value (e.g. gold) to trusting someone to hold that value. From here, moving money online was an easy next step – simply holding transactions (and their records) digitally rather than performing all of this in person. The banks would keep track of who owns what on their central computers. Customers would trust the banks, who would trust their computer!
This started to change in 2008 when Satoshi Nakamoto proposed the idea of Bitcoin. Instead of having a ledger hidden away on a bank’s computer, this system would use a transparent ledger with no central authority. Everyone would be able to see the transactions on the ledger and the balances (although the owners’ identity is hidden). As such, the system (blockchain) would be virtually unhackable since it is held simultaneously on millions of computers. No coins or notes would be required, and no government could control the money supply. All that was required was people to use the Bitcoin cryptocurrency and merchants to accept payment from it, which is what has been increasingly happening since (e.g. Microsoft, Wikipedia and BMW).
How should investors regard Bitcoin?
This is a very brief sweep of how the Bitcoin cryptocurrency works. Yet the key question now is whether/how investors should include it in their portfolio. Here, it’s important to consider how the price of Bitcoin has moved over time:
Source: Coinbase
A few things immediately stand out here. First is the striking rise in the price of Bitcoin from less than $0.01 at its inception to nearly $11,000 today. This is one reason why many inexperienced investors are excited by Bitcoin, yet it’s important to remember that past performance does not guarantee future returns. Secondly, there has been considerable volatility in the price of Bitcoin over the past 20 years. Regarding Bitcoin as a ‘safe’ asset, similar to a UK government bond, is therefore clearly incorrect. Instead, the cryptocurrency should be seen more as a high risk, speculative asset which investors should approach carefully. Cautious investors looking to hold onto wealth (e.g. those near retirement) will likely want to keep any cryptocurrency investments to a minimum – or steer clear entirely. More ‘adventurous’ investors may be willing to take more of a risk with their money. However, it’s important to ensure that you fully understand what you are investing in beforehand. It might help to see cryptocurrency investing a bit like horseracing – only commit what you can afford to lose.
Warren Buffet, world-famous investor, has some important thoughts to consider on this subject. He notes that Bitcoin cannot produce anything or grow (e.g. like a company), and the only way to make money from it is to buy some and hope another person will want to buy it from you later at a higher price. There is no guarantee that this will happen – although it could. As such, Bitcoin is a very speculative investment that is intriguing and in many ways ingenious, yet it’s important to not jump into it without fully considering the risks involved.
Invitation
Bitcoin is a difficult financial phenomenon to explain and to understand. We hope that this article has helped you understand some of its features and intricacies.
If you want to start a conversation about your financial plan and investment strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
e: [email protected]
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.