En español | Cryptocurrencies like Bitcoin are creating a lot of buzz at the moment, not because they have soared, but because they have fallen about 45 percent. You may be considering jumping in: Perhaps your kids already have and made a fortune, giving you a major case of FOMO (fear of missing out). Could now be the right time to buy?
I first wrote about Bitcoin basics in 2017. I frankly expected to be pretty critical but, in the end, came away with more respect for the digital currency than anticipated.
Bitcoin was launched in 2009 and is by far the most widely adopted cryptocurrency, with a total value of over $677 billion. Unlike government-created currency, such as the U.S. dollar, there is a finite amount of bitcoins — 21 million. Investopedia notes 18.6 million coins have been “mined,” leaving about 3.4 million still to be discovered.
How Bitcoin works
Bitcoin is a cryptocurrency, which means it's not sponsored by any government and exists only electronically. Although it's becoming increasingly common to be able to buy things with bitcoin, if you want to take profits in bitcoin, you have to translate them into dollars.
To create a bitcoin — a process called mining — you need to be able to answer increasingly complex mathematical problems. Bitcoin mining requires extremely fast computers and sophisticated software, as well as a great deal of electricity. Bitcoin is limited to about 21 million total coins.
Bitcoin transactions are secure because they use blockchain technology — a type of database that stores information sequentially across many different computers. Transactions are permanently viewable and available to anyone.
To use bitcoin, you need a “wallet” — a piece of software that allows you to transmit bitcoins between users as well as your bank. Your wallet has a password; if you lose your password, you lose your bitcoin. There is no “reset my password” feature if you forget.
Strictly to fact-check what I was told on how one buys bitcoins, I invested a paltry $200 in the cryptocurrency in October 2017. Today, it's up about 800 percent and is worth about $1,800. Yes, I wish I had bought a lot more. In fact, as Bitcoin surged, my brain on Bitcoin kept hounding me to dump my stock index funds in favor of Bitcoin. I fought back that inevitable get-rich-quick urge.
Others did not resist that urge. CBS reports there may be 100,000 Bitcoin millionaires, though there may be fewer now from the pullback. Some made hundreds of millions of dollars from Bitcoin. I bet you or your children have probably heard these stories of newfound wealth as well.
So the death of Bitcoin has been wildly exaggerated. In 2017, JPMorgan CEO Jamie Dimon called Bitcoin a “fraud” that would eventually blow up. Dimon said Bitcoin mania was reminiscent of the Dutch tulip bulb craze in the 17th century: “It's worse than tulip bulbs. It won't end well. Someone is going to get killed.” Apparently 100,000 Bitcoin millionaires didn't listen.
6 Arguments to buy Bitcoin
There are many arguments to buy Bitcoin. They include:
- Our fiscal and monetary policy will cause the value of the dollar to decline or plunge. This is now beginning to result in high inflation.
- Unlike paper currency, there will never be more than 21 million bitcoins discovered, and an estimated 3.7 million bitcoins have been lost, meaning that without the private key, they will never be found. So perhaps there will never be more than 17.3 million bitcoins in circulation.
- Bitcoin is becoming more mainstream, with more firms adopting its use for transactions. Financial programs and websites now regularly show Bitcoin price along with traditional stocks, bonds and gold.
- The blockchain technology used in Bitcoin is a decentralized and secure method to conduct transactions, bypassing traditional fees charged by banks and financial institutions.
- It's the new, digital version of gold. Gold has been a store of value since about 550 B.C. Bitcoin is barely 12 years old but is being widely adopted and is far easier to use in transactions.
- You can buy bitcoin on sale. On April 13, bitcoin traded at an all-time high of $64,899. As of May 19, it reached an intraday low of $35,718 — a 45 percent off sale.
6 Arguments to not buy Bitcoin
As strong as these arguments are, I think the arguments to either avoid or tread lightly are far stronger. These are:
- It's still way up over the past five years, so, with a longer perspective, you would be buying very high. For the five years ending on May 19, 2021, Bitcoin has returned an astounding 7,876 percent return.
- Bitcoin cannot surge nearly as much in the next five years as it did in the last. Let me be clear, I know I can't predict the future of any investment. But, according to my math, another return like the past five years would make the value of Bitcoin being almost $88 trillion in five years — more than four times the U.S. gross domestic product for 2020. That's not going to happen. The get-rich-quick days of Bitcoin are likely to be over.
- Bitcoin has many crypto competitors, some with more utility. There are thousands of cryptocurrencies in existence and no barriers to creating new ones. Dogecoin was said to have been created as a joke but, as of May 18, has a value of $43 billion. Ethereum has a value approaching half that of Bitcoin and uses blockchain technology not only for maintaining a decentralized payment network but also for storing computer code which can be used to power tamper-proof, decentralized financial contracts and applications.
- The U.S. government and other governments could crack down on Bitcoin. In a worst-case scenario, governments could actually ban cryptocurrencies. It's already garnered the attention of the IRS.
- The arguments for the devaluation of the dollar and hyperinflation have been floated for decades yet never occurred. I confess that I bought gold back in 1980 because I was sure all the money we were printing would lead to paper money being worth little. But Japan has been running at higher deficits than the U.S. and fighting deflation — falling prices, not rising prices — for decades.
- Bitcoin may be more volatile than your gut can handle. Every time the stock market plunges, I hear the pain in people as they describe their losses. Bitcoin will likely make the stock market look stable by comparison.
I'm intrigued by Bitcoin and the possibility it disrupts the financial industry much the way the internet changed retail. But that's far from a certainty.
If you do invest, I strongly recommend keeping it a small part of your portfolio and only if you can afford to lose all of it. It's a distinct possibility that it could be worth little or nothing in five years. I recommend putting no more than 2 percent of your portfolio in Bitcoin or any cryptocurrency, especially for people 50 and older.
Allan Roth is a practicing financial planner who has taught finance and behavioral finance at three universities and has written for national publications including The Wall Street Journal. Despite his many credentials (CFP, CPA, MBA), he remains confident that he can still keep investing simple.