Bitcoin – A Primer

“All that glitters is not gold” William Shakespeare, The Merchant of Venice

Bitcoin – A Primer

“Fiat” is a term derived from the Latin meaning “Let it be done.” The US Dollar, like all major global currencies, is a fiat currency. This means the US government merely declared the dollar is legal tender as opposed to the previous standard of backing the currency with gold. The value of a dollar is determined by a host of intangible factors such as history, supply and demand, and faith in US government institutions.

“Crypto” is a term derived from the Greek meaning “hidden.” Cryptocurrency is digital money: there is no physical coinage, and it is neither backed by gold nor government. There are more than 6700 different cryptocurrencies totaling a staggering $2.2 trillion. Bitcoin is the first, and by far the most valuable, type of cryptocurrency: the number of Bitcoins available is finite, 21 million to be exact. Bitcoins are built on a technology called the Blockchain which functions like a ledger in the Cloud, recording the anonymous activity in the cryptocurrency world including Bitcoins as they are “mined” or created. Bitcoin is the brainchild of a still unknown person or persons who goes by the pseudonym Satoshi Nakamoto. All this mystery adds to its appeal in the nether reaches of the internet. Is your head hurting yet? Hang on.

The first Bitcoin was created in January 2009, with an initial value of $0. In May of 2010 Laszio Hanyecz bought two pizzas in Jacksonville, Florida for 10,000 BTC. At the recent high of $63,346.79, that would be over $633 million. Now that’s a pricey pizza!

In early 2011, one Bitcoin grew to be worth $1.00. Two years later the price went up 1200-fold to $1242. It promptly dropped 72%, bottoming in April 2014 at $342. Three years later in March of 2017, it grew back to the previous high and beyond at $1,290 and by December of that same year it grew 57-fold to $19,783. Whew!!! Of course, it started dropping like a rock again, bottoming in December 2018 at $3,300 for an 83% decline over 12 months. Finally, on April 10 of this year, its value had increased 18-fold to hit $60,000.

Perhaps the increases are getting a bit less dramatic but what’s next? Anybody for a little Texas Hold’ Em? All in for the Bitcoin bet? Well, we aren’t. In fact, we are mostly precluded from buying cryptocurrency as the SEC has not yet figured out how to regulate the market. It’s still the Wild West out there without much in the way of law and protection for investors. What is clear is that Bitcoin is not functioning as a viable currency. Its volatility is beyond comprehension and comfort. No one wants money that can drop in value by 83%.

 

I am reminded of one of the smartest scientists in history, Sir Isaac Newton. You remember he discovered gravity when the apple fell on his head. Although considered one of our foremost mathematicians, when it came to his investments, Sir Isaac was fallible and emotional like the rest of us. He, like many, suffered from FOMO: Fear Of Missing Out.

His intelligence and work won him much fame and fortune during his lifetime. Generally a conservative investor, he changed his style when he saw the fortunes investors were making on the London stock exchange investing in the South Sea Company. During this frenzy, he too invested and watched it skyrocket in value. As the value kept rising, he sold for significant gains. Then he invested again, this time risking even more of his fortune. Ultimately, he sold nearly all his conservative bond holdings, only to see one of the greatest financial collapses in history wipe out his entire investment and personal fortune. That, from possibly the greatest mathematician of all time. If Sir Isaac can make that all too human mistake, no one is immune.

Today Bitcoin remains a speculation, yet experts agree that digital currencies are here to stay. They are not intended to be an investment just like investing in a dollar bill is not an investment but rather a means to purchase a good or service.

Once the SEC figures out how to regulate the market and the value stabilizes, Bitcoin will be a mainstream financial tool.  Today’s Bitcoin frenzy is marking the beginning of digital currencies.

We all want to strike it rich like some of the early 49ers of gold rush fame. According to Deloitte “The economic winners of the California Gold Rush were the… companies…who saw an opportunity to serve…the losers were the miners…” Like Levy Strauss and Bank of America who profited and started from the gold rush, some of the stocks you own in your portfolio are exploiting and profiting from today’s digital gold. While we all experience investment FOMO from time to time, don’t be a miner, rather continue to be a long-term investor.

Mark F. Swingle, CFP ® and the Westfield Financial Planning team