Investing in Bitcoin: What does it take?

The recent buzz about Bitcoin has many people talking about it, but not many understand what it is and how it can potentially change the landscape of financial transactions. You can probably find hundreds of articles online explaining what Bitcoin is, many of which can be too technical for laymen to understand.

If you are thinking of transacting or investing in Bitcoin, or are just intrigued by how it works, here are a few things you should know.

What is bitcoin?

Bitcoin (BTC/XBT) is a virtual currency with its own financial network that is similar to Visa credit card or PayPal. However, unlike these networks, Bitcoin is decentralised, meaning no entity (individual, company, government or country) owns or controls the Bitcoin network.

It is completely unique from other financial networks because it is the first open financial network in the world. When it comes to setting up a new financial network, Bitcoin does away with the norm of partnering with an existing bank and complying with a set of complex rules.

Since Bitcoin has no such restrictions, users or owners of Bitcoins do not need to gain permission or assistance to create new Bitcoin-based financial services.

And unlike cash, Bitcoin is more transparent and is fixed at 21 million coins that will be released incrementally and predictably over time.

It all started in 2008 when a pseudonymous programmer known as Satoshi Nakamoto posted a paper explaining Bitcoin’s design to a cryptography e-mail list.

Click on the video below for an explanation:

What is Bitcoin? (v1)

How does it work?

Globally, people are trading hundreds of thousands of dollars’ worth of bitcoins every day without middlemen or credit card companies. Here are some of Bitcoin’s characteristics:

Bitcoin investors are in for a wild ride

If you have read reports on how certain Bitcoin speculators have been profiting from investment in the virtual currency and want a piece of the pie, it is best to understand that it is a highly volatile investment option.

Firstly, Bitcoin is an unregulated asset with its price being driven almost entirely by speculation, fuelling volatility and price swings. As of July 2013, the use of Bitcoin in the retail and commercial marketplace is relatively small compared with the use by speculators.

The price of a bitcoin can unpredictably increase or decrease over a short period of time due to its young economy, novel nature, and sometimes illiquid markets – making it a high risk and yet potentially high yield investment.

Though past performance is no guarantee of future performance, it is still noteworthy that Bitcoin started this year at around US$13 (RM41.80) and is now well above US$900 (RM2,954) at the time of writing.

For the sake of simplicity, Bitcoin is akin to online gold. Like gold, it has a controlled supply, and much of its demand is driven by people who invest in it. Both Bitcoin and gold do not require the individual to take on any credit risk in order to own it. Unlike cash, you need not keep it in a bank account to preserve its value, as you can store your own gold and bitcoins without the help of any third party.

What about the bad press?

Since its inception, Bitcoin has gained a rather negative reputation due to the anonymity it allows in its transactions. With the recent shutdown of an illicit drugs website, Silk Road, by the US Federal Bureau of Investigation, it has been deemed the choice currency of many black markets.

But there are many people who are looking beyond its shady past and learning to leverage on its chameleon-like characteristics to generate profit.

Malaysia is not out of the picture when it comes to Bitcoin controversies. Many scammers are taking advantage of Bitcoin’s anonymity and the fact that payments are irreversible. A group of scammers recently created multiple MailChimp accounts (an online email blast service provider) to send out emails purporting a Bitcoin Draw set up by the Penang Bridge International Marathon organisers.

The Bitcoin Draw invited interested parties to send bitcoins to a Bitcoin address in order to get their personal Bitcoin addresses engraved on the marathon medals.

The above scam may seem trivial compared with a recent alarming report about a claim made to a Forbes writer anonymously, confessing to be the mastermind behind a website called Assassination Market.

Assassination Market is a site that crowdsources bitcoin-denominated funds as bounties placed on the heads of key government officials. This has further worsened Bitcoin’s reputation as a legitimate financial network.

Paying for assassinations with cash can result in the money trail being traced back to the mastermind. However, by using Bitcoin, assassinators are even harder to track due to its anonymity.

Is it all bad?

Despite the bad press, Bitcoin continues to fluctuate and increase in price.

The famous Winklevoss twins, who famously battled Mark Zuckerberg over the origins of Facebook, started buying Bitcoin at US$9 (RM29.90). Their investment was worth US$11 million (RM35.3 million) in April 2013 at US$120 (RM389) per coin.

At the time of writing, US$11 million worth of bitcoins is equivalent to about RM35.5 million.

Tyler Winklevoss, one of the twins, thinks that the cyber-currency may be a better long-term investment than gold. Like gold, the virtual currency retains its value regardless of what central bankers do to the money supply. But unlike gold, bitcoins are easier and cheaper to store.

However, Bitcoin may not be suitable for everyone. “You have to be technically savvy, and there’s no insurance,” said his twin Cameron Winklevoss, according to CNN Money.

If you do decide to take the plunge into the Bitcoin market, it can pay handsomely if sold at the right time.

Kristoffer Koch, a Norwegian, invested 150 kroner (RM79) in Bitcoin in 2009, after discovering it during the course of writing a thesis on encryption. He then forgot about it until its widespread media coverage in April 2013, which reminded him of his investment.

When he checked his Bitcoin wallet, he found US$886,000 (RM2.8 million) worth of bitcoins.

“It said I had 5,000 bitcoins in there. Measuring that in today’s rates it’s about 5 million kroner (RM2.8 million),” Koch told NRK.

Koch exchanged one-fifth of his 5,000 bitcoins, generating enough kroner to buy an apartment in Toyen, one of the Norwegian capital’s wealthier areas.

What’s the future for Bitcoin?

Though bitcoins are still not universally accepted, their popularity is growing. There are various Bitcoin communities around the world, even in Malaysia, promoting it to consumers and merchants.

US-based Robocoin has even installed the first Bitcoin automated teller machine (ATM) in Vancouver, Canada, lending legitimacy to it. Its chief executive officer Jordan Kelley said that the ATMs are making those money transfers much quicker.

“People need to be able to get some of their money out,” he told ABC News. “Our customers can walk up to a machine and buy and sell bitcoins for cash.”

Bitcoin may be here to stay, with famous figures like Sir Richard Branson (pic) endorsing it. The British billionaire said his company Virgin Galactic is now accepting the digital-only currency for its commercial spaceflights aboard SpaceShipTwo.

On Nov 22, Virgin accepted its first bitcoin payment from a flight attendant in Hawaii, Branson announced in a blog post, saying he expects “many more to follow in her footsteps.”

Branson, who has invested in bitcoins himself, nonetheless has a positive outlook of the virtual money’s future.

“I think the fact that there’s going to be a limited number of bitcoins out there and it will ultimately be capped – unlike normal currencies where governments can print more currencies – gives it a sense of security,” Branson told CNBC, referring to the 21-million bitcoin cap.

Technical jargon aside, the one important question that most people have when it comes to Bitcoin is: “Can a ‘crypto-currency’ really compete with conventional cash?”

Branson seems to believe in it. Perhaps it can compete with cash in the future, but at the moment, it remains one of the highest risk assets you can invest in. It is best to do as much research as possible before deciding to invest in something as volatile and new as Bitcoin.

 

* This article was first published on Digital News Asia.