Investing in bitcoins? 4 things to consider

Some people call it the future of transacting and doing business, while others call it a bubble that will crash sooner than later. One thing is certain bitcoin is now available in the country and is at the disposal of Filipinos who want to transact and use it as a form of exchange.

In a nutshell, bitcoin is a “virtual” currency that can be used to purchase “real” good or services. It also makes paying easier and accessible via your mobile app and it also comes with lower costs per transaction compared to banks, Paypal or Visa, etc. (READ: Explaining Bitcoin: A new way to pay)

In other countries, it has been regarded as a form of investment traded via a formal exchange where investors attempt to make money by buying the conversion low and selling it higher later. This is where we have seen early investors become instant millionaires by buying early and selling once demand would kick in, which brought the prices higher.

Looking at the chart below, one bitcoin has drastically jumped from merely being worth pennies in April 2011 to US$966 per bitcoin as of January 20, 2014. Bitcoin uses the same supply and demand principles that are present in a foreign exchange market. However, given its limited supply (only 21 million bitcoins are created so far around 11 million have been mined) the demand for bitcoin may further increase in the future.

As what I always tell my clients, an investor should make decisions based on research, logic, and the conviction that where they are putting their money is something worthwhile. While each investment is a personal decision, one must factor in risk tolerance, investment horizon, and the money that will be set aside for the investment.

It will not be prudent to invest in bitcoins just because they are the talk of the town right now. In line with that, here are 4 things to consider before investing in bitcoins:

1. Volatility

The exchange rate of bitcoins has gone up in the past by large percentages and also gone down significantly. The chart below shows that the exchange of bitcoin against the dollar went up starting October 2013 from US100 per bitcoin to US$1,200 USD per bitcoin sometime December 2013. That’s 1,100% in just a matter of 3 months!

To put it into perspective, in terms of gains, our local stock market went up 33% from January 2012 to December 2012 and that was already considered a very strong market. In investing, when it is too good to be true, maybe it is.

They say what goes up, must go down. Fourteen days after its peak, the exchange of bitcoin dropped from a high of around US$1,200 per bitcoin to a low of around $550 per bitcoin. Talk about wild swings. That’s a 55% loss in just a few days of trading. If strong upward and downward swings in investments are not for you, it’s best to stay away from investments as volatile as this.

2. Value

No one knows what the fundamental value of one bitcoin is, unlike stocks which you can at least attempt to value by computing estimated earnings and growth. For bitcoin, it is pure supply and demand.

The difference? Bitcoin is a virtual currency that does not have the backing of any hard assets. How do you value something that does not exist? The value merely is based on what buyers believe the price should be and what sellers also believe what they should sell it for. It is purely a supply and demand play, which at this point does not have any long-term value to make it sustainable.

Warren Buffet said it well: “Price is what you pay for, value is what you get!” If you do not get value in return, price will definitely die down.

3. Regulation

Unlike all currencies in the world, bitcoin is not regulated by any central bank or government. It is rather an open source system that works outside government intervention. It may have its upside by having lower transaction costs because no one regulates it, however I believe having no formalized structure will hurt it more than help it over the long.

China and India have made moves to block or dampen the use of bitcoin in their respective countries. If other countries follow suit, the use of bitcoin will become sparse and we may see a massive selldown and decline in price.

4. Security

Last November 2013, hackers stole over 1,295 bitcoins worth over a million US dollars from a Denmark-based Bitcoin exchange.

Security has been one of the key concerns surrounding bitcoin over the past years. The thing with bitcoin is once it is taken, it cannot be traced and is gone forever.

For an investor, one of the biggest considerations is whether you trust the platform you put your money into or not. It’s your hard-earned money, you don’t want to see it here today and gone tomorrow!

These are possible risks that investors will take upon investing in bitcoins.

As investors, it is our responsibility to see the risk, manage them and ultimately see if the investment is something that fits our risk profile. My desire is to see more Filipinos financial free and invest knowing what they are getting into. – Rappler.com

 

Marvin Germo is a registered financial planner, an author, personal finance consultant and a stock market trader and investor. He has around 7 years of experience in the Philippine financial industry. He specializes in technical analysis and position trading. Read his blog. Follow him on Twitter: @marvingermo