Investments

August 31, 2017 / Thomas Balis

A Bit About Bitcoin – Your Questions Answered

Recently, one of our financial planners mentioned that he’d had several client inquiries about Bitcoin.  Indeed, there are few topics that have garnered more attention from the financial community in the past few years.  Given this popularity, we thought it might make sense to take a closer look at Bitcoin and how it may or may not fit within an investment portfolio.

What is Bitcoin, anyway? 

Bitcoin is a digital currency created in 2009 founded on the ideas set out in a whitepaper by Satoshi Nakamota.  It offers the potential of lower transaction fees than traditional online payment systems.  It is not a government issued currency, is not legal tender, and is not backed by any bank or government.  There are no physical bitcoins; rather records are kept on a public ledger in the cloud and are verified by massive amounts of computing power. Balances are kept using public and private keys similar to account numbers and PINs.

What can I do with Bitcoin? 

Bitcoin can be used for purchases at any merchant that accepts it as a form of payment.  While not ubiquitous, Bitcoin network volume is on par with the PayPal and Discover networks.  It can also be used as a form of remittance between countries, similar to Western Union. 

How does it work? 

Bitcoin is one of the first digital currencies to use peer-to-peer technology to facilitate instant payments.  The open ledger, or blockchain in which bitcoin transactions are recorded updates every 10 minutes.  People and companies who own the governing computing power, and participate in the Bitcoin network (aka miners) get paid with the release of new bitcoins and the receipt of transaction fees paid in bitcoin.  These miners are the decentralized authority managing the Bitcoin network. 

Open ledger? 

This cloud based record maintains an auditable track record of all the bitcoin transactions that have ever occurred.  In fact, it’s possible to find out where every bitcoin has ever been.  It is working 24 hours a day, and the transaction settlement speed removes much of the counterparty risk and costs present in more traditional financial systems.

So, what’s it worth?

This can be a controversial topic.  In the purest sense, “Bitcoin should not be considered a currency (although currency is one attribute of bitcoin) but an open ledger within which there is value” says Charles Cascarilla, CFA (2015).  There will only ever be 21 million bitcoins that will exist in the Bitcoin network, so its scarcity resembles a currency. Every bitcoin can be divided to eight decimal places, so there are many partial bitcoins that can exist.  It’s the Bitcoin network that gives bitcoins value, just as publicly tradable private ledger systems such as Visa and MasterCard have value.

Is it risky? 

“It is pretty much the highest-risk…investment that you can possibly make,” says Barry Silbert, CEO of Digital Currency Group, which builds and invests in Bitcoin and blockchain companies.  Many investor alerts have been issued by the Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA), the Consumer Financial Protection Bureau (CFPB), and other agencies.   Like any investment, Bitcoin values can fluctuate, and have seen wild swings in price.  Moreover, fraudsters and scammers may attempt to sell false bitcoins.

How do I get Bitcoin?

Digital wallets can established with a variety of vendors.  Coinbase and Xapo are two of the more user-friendly options. The August 30 price of one bitcoin was $4,588!

Can I hold Bitcoin in my IRA? 

Bitcoin is ineligible to be included in any tax-advantaged retirement accounts.  In March 2014, the IRS stated that all virtual currencies, including Bitcoin, would be taxed as property (not currency.)  Gains or losses from bitcoins held as capital are realized as capital gains or losses.

This blog article only scratches the surface.  Investing in Bitcoin is not for the faint of heart.  Those considering any investment in Bitcoin should thoroughly discuss it with their financial advisor.  The Investment Management team at HFA does not invest in Bitcoin within our investment models. We largely avoid alternatives as a rule in our portfolios, and we do not invest directly in any currencies, digital or traditional.   Rather, we use more conventional investments such as mutual funds and ETFs. As always, if you have further questions on this topic, please do not hesitate to contact our office (610-651-2777).

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