Cryptocurrency

What You Should Know About Bitcoin

In October 2008, someone using the pseudoname “Satoshi Nakamoto” published a whitepaper titled “Bitcoin:  A Peer-to-Peer Electronic Cash System”.  The paper can be found here.  To this day, nobody has identified the real Satoshi Nakamoto.  Satoshi was very active in the development of Bitcoin and mysteriously went silent in 2011, and hasn’t been heard from since.  Rumors are out there that Satoshi has over 1 million Bitcoins, which at today’s price would be close to 10 billion US dollars.

Even though I am getting a bit tired of hearing about Bitcoin and other cryptocurrencies I wanted to write this as an educational piece for those who are uninformed or are not paying attention.  Bitcoin is something to pay attention to, but not necessarily something you should participate in. Bitcoin should not be laughed off, but it is not something that will end world hunger either.  You will hear very strong opinions on both sides.

The speculation currently ongoing in the cryptocurrency world is unlike anything I have seen in my lifetime.  Bitcoin hit $11,000 for the first time ever on November 30th…..on the 29th it hit $10,000 for the first time ever.  While it is true that $10,000 invested in Bitcoin in 2010 would make you a billionaire today, good luck finding a single person that did that (late edit:  it is now reported that the Winklevoss twins have become Bitcoin billionaires, but their initial investment is unknown).

The only reason many of us are paying attention, is because of the incredible increase in value.  Recently there was this report from CNBC that one of the primary exchanges for Bitcoin, Coinbase, opened 100,000 new accounts over Thanksgiving weekend.  I can just imagine all the kids home from college, telling their families how much money they are making buying Bitcoin in between classes which helped drive the herd of new accounts.  CNBC also had this article, which states Coinbase now has more active accounts than Charles Schwab, which made my jaw drop.

Acquiring Bitcoin:

Bitcoin can be bought or it can be mined.  Just a few years ago people were able to mine Bitcoins using a desktop or laptop, which evolved to using graphic processing units, and now application-specific integrated circuits (ASICs).  The sole purpose of the ASIC is to mine Bitcoins.  A miner must verify if transactions are valid, then bundle those transactions into a block, add the header from the most recent block into a new block as a hash, and solve the proof of work problem.  Simple right?  Only after all this is complete is the miner rewarded with Bitcoins.  This process repeats about every 10 minutes.  Only 21 million Bitcoins will ever be mined, which is estimated to be in the year 2140.

Think you have a chance mining Bitcoins?  Think again.  Try Googling “Bitcoin mining farms” and check out some of the operations and determine if you can do better.  The energy costs of Bitcoin mining are reported to be astonishing.  According to this report earlier this week, the electricity used to mine Bitcoin in 2017 is bigger than the annual usage of 159 countries.

Buying Bitcoin is easy to do online and you can buy as small as 1/100 millionth of 1 Bitcoin.  I will not recommend any avenues for those interested, best to do your own research.  Bitcoins will be stored in your digital wallet.  You are supplied a private key that you must keep track of to move your Bitcoins.  If you lose or cannot remember your private key, your Bitcoins are gone forever.  Some data out there estimates over 4 million Bitcoins are lost forever.

What is blockchain?:

The underlying technology of Bitcoin is something called blockchain.  Imagine blockchain as a type of ledger that is duplicated thousands of times across networks of computers.  The network is designed to regularly update the ledger through the mining process.  Previous transactions can not be altered in any way, can only be reversed with new transactions.  The blockchain is not stored in any single location, and its records are public but your identity is protected (people can see your public key but not who is associated with that public key).  A decentralized network like blockchain has no single point of failure, cannot be controlled by a single entity, person, or server.  Now think about the power behind a decentralized network like that.  In the future, titles to property could be on the blockchain as well as transacting property with other parties (think of buying or selling a home with no title company), stock transactions could occur there, money transfers over the blockchain could replace wires and automated clearing house transactions.  There are many possibilities, including storing a digital key to your house.

Why are the coins worth anything?:

To me, this is the ultimate question.  The blockchain is an incredible concept, and gift to society by Satoshi Nakamoto (maybe it wasn’t so much a gift if they really possess 1 million Bitcoins), but how do we value this?  The Bitcoin token is just the reward to miners for helping build out the blockchain, so why is worth $11,000?  Currently there is very little practical use for Bitcoins at all.  Of course there are rumors that major Ecommerce businesses will begin accepting them, but does that really make them worth more?  Bitcoin at the present time is an extremely volatile asset.  A business accepting Bitcoin as payment would be taking a huge risk unless they immediately converted to dollars.

Determining true value on cryptocurrency is impossible (since we have never seen it before).  Everyone is guessing.  I would not be surprised if it went down to $500, nor would I be surprised to see $20,000.  I have spoken to a number of investors in cryptocurrency that have zero knowledge as to what the blockchain is or how it works, but they have sunk reasonable sums of money into different coins recently, solely because of the recent price appreciation.  Bitcoin may not be a bubble, but there is plenty of bubble-like behavior out there.

Bitcoins could be used universally someday, and are already useful for illegal activities.  Imagine trying to carry $100,000 cash on an airplane to China.  Now imagine carrying $100,000 worth of Bitcoins in your Iphone app into China.  One is perfectly allowed, the other is not.  Several countries have already banned cryptocurrencies.

Should you own it?

If you don’t understand how it works, do not buy it.  If you haven’t read Satoshi’s whitepaper and understand it, do not buy it.  It does not have a place in my personal portfolio since I cannot determine value with any reasonable guess.  I spent this entire article discussing Bitcoin, but now there are over 1,300 different cryptocurrencies (according to this site).  New coins are listed every week via initial coin offerings.  Why are there so many initial coin offerings?  I will tell you, just think about Satoshi that I mentioned several times.  If you can launch a new coin, but mine 1 million of them for yourself before it gains traction, then dump them all once it gains value, you would probably be a rich person.  My suspicion is that the littering of initial coin offerings will someday be a black eye on the tech community, as were the pump and dump internet stocks of the 1990s were a black eye for Wall Street.

Recently, legendary investor John Bogle was on Bloomberg.  When asked if investors should add Bitcoin to their portfolio he responded “Avoid it like the plague.  Do I make myself clear?”.  Time will tell if Bogle is right.  His track record is good.

Fear of missing out (FOMO):

Most people would rather lose together, than miss out on their own.  If you are annoyed that some of your friends are making great returns on Bitcoin and you are stuck with your old school stock and bond portfolio, resist the urge to join them just to be joining them.

A prediction for the future:

We are still a long way from blockchain technology being widely adopted and implemented.  Imagine the internet in 1994, that is where blockchain is right now.  By 2000 the internet was in every household in America.  This isn’t going anywhere folks.  Government will try and make the case in the future that this is bad for us and they need to regulate or squash it, as they like to control the currency.  Recently the IRS ordered Coinbase to turn over all user data for people transacting more than $20,000 worth of cryptocurrency.

I suspect the major player a decade from now in blockchain technology is one you have never heard of yet.  You should be excited though, as this could potentially be a way for more secure online transactions and digital asset storage.

Financial Industry Regulatory Authority (“FINRA”) and the Securities and Exchange Commission (“SEC”) have issued multiple warnings to investors regarding the risks associated with Bitcoin and other cryptocurrency. New products and/or technology, such as Bitcoin and other cryptocurrency, are typically considered high-risk investment opportunities as they commonly are targeted by fraudsters who manipulate the market with artificial promotional scams. The biggest risk factors surrounding Bitcoin (and other cryptocurrency) issuers include that they are not registered with the SEC (or local country regulator) and can be exploited by criminals for money laundering/terrorist financing making the source of funds difficult to follow and verify. The opinions expressed are those of the writer, but not necessarily those of RJFS or Raymond James, are and subject to change at any time. Information contained herein was received from sources believed to be reliable, but accuracy is not guaranteed. Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed web sites or their respective sponsors. Raymond James is not responsible for the content of any web site or the collection or use of information regarding any web site’s users and/or members.