Have you heard about the market in Bitcoin? Turn on any financial news channel and the topic will likely come up within fifteen minutes at most—especially given the recent price surge. What’s all the fuss about, and why are some of its fans comparing it to gold?
How Does Bitcoin Work?
Bitcoin is the most well-known and expensive cryptocurrency. 1 Cryptocurrencies are a subset of digital currencies, or money that is moved electronically via a network. Digital currencies have become mainstream since the advent of online banking, and most people think nothing of doing all their banking online or even using their phones to make purchases. These transactions involve digital currency but digital currency as the electronic representation of an existing national paper currency. Cryptocurrencies move beyond mere representations of existing currencies and are entire end-to-end, digital payment systems and thereby currencies in and of themselves.
Bitcoin was invented in 2009 by a person or group of people with the pseudonym Satoshi Nakamoto—the story is a saga unto itself. The payment system is the world’s first decentralized digital currency, meaning that it works without a central administrator or governing entity. Instead, Bitcoin transactions are recorded in what’s known as the blockchain, or an online ledger distributed via technology such that all participants have the same records, which are inherent to the technology itself. 2
Is Bitcoin a Good Investment?
Bitcoin enthusiasts see the currency as “one of the final steps in the evolution of economics.” An ever-faster move from physical to digital assets, via smartphone, will bring technology to the messy and inegalitarian financial system, whose self-evident flaws were laid bare by the financial crisis of 2008 and the subsequent inequality crisis. 3 If the explosion in the value of Bitcoin wasn’t evidence enough, then the recent comments of such august leaders as Jerome Powell on the likelihood of blockchain technology having significant future application are taken as wholesale endorsement of Bitcoin by the cryptocurrency’s fans. 4
Yet Bitcoin has plenty of skeptics and is displaying ever-greater evidence of a Dutch-tulip-bulb-type mania. 5 The very explosion in the price of Bitcoin cited by its adherents as proof of concept should be a warning to any market observer. The prospects for any technology, such as blockchain, do not mean that any one cryptocurrency which uses it—and there are many—merits such supremacy. In fact, it is entirely conceivable that Bitcoin has disproportionately benefited from name recognition as investors late to the party simply pile into cryptocurrencies by investing in the only name they know.
Furthermore, as Jim Rickards points out, the amount of fraud and illegal activity in the Bitcoin arena does not bold well for a currency. In fact, cryptocurrencies in general carry a high risk of theft. Recently, hackers stole more than $30 million worth of Tether tokens, a new, dollar-backed digital currency. 6
Rickards isn’t the only financial expert to express criticism of Bitcoin. Former Fed chairman Alan Greenspan compared the cryptocurrency to continental currency, a fiat currency issued to pay for the Revolutionary War that collapsed shortly thereafter. 7
Aside from the opinions of these experts, there are some practical considerations for anyone thinking about jumping on the Bitcoin bubble. For one, the IRS views profits from the cryptocurrency as taxable income and is planning a big crackdown on tax evaders. 8 Secondly, not many vendors accept Bitcoin, and some of the large ones that did, such as Steam, have stopped for practical reasons: slow processing time, huge transaction fees, and a volatile currency. 9
What Does Bitcoin Mean to Gold Prices?
Bitcoin has likely pulled some demand from gold, as those investors looking for an alternative to equities have been attracted by the soaring prices. However, gold’s status as a safe haven and an uncorrelated asset is time-tested and well understood by markets all over the world, and unlikely to change anytime soon. 10 Finally, the biggest nail in the Bitcoin coffin is that same old refrain of the market bubble believers: “this time it’s different.” 11