Bitcoin (BTC) is a new type of digital currency – with cryptographic keys – that is decentralized to a network of computers used by users and miners around the world and is not controlled by a single organization or government. It is the first digital cryptocurrency to attract public attention and be accepted by a growing number of traders. Like other currencies, users can use digital currency to purchase goods and services online, as well as in some physical stores that accept it as a form of payment. Currency traders can also trade bitcoins in bitcoin exchanges.
There are several major differences between Bitcoin and traditional currencies (e.g. the US dollar):
- Bitcoin does not have a centralized authorization or clearing house (e.g. government, central bank, MasterCard or Visa network). The peer-to-peer payment network is managed by users and miners around the world. The currency is anonymously transferred directly between users via the Internet without passing through the clearing house. This means that transaction fees are much lower.
- Bitcoin is created through a process called “Bitcoin mining”. Miners around the world use mining software and computers to solve complex bitcoin algorithms and to authorize Bitcoin transactions. They are rewarded with transaction fees and new Bitcoins generated by solving Bitcoin algorithms.
- There is a limited amount of Bitcoin in circulation. According to Blockchain, there have been about 12.1 million in circulation since December 20, 2013. The difficulty of mining Bitcoin (solving algorithms) becomes more difficult as more Bitcoin is generated, and the maximum amount in circulation is limited to 21 million. The limit will not be reached until around 2140. This makes Bitcoins more valuable because more and more people are using them.
- A public book called ‘Blockchain’ records all Bitcoin transactions and shows the ownership of each Bitcoin owner. Anyone can access the public ledger to check transactions. This makes the digital currency more transparent and predictable. More importantly, transparency prevents fraud and double consumption of the same Bitcoins.
- Digital currency can be obtained through Bitcoin mining or the Bitcoin exchange.
- Digital currency is accepted by a limited number of merchants on the web and at some retail outlets.
- Bitcoin wallets (similar to PayPal accounts) are used to store Bitcoin, private keys and public addresses, as well as to anonymously transfer Bitcoin between users.
- Bitcoins are not insured and are not protected by government agencies. Therefore, they cannot be recovered if a hacker steals secret keys or loses them on a faulty hard drive or due to the closure of a Bitcoin exchange. If the secret keys are lost, the associated bitcoins cannot be recovered and will be out of circulation. Visit this link for a Bitcoin FAQ.
I believe Bitcoin will gain more public acceptance because users can remain anonymous while buying goods and services online, transaction fees are much lower than credit card payment networks; the public book is available to all, which can be used to prevent fraud; the currency supply is limited to 21 million, and the payment network is managed by users and miners instead of the central government.
However, I don’t think it’s a great investment tool because it’s extremely unstable and not very stable. For example, the price of bitcoin rose from about $ 14 to a peak of $ 1,200 this year before falling to $ 632 per BTC at the time of writing.
Bitcoin jumped this year because investors speculated that the currency would gain wider acceptance and become more expensive. The currency fell 50% in December as BTC China (China’s largest bitcoin operator) announced it could no longer accept new deposits due to government regulations. And according to Bloomberg, China’s central bank has banned financial institutions and payment companies from handling bitcoin transactions.
Bitcoin is likely to gain more public acceptance over time, but its price is extremely volatile and very sensitive to news – such as government regulations and restrictions – that could negatively affect the currency.
Therefore, I do not suggest investors to invest in Bitcoins unless they are purchased at a price less than $ 10 per BTC as this would allow much higher margin of safety.
By the way, I believe it is much better to invest in stocks that have strong fundamentals as well as great business prospects and management teams because core companies have intrinsic values and are more predictable.
Disclosure: Victor Liang has no position in bitcoins and has no plans to change his position in the next 72 hours.