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The Pros And Cons Of Biting on Bitcoins

If you love edgy bets, the Bitcoin may be for you.

Only a few years old, this virtual currency has been on a roller coaster ride. Last year, Bitcoins traded for only a few pennies. Then in June, Bitcoins soared to over $30 a coin, making it a top-performing currency. More recently, they've traded in the low- to mid-single digits — still a huge gain for early investors.

Bitcoin
Source: shopify.com
Bitcoin

A fiat currency used in Internet commerce, Bitcoins aren’t pegged to an outside barometer. Instead, their worth is determined by a computer algorithm invented by an anonymous, shadowy programmer. No clearing house, government agency or mint watches over them. Instead, peer-to-peer networks dispense and monitor coins, which can be exchanged for dollars.

Given their newness, novelty and volatility, Bitcoins have passionate fans — and critics.

“This is a long-term, high-risk investment,” says Patrick Strateman, a software developer and Bitcoin investor. “Some people are speculating. But others are holding on for much higher returns.”

These wild fluctuations make Bitcoins a difficult investment for average investors, though. Bitcoins have been known to go from $17 a coin to pennies in the blink of an eye.

The coins have also created Bitcoin millionaires, who were early investors. Investment bubbles may even just be part of Bitcoins birthing drama, say fans. Bitcoin lead developer Gavin Andresen has predicted that there will be between one and five Bitcoin bubbles by 2015.

This high-stakes currency does have some key strengths going for it too.

Supply is limited. The Bitcoin algorithm mimics dwindling gold or other precious metal supplies. And the algorithm slows coin issuance by half every four years. Today, there are 7.5 million Bitcoins. The ceiling is 21 million, when no more Bitcoins will be issued.

Also, lots of people want to see Bitcoins succeed, since they’re riding strong anti-government sentiment.

“This is a truly Democratic currency,” says Donald Norman, spokesman for the Bitcoin Consultancy in London and who sees Bitcoins either growing wildly or dying. “No one can manipulate it. It’s a new tool.”

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The biggest hurdle to Bitcoin’s value? Lack of widespread use. The problem is that so far Bitcoins aren’t accepted in everyday commercial transactions, says Jon Nadler, a senior analyst at Kitco Metals. “It’s an underground, counter currency,"

That view will have to change before Bitcoins are widely used, he adds; if and when Bitcoins gain in acceptance, their price is sure to be driven up.

For those with strong stomachs,Mt. Gox is the primary exchange site for investing in Bitcoins in the U.S., accounting for 90 percent of transactions from dollars into coins. At the unregulated site, commissions depend on the amount bought. For less than 100 coins, it’s 0.60 percent per transaction.

However, security has been a problem. In June, the Mt. Gox site was hacked, causing Bitcoin prices to quickly plunge from $17.50 to pennies. These issues have been largely resolved though, says Strateman.

“Mt. Gox has made significant security improvements, rewriting the site from the ground up,” he says.

Also, a small market means that large purchases can shift Bitcoin values. Total volume is a small fraction of that for big ETFs that trade gold, for example.

“The problem will be fixed as the market grows,” Stratement adds.

This volatility —and lack of transparency — has scared away some investors and critics. Bitcoins currently lie outside U.S. government regulation and New YorkSenator Charles Schumer has expressed concern that they’ll be used for money laundering and other shady practices since the coins can’t be tracked.

“Bitcoins are a networked global currency,” explains Chris Skinner, chairman of the Financial Services Club in London. “They can’t be regulated because they’re open sourced.”

Norman is upbeat, though, about Bitcoins future. “A lot of speculators have left,” he says, adding that inventing the world’s first decentralized currency takes time.

Others have doubts.

“You can’t create an alternative currency,” says Nadler. “The dollar isn’t dying.” Yet even Nadler adds that Bitcoins, only cobbled together in 2009, haven’t gone through their life cycles yet.

But, counter other experts, no one really knows what’s going to happen.

“Bitcoins are best suited to investors comfortable with startups,” says Skinner. “They’re still high risk, and I wouldn’t bet the farm on them.”

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