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Use caution before joining bitcoin frenzy

  • Investors pushed the price above $5,200 on Thursday, marking a new high.
  • As a new asset class, cryptocurrencies come with volatility and uncertainty.
  • Even if you're a fan of bitcoin and its brethren, keep portfolio exposure to a minimum.

With bitcoin hitting a new all-time high in early trading Thursday, investors might be wondering whether they should venture into the developing world of cryptocurrency.

Tread with caution.

Bitcoin reached $5,231.28 on the news that China might reverse its recent shutdown of cryptocurrency exchanges, surpassing its previous high of $5,013.91 hit on Sept. 2. Year to date, it's up about 424 percent. (Click on the chart below to enlarge.)

Nevertheless, it's part of a young asset class that comes with many unknowns.

"From an allocation standpoint, think of it as an alternative investment," said certified financial planner Samuel Boyd, senior vice president of Capital Asset Management Group in Washington, D.C.

"You wouldn't want more than 5 percent of your overall allocation in it," said Boyd, who calls himself a fan of bitcoin, due to the technology underlying it.

In simple terms, bitcoin — which dates only to 2009 — is part currency, part commodity. It can be used as payment for transactions at companies that accept it the same way U.S. dollars are, or it can be viewed as an investment similar to gold.

The total value of all bitcoins in existence (roughly 16.6 million) stands at about $86 billion. Add in the other few hundred cryptocurrencies and it's a $155 billion market.

Yet these new assets comprise just a fraction of the world's multitrillion currency market. And as a new asset with a smaller pool of investors, cryptocurrencies are subject to wild swings in value. In the last week alone, for instance, one bitcoin has ranged from Thursday's high of more than $5,200 to a low of about $4,200.

It's also largely unpredictable which digital currencies will have staying power. Like any new market — remember all those dot-com busts? — it can take years for a shakeout and for lawmakers and regulators to figure out their oversight approach. Already, the anonymity that comes with these digital transactions raises concerns about money laundering and the funding of illicit activities.

Another major difference is that bitcoin's creation, value and integrity come from complicated, mathematical wizardry, known as "blockchain" technology, which regulates the creation of new units and essentially ensures the security of every transaction involving the digital currency.

Basically, new bitcoins come into circulation via so-called miners, who use dedicated computer hardware and software to help create new bitcoins. (See chart below.) When 21 million units are reached, expected in 2140 or so, no more bitcoins will be created.

Source: Blockgeeks.com

Brian Sansom, of Middletown, Delaware, is both a cryptocurrency investor and miner. Intrigued by the technology used, which eliminates the need for traditional banks in transactions, the 36-year-old web designer and app developer began his foray into the world of digital currency about four years ago.

"It gives control to people instead of a government, and I like that," Samson said. "And its value is going up. I like that, too."

From the perspective of Samson and other bitcoin investors, digital currency is changing the way the global financial system works whether corporations realize it or not.

A large monitor keeps cryptocurrency miner and investor Brian Samson updated on his earnings.
Salvatore Agostino
A large monitor keeps cryptocurrency miner and investor Brian Samson updated on his earnings.

Samson, who paid $80 for his first bitcoin in 2013, said in August that he had earned about $140,000 in the digital currency from his mining activity and investing. He said he also holds roughly $26,000 in litecoin and ethereum from mining income.

Shoshi Bacon, of Forest Hills, Queens, began investing about a year ago when one bitcoin was worth $500. Since then, she has put a "significant chunk" of her net worth in bitcoin.

"It's been a fascinating and exciting ride," said Bacon, who is in her 50s. "The potential for the future of blockchain [technology] is just amazing. It's a whole new frontier of opportunity."

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(Correction: The story has been updated to correct the number of bitcoins in circulation.)