×

As bitcoin soars and ICOs spread, advisors urge caution

  • The total value of the 16 million bitcoins in existence were worth more than $110 billion a week ago, as the price of each one soared to a record high of $7,879 before plummeting by 30 percent on Saturday.
  • CME Group announced it would launch a futures contract on bitcoin.
  • Advisors might buy bitcoin themselves, but most still aren't recommending them to clients.
Bitcoin
Getty Images

It's been a wild ride for bitcoin investors in the last week.

The news that the CME Group would launch a futures contract on the first and most highly valued cryptocurrency in the market sent the price of each bitcoin flying to a record high of $7,879 last week — more than 10 times its price of just a year ago.

On Wednesday, however, sentiment reversed sharply, as a plan to make the bitcoin network more practical for users fell apart. It was reason enough for scores of hedge funds now trading the digital currency to take some profits. Bitcoin was down 30 percent by Saturday.

"Bitcoin [and other cryptocurrencies] are not for the faint of heart," said Ian Weinberg, CEO of Family Wealth & Pension Management. "I expect a lot more upside and downside volatility.

"It's getting on the radar screen of Wall Street now, but this is speculation. I don't consider it an investable asset class yet," he added.

Neither does Amy Hubble, a certified financial planner and founder of Radix Financial. Like Weinberg, she is fascinated with the potential of bitcoin and the blockchain technology underlying it. The run-up in price hasn't escaped her notice, either.

"Advisors should not stick their head in the sand about an asset class that returns over 800 percent in a year," said Hubble. "As a fiduciary, I have a responsibility to research and be conversant on emerging investment opportunities."

More from Smart Investing:
Bitcoin too risky for "serious" investing, say advisors
Millennials lack confidence to invest: Bank executive
What investors should do before market gets gored

Hubble, however, has gone deep enough into the weeds on bitcoin to know that she's not yet ready to invest in it. "Bitcoin and other protocol tokens don't have any cash flows, they don't pay dividends, there is no way to systematically determine demand growth for them, and I don't have the technical expertise to determine the value of one cryptocurrency over another," she said.

The investment story for bitcoin and cryptocurrencies is attractive to more than just techies and libertarians, however. The blockchain technology employed by cryptocurrencies is a major innovation. It offers a secure way to execute transactions worldwide without intermediaries taking their pounds of flesh: no central bank, no clearing firm, no "trusted" third party. It has the potential to lower costs and improve security by cutting out financial middlemen for all sorts of transactions in a wide range of markets.

"It's an alternative currency with no third-party mediator audited on a daily basis by its own users," said Samuel Boyd, an advisor with Capital Asset Management Group. "If cryptocurrencies become widely accepted, bitcoin is the gold standard."

Bitcoin: The pros and cons

Pros

• Volatility
• Big gains
• Interesting topic for cocktail parties

Cons

• Volatility
• Manipulation of the ledger
• Government regulation
• Total loss of money

The so-called blockchain underlying cryptocurrencies essentially constructs a public ledger of transactions and replicates it across all the computers in a network, making it virtually impossible for people to reverse transactions or to double-spend currency. Bitcoin owners have a continuously updated record of every transaction in the currency since it was created by the mysterious Satoshi Nakamoto in 2009. Every 10 minutes a new block of transactions is added to the chain and transmitted across the network.

Theoretically, people with enough computing power — such as a coalition of bitcoin miners, who help maintain the integrity of the network and get rewarded with new bitcoins — could manipulate the blockchain, but it would likely not be in their best interest to do so.

"There could be malicious actors, but as bitcoin owners, they would probably hurt themselves more than anyone else," said Matt Green, a professor of computer science at Johns Hopkins University.

As a medium of exchange, bitcoin has thus far been a flop. While plenty of companies will accept bitcoin as payment for their products and services, few consumers have taken advantage. It takes a lot of computing power and is inconvenient for small-value transactions.

"This is an unregulated market. I'm an RIA, and I can't recommend this to clients." -Samuel Boyd, senior vice president, Capital Asset Management Group

"The value of bitcoin is optimized for speculation, not for spending," said Green.

It is most popular as a payment tool with money launderers, drug dealers and criminal organizations attracted to its security and anonymity. It is also useful for people in countries where the local currency is unstable, such as Venezuela, or where governments have currency controls, such as China.

It is not convenient for mainstream consumers. "People don't use bitcoin to buy a cup of coffee," said Boyd at Capital Asset Management Group.

As a store of value, however, bitcoin has become a huge hit. The roughly 16.5 million coins in circulation had a market value of significantly more than $100 billion before the recent drop in price, and the launch of a futures contract on bitcoin could expand the investor base beyond the tech-oriented enthusiasts and the hedge funds that love the volatility.

For investors, however, there remain many open questions about bitcoin's future viability:

Will it evolve to be a better currency, or will it be displaced by more practical cryptocurrencies, such as Ether or Bitcoin Cash? The software upgrade or fork, called Segwit2x, that was scrapped last week would have doubled bitcoin's transaction-processing capability. While the price of bitcoin plunged late last week, the price of Bitcoin Cash — an offshoot of bitcoin, with more capacity — more than doubled.

Will governments look to regulate and/or curtail the use of cryptocurrencies? The Securities and Exchange Commission has driven most new initial coin offerings offshore because of the commission's concern with scams.

Your Wealth: Weekly advice on managing your money

Sign up to get Your Wealth

Please enter a valid email address
Get this delivered to your inbox, and more info about about our products and service. Privacy Policy.

• What happens when the finite supply of 21 million coins is reached and bitcoin miners no longer have an incentive to maintain the integrity of the network? Could another fiasco like Mt.Gox happen, when the theft of $400 million in bitcoins in 2014 (yes, they can be stolen) torpedoed the largest such exchange at the time and sent the price of bitcoin plummeting?

• Will bitcoin creator Satoshi Nakamoto — likely a pseudonym for a group of individuals — ever resurface? Nakamoto dropped off the radar screen years ago but owns about 5 percent of existing bitcoins, a potentially ominous overhang on the market.

JPMorgan Chase's Jamie Dimon may call it a fraud, and Saudi investor Prince Alwaleed bin Talal may think it's Enron, but as the gold standard of cryptocurrencies, bitcoin is the future of money, say enthusiasts. Either way, it is about as volatile as you can get when it comes to investments.

Boyd, who bought his first bitcoin four months ago at a price of $3,500, is cautious talking about it with clients. "Investors need to use truly disposable income, because the investment could go to zero," he said. "I'm an RIA, and I can't recommend this to clients."

— By Andrew Osterland, special to CNBC.com

Latest Special Reports

  • Get inspired by My Success Story which profiles how people achieve their financial goals.

  • A globe-trotting look at the world of investing, from developed Europe and Asia trends to the least-traveled frontier markets.

  • High-end travel companies are pulling out all the stops to cash in on top clients.

Financial Advisors