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What is Bitcoin?

What is Bitcoin

Are you feeling crippled about cryptocurrencies? What exactly is Bitcoin?

You’ve seen countless headlines about the Bitcoin buzz:  The Bitcoin Boom: In Code We TrustAs Bitcoin Scrapes $10,000, An Investment Boom like no Other,  and my favorite headline is Why Bitcoin is Stupid.

But the question remains, what is Bitcoin? Is it a good, or bad investment?

A reader wrote in to Ask Carly to find out.

Ask Carly is a way for us to stay connected and support one another on our journey to gaining financial independence. It’s a judgement-free place to get some solid advice, because, you don’t need to figure this money stuff out on your own.

You can submit your question about life and money here.

Carly, I wanted to see what your thoughts are on cryptocurrencies such as Bitcoin, Metacoin, and Ethereum. Are you gung-ho like the millennials of our time? Do you avoid them like the plague?

If you do avoid them, is it because of moral obligations, like you’re not taxed on cryptocurrencies and that it’s a currency that can used in black markets since there are no “fingerprints” with transactions? Or do you avoid cryptocurrencies because you think it’s a bubble that will burst?” 

Let’s start by outlining what Bitcoin is.

Bitcoin is a fully digital currency, with no government to issue the currency, and no banks manage transactions. In a nutshell it is a peer-to-peer electronic cash system. The transactions are verified through the use of cryptography, which is secure communication written in code, (here’s a quick video explaining cryptocurrencies) that is recorded in a public ledger, called a blockchain.

It was created by someone under the fake name, Satoshi Nakamoto, and later released in 2009 as a public open-source software. Bitcoin was the first cryptocurrency, and now there are thousands of cryptocurrencies like Metacoin, and Ethereum.

What is the appeal?

It’s appealing because, there are no fees on transactions, versus paying with PayPal, or cards where the business pays 2-3% in transaction costs. A decentralized currency is beneficial for places like Venezuela with unstable governments where hyperinflation hits extraordinarily fast and money becomes close to worthless overnight.

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Will Bitcoin become the world currency?

More and more people own cryptocurrencies. An article by Investopedia explains that for cryptocurrencies to become a mainstream financial system, a lot would have to happen. Merchants accept Bitcoin now, but they’re still in the minority. Consumers are hardly using cryptocurrencies to purchases items, and instead purchase them only to see the value rise. It’s difficult for cryptocurrencies to keep the anonymity of transactions and prevent laundering money or tax evasion.

To become a world currency, one personal finance blogger, stated that Bitcoin must be:

  • Easy trading between people 
  • Widely accepted as legal tender for all debts, public and private
  • A stable value that doesn’t fluctuate (otherwise it’s impossible to set prices)

Currently it does none of the above.

Should you invest in Bitcoin?

I’m not for two reasons: it has no intrinsic value and it’s not a diversified investment. Although values have skyrocketed, what people own in Bitcoin has no intrinsic value, unless you cash out.

When investing you have ownership of an asset and there are three main asset classes: stocks, bonds, or cash. You can also view real estate or your home as an investment.

Your home provides value (you live in it!), and stocks have value, the companies you’re investing in provide actual goods and services used in society.

Cryptocurrencies are now being considered a new asset class, and you can purchase cryptocurrencies within your IRA. When investing you want to keep in mind your asset allocation (the percentage of your portfolio in stocks, bonds, cash, or in this case cryptocurrencies).

Also, you want to be well diversified with different industry sectors.

Morningstar states that when investing there are 11 main industry sectors: like energy, healthcare, technology, utilities.

You may think that, well there are 1,000 different cryptocurrencies, I can diversify by owning multiple different cryptocurrencies. Nope, that means you’re investing all in the same asset class, and within the same industry. You aren’t getting the diversification you need.

It’d be like investing only in the tech sector during the nineties, it’s a bad idea.

One financial planner urged their client who was determined to invest in Bitcoin to limit their investment to 1% of their portfolio. For example, if you have assets totaling $10,000, then invest $100.

That is my take on what Bitcoin is and why I’m not crypto crazy.

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