By Scott Whyte, AAMS®, Financial AdvisorScott Jpeg
If you have followed the financial news media in the past year, you may have heard a lot of buzz surrounding a new “digital” currency, bitcoin. And that buzz includes investors trying to determine how they can get on the bitcoin investment train.

Bitcoin (symbol BTC, XBT, etc.) is a peer-to-peer payment network and digital currency based on an open source protocol which makes use of a public transaction log. This description, which I repeat verbatim from Wikipedia.org, is one of my main concerns with respect to bitcoin. Most people would need an Internet dictionary to begin to understand what bitcoin is all about. But like any new type of investment product, you need to do your homework before you invest in bitcoin.

I like to describe bitcoin simply as a digital currency because there is no physical currency involved. The currency itself is created and exchanged through the use of a decentralized computer network. Much like Napster, which you may recall was how people traded digital music files (MP3 files) anonymously and illegally prior to iTunes selling downloadable music legally, anyone can set up their computer to become involved in the creating and trading of bitcoins. Much like Napster in the early days, there is no centralized control of the bitcoin currency by one computer, company or country.

Users who get involved in the transaction end of the bitcoin marketplace are known as “miners” and they can receive payment (in bitcoin, of course) for the computing power they provide to create and provide maintenance for the “blockchain”. The blockchain is the public log that records bitcoin ownership currently as well in the past. Cryptography is used to protect the integrity of the blockchain. As of December 2013, the number of bitcoin miners was approximately 172,000.

Bitcoins were initially mined and created in January 2009, following a protocol outlined by an anonymous developer known as Satoshi Nakamoto. I describe him as anonymous as it is not publicly known who Nakamoto is or even if the name refers to an individual or a group of people. At present, there are approximately 12,190,000 bitcoins in circulation and although additional bitcoins are in the process of being created by miners, there is an upper limit of 21 million bitcoin that may ever be created. According to bitcoin.com, this limit would be reached by the year 2140. As you can see, the creation of bitcoins is expected to slow dramatically as each year passes.

There are a couple of ways to acquire bitcoins either by acting as a miner, accepting bitcoins in payment for goods or services or buying bitcoins from an exchange such as Mount Gox.  The volatile and bubble-like value of bitcoin is at the root of my concerns as the title of this blog suggests. Bitcoin was worth about $32 US at the beginning of 2013. During this year alone, the currency has appreciated to more than $1,200 US, but as of the writing of this blog, the value has plunged back down to approximately $750 US. For bitcoin to work effectively as a currency, it can’t have these kinds of dramatic fluctuations in price over short periods of time.
These rapid price swings are, in my opinion, due to rampant speculation about the future value of the currency. If investors’ willingness to bid up the value of the currency decline, so will the price of bitcoin. While the trend this year has been wildly up, there is no guarantee that trend will continue. Other virtual currencies can, and are, being created to compete with bitcoin.

So many questions exist about the stability of digital currencies and this is why I recommend investors be extremely cautious if they are considering an investment in bitcoin or other digital currencies. In addition, bitcoin isn’t currently regulated by the SEC, Federal Reserve or any US government agency, another good reason to be cautious if you intend to invest in this speculative investment product.

Just like with any other investment, you need to know what you are looking to accomplish with the investment, what risk you are taking, how to get in and out of the investment and what fees or other costs are involved! With bitcoin, it is difficult enough just to understand what it is and how it works. And with the Wild-Wild West aspect of this new digital currency, I look at bitcoin investing as even riskier than gambling. At least when you go to the casino, you know the “house” usually wins, but you might be able to occasionally win or break even. The problem with bitcoin investing is it is hard to figure out who the “house” is.