How a Digital Currency Became Worth More Than Gold
Tagged in:
Tap to Read Full Story

Much like the stock market overall, Bitcoin has been on a tear this year. In the first half of March alone, the cryptocurrency rose almost 5 percent, topping $1,250 and surpassing the price of an ounce of gold—though it’s worth noting that it dropped dramatically in the days that followed (but we’ll get back to that). Speculation seems to be the primary driving force behind its surge in recent months, but the cryptocurrency has been gaining acceptance as payment by more retailers, too.

Wait, crypto…what? Bitcoin?

Let’s back up. A “cryptocurrency” is a computer-generated currency that uses cryptography (or secret codes) for security. Cryptocurrencies have no physical form and are stored in virtual “wallets.”

Bitcoin was created in 2009, and bitcoins are still being “minted,” though the creator has put a cap on total production at 21 million. Initially, bitcoins were worth pennies. But as the community of Bitcoin buyers and merchants has grown, so has its value.

You’re saying fake money is now worth more than the real stuff?

Just like any currency, cryptocurrencies do have value—but it is tied entirely to how much someone’s willing to pay. “Unlike stocks, bonds or real estate, bitcoins do not generate income or pay dividends,” explains Certified Financial Planner Taylor Schulte of Define Financial. “When you buy bitcoins, you are essentially betting on price appreciation alone as a way of making money on your investment.”

So what’s the appeal? For one, though it’s been a bumpy ride, the currency’s value has grown significantly over the past eight years. It has also gained acceptance, with a small but growing number of retailers now accepting it as payment, including Starbucks and Amazon (for gift cards). Because it doesn’t depend on banks, it’s also possible to send or receive bitcoins anywhere at almost anytime. What’s more, using bitcoins is about as close to making anonymous purchases as you can get, which is a draw for people who take their privacy very seriously. (It’s also what makes Bitcoin popular on the black market.)

What’s the catch?

There are a couple big ones, like the fact that its digital form makes it vulnerable to network crashes or hackers. In 2014, the Bitcoin exchange MtGox lost 850,000 bitcoins to hackers—at the time valued at nearly $620 million—and just last August, nearly 120,000 units—at the time valued at about $72 million—were stolen from another exchange, Bitfinex.

On top of that, because these currencies hold no intrinsic value—as a precious metal like gold does—and aren’t backed by any government institution, they’re prone to large swings in value driven largely by speculation. That was on full display the weekend of March 17, as Bitcoin shed about a fifth of its value (dropping below $950 at one point, before bouncing back to about $1,050 on Monday) as an ­increasingly bitter split in the ­developer community behind Bitcoin threatened to split it into two competing currencies.

But that’s hardly its first big swing in value. Between January and November 2013, the value of Bitcoin shot up from less than $15 to nearly $1,000, according to CoinDesk’s Bitcoin price index, which aggregates pricing data from some of the largest digital-currency exchanges. Then it dropped back into the $200s in 2015, before climbing in value again. 

“Investors love to chase hot investment trends. It’s fun, sexy, and exciting,” says Schulte. “But to make money in Bitcoin, you have to get the timing right and, historically, timing the markets has been close to impossible for most investors.”

[ad 1]

So, should I invest in cryptocurrencies?

You can buy bitcoins through exchanges like Coinbase. But whether you should depends on your tolerance for risk—and whether you can afford to lose the money you invest. Bitcoin’s value has yet to fully recover from the weekend drop, and there’s no guarantee it will go back up—especially if it splits into two separate currencies. Keep in mind that Bitcoin is still near its record high, and up nearly $1,000 already from its low in 2015.

If you’re still interested, though, and can stomach the swings, make sure this fits into your overall investment strategy and isn’t likely to threaten your long-term financial goals. “You could win big,” says Schulte. “But odds are you would do much better with a low-cost, diversified investment portfolio.”

This story was updated on March 20, 2017.

Related