11 December 2017

Stephen Furness

Director - Wealth Management

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For the past few months, Bitcoin has been the word playing on everyone’s lips. Despite being around for several years now, it has exploded in popularity across the globe. It seems to be everywhere – in the media, on blogs, creeping into everyday conversations. But what is it exactly and is it worth all the hype?

 

The basics

To understand Bitcoin, you need to first understand cryptocurrency. Cryptocurrency is a virtual currency. Unlike the currencies we’re all used to, like the Aussie dollar or the Japanese yen, cryptocurrencies are entirely digital. There are no physical notes or coins to carry around in wallets or exchange hands. Cryptocurrencies use cryptography and blockchain technology for anonymity and security, making it difficult to counterfeit. As of 11 December 2017, the entire cryptocurrency market was worth over AU$500 billion, according to CoinMarketCap.com.

There are various cryptocurrencies in the market today such as Litecoin or Ethereum but perhaps the most popular and well-known is Bitcoin which also happens to be where it all started. Bitcoin was launched in 2009 by an individual or group using the pseudonym Satoshi Nakamoto.

One of the most attractive features of cryptocurrencies is that they are not issued or governed by a central authority or bank, rendering them theoretically exempt from government interference or manipulation. In fact, blockchain technology, which facilitates and tracks the secure and anonymous transfer of Bitcoins and other cryptocurrencies, was designed to give companies a secure, digital alternative to bureaucratic, time-consuming and paper-heavy banking processes.

On the flip side of the coin, however, this can also be quite risky. Regulators are struggling to keep up with cryptocurrencies. ASIC has attempted to provide some guidance of its own while the US Securities and Exchange Commission has ruled that some coins are actually securities and therefore subject to regulation. Chinese and South Korean regulators have flat-out banned Initial Coin Offerings. This lack of standards and regulations surrounding cryptocurrencies means that investors are faced with significant risks and no protections. But this hasn’t stopped the rapid increase in popularity of cryptocurrencies, more specifically Bitcoin.

 

The Bitcoin pie

As of 11 December 2017, one Bitcoin was worth AU$20,136.08. Since Bitcoin started in 2009, it has been rather volatile. So what has caused this rise in popularity? Arguably the key driver of the valuation of Bitcoin (or any asset for that matter) is demand. The popularity of Bitcoin has surged in recent months. The speculation and pure hype surrounding Bitcoin (fueled by the media and the extreme price swings in short timeframes) has made the prospect of grabbing a slice of the Bitcoin pie extremely attractive. No one wants to miss out.

 

Bitcoin is a currency, not an investment asset

Most of you reading this will recall the dot-com bubble of the late 1990s where speculation, excitement and hype drove the stock values of internet-based companies to incredible heights before crashing in the early 2000s. Or the Dutch Tulip Bulb bubble of the early 1600s where the now-famous blooms caused a significant financial boom before the bubble burst. The graph below gives an interesting illustration of the rise and fall of some of the most famous asset bubbles and how bitcoin compares (source: Elliot Wave International).

Many high-profile investors and commentators are drawing parallels between these two famous economic bubbles and the rapid rise of cryptocurrency prices. Many people are pouring huge amounts of money into cryptocurrencies and the value of cryptocurrencies are climbing at a rapid rate because other people are also investing money in them. However, this doesn’t mean the bubble will burst and it certainly doesn’t mean cryptocurrencies, like Bitcoin, are investment assets.

When a private company issues new shares to public investors, we call that an Initial Public Offering, or IPO. Cryptocurrencies work in a similar way. When new coins are issued to interested parties in exchange for money, this is known as an Initial Coin Offering or ICO. The difference here, however, is that ICOs don’t give buyers actual equity in the companies offering them, only credit. Therefore, ICO’s shouldn’t be described as investment assets but rather currencies which buyers can use to purchase a product or service at a later date.

Furthermore, cryptocurrencies are not backed by a useful asset (like stocks, bonds or houses) and they do not have a company generating revenue whose profits you might share. When stocks, bonds or houses collapse in value, investors still own a stock, bond or house. If cryptocurrencies happen to go to zero, then those who poured money into an ICO would own nothing.

At the end of the day, the popularity and price hike behind cryptocurrencies is driven by speculation – nothing more. The value being stored in cryptocurrencies is simply everyone else’s agreement and speculation that there is in fact value there. But there is no other asset. If you’d like to speak to us in more detail about cryptocurrencies or Bitcoin in particular, please get in touch on (07) 3391 5055 or email at advice@mgdwealth.com.au.

Disclaimer: This article contains general information only and is not intended to constitute financial product advice. Any information provided or conclusions made, whether express or implied, do not take into account the investment objectives, financial situation and particular needs of an investor. It should not be relied upon as a substitute for professional advice.