What is Bitcoin and Should You Invest in it?

What_is_Bitcoin_Should_I_InvestIf you’re like me, you’ve probably sent a peer to peer payment before.  Whether its the monthly rent, or gambling debts owed to a friend, sending money through Paypal or similar services is pretty easy(and free!).  Bitcoin essentially does the same thing but with its own currency.  Yes that’s right, Bitcoin has its own currency that can be used to pay for merchandise/services all across the web.

Bitcoin can be exchanged through a computer or smart phone app without the help of a financial institution.  In order to acquire Bitcoins you need to pay money for them or trade some type of service with someone who already has some.  You can also try your luck at ‘mining’ Bitcoin which essentially forces your computer to do memory intensive calculations in order to receive a fraction of a Bitcoin.  Most Bitcoins are already out in the market though so your best bet is to pay cash or trade some type of service for them.

The Price and Volatility of Bitcoin

Bitcoin has seen a huge jump in value since it was released in 2010, but during that time the price has also been very volatile.  The USD value of a bitcoin increased ten-fold in early 2013 from $13/BTC on 1 January to $190/BTC on 9 April, three months later.  On April 10, 2013, Bitcoin dropped from a price of $266 to $105 before returning to a value of $160 within six hours.

I think part of Bitcoin’s huge price increase has to do with the recent Cypress bank tax.  Since Bitcoin is not owned by any government or organization, it requires a majority vote of Bitcoin holders in order to change any lines of coding.  The Cypress Bank Tax would have been the first case we’ve seen where a government decided they had the power to go in and take your savings away from you.  That would never happen with Bitcoin since there’s no one that can come after that money.

Ever since I was young, people have told me that when you put your money into a bank it will stay safe.  I know I can’t expect great interest rates anymore and it might not be worth as much due to inflation when I take it out but I didn’t think I could ever lose money.  In the US, we have FDIC limits that guarantee(up to 250k) our money.  As we’ve now seen, those guarantees aren’t nearly as strong in other countries.

A Drug Dealer’s Best Friend

There aren’t many black market drug dealers who take credit card but what if they took Bitcoin?  Bitcoins are untraceable and considered the online form of paying with cash.  A lot of critics have pointed out the negative uses of Bitcoin but I think the benefits more than outweigh the drawbacks.  Any time you involve a middle man like a bank or the government, you lose.  They’re always going to want their cut or make things in-efficient.

As for how I would use Bitcoin, I don’t think the government should be allowed to tax the money I make online since I could be making that money anywhere in the world.  It would be nice to get paid for all the work I do online in Bitcoin since the US government would have no record of it and wouldn’t be able to tax it.

I hate having to exchange money, worrying about ATM withdrawals in foreign countries and so on.  Even though the dollar is widely accepted throughout the world, it would be pretty cool to be able to pay with Bitcoin in any country around the world.

Bitcoin as an Investment

Although Bitcoins were designed to be used as a form of digital currency, most people these days are just hoarding Bitcoins.  Why would anyone pay 20 Bitcoins for a tv today when they can wait until tomorrow and it will only cost 19.75 Bitcoins?  So you have the hoarders and you also have the Bitcoin investors, people who are looking at Bitcoin as an investment and holding it until a later date so they can sell for a nice profit similar to what you would do with gold or stock.

It seems like I’m a little late to the Bitcoin party so I won’t be investing any money in it.  But should you decide to invest in Bitcoin remember that you shouldn’t invest anything you aren’t willing to lose.  I don’t really see Bitcoins taking off in the future since no one is actually spending Bitcoins right now.  You can use Bitcoins on a few hundred sites across the web but I don’t think you’ll see any large retailers accepting Bitcoins anytime soon.  The price volatility makes it too risky for a company like Amazon or eBay to accept Bitcoin.

How Can Bitcoin Succeed?

Even though I do think Bitcoin is a bubble that will eventually burst, I like the idea of a non-regulated digital currency.  Most of the ‘dollars’ I use on a daily basis might as well be a digital currency.  I rarely use cash and any transaction over a couple hundred dollars is almost always performed online.  So in a way I would say that the dollar is already a digital currency.

Honestly, I don’t see a whole lot of difference between dollars and how Bitcoin is used.  Money is valued only as a medium of exchange.  Why is gold worth so much more than salt or pepper?  Most gold is traded electronically these days anyways so again I ask, why is gold worth so much?  Once the initial excitement and flurry of Bitcoin dies down I think it could become a legitimate form of online currency.  The main problem with Bitcoin right now is its volatility.  But once its exchange rate settles down, it could be a good way to pay and get paid all across the world and web.

Readers, have you ever heard of Bitcoin before reading this article?  Do you think it could ever become a legitimate form of currency or is it just a fad that will pass with time?

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-Harry @ PF Pro

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Hi, I'm Harry, the owner and head writer for Your PF Pro. I started this site back in 2011 in order to create a place where young professionals could come and get all of their financial questions answered. On the site, you'll find articles on everything from asset allocation for retirement to saving money at Chipotle! So enjoy..

Comments

  1. says

    Very informative article. One correction: PayPal might appear to be free from the payor’s side of the exchange. But the merchant (the payee) must pay a pretty hefty transaction fee 3%+ to Paypal. This is as high as VISA/Mastercard!

    So with Bitcoin there’s no transaction fee. And no traceability, so it’s a black marketeer’s currency of choice.

    For ordinary users, though, the benefits of no transactions fees must be weighed against the risks. The biggest risk is that there’s no FDIC guaranteeing that your money will always be there, like with a bank. And the most important Bitcoin exchange – a website called Mt. Gox – has been hacked a couple times, already! So, I would be cautious about putting a whole lotta dough into Bitcoins.

    • says

      That’s partially true. Paypal does charge a ~3% fee for transactions for goods/services(buyer/seller protection is included in this though). But if you select the option to pay a friend/family member there is no charge as long as you fund with a bank account. You can also use services like Amazon Payments to send up to $1,000 funded with any credit card completely free, I do it every month.

      The US has the FDIC guarantee but what do other countries have? I’m sure they have some organization guaranteeing bank deposits but those guarantees are not comparable to the FDIC. I wouldn’t put anything into Bitcoin I wasn’t afraid of losing..

  2. says

    I too like the Bitcoin construct. Mt. Gox did have a security issue a while back, and VERY recently the largest mining pool operators, then the mining rig manufacturers, and now Mt. Gox itself are the victims of DDoS attacks. The severity of the attacks are are strong evidence that BTC adoption has reached a point in it’s growth/proliferation that it has now been viewed as a sufficient threat so that some group has devoted so much effort trying to destabilize the market.

    The nature of the BTC network is P2P so it’s incredibly difficult to disrupt. But the stand-alone players are open to attack.

    Now, this could simply just be market manipulation, but It might be something larger. Now put on your tin-foil hat… Who has the most reason to be threatened by BTC?

    The USA actually has the MOST to lose from BTC. Why? The USD is the defacto international reserve currency, and if BTC grows, it could easily replace it. This would destroy the demand for US debt and change the fiscal world forever.

    Call me crazy, but a world-currency is inevitable in my mind. It may take a few years, or a few thousand years but it will happen eventually.

    Who’s to say it isn’t BTC? I’m in. I’ve purchased some mining equipment and it’s chugging away.
    hungry hungry artist (@blerghhh) recently posted…PUT updateMy Profile

    • says

      I don’t think it will replace the US dollar anytime soon but I also see a need for a world currency. Like I mentioned in my article, how nice would it be to be able to travel anywhere across the world and have currency on your phone to pay for things.

  3. says

    How funny, the first time I heard about Bitcoin was last night on the The Colbert Report. I don’t really have any input since I still don’t fully understand it, but thanks for explaining it better for me!

    • says

      Here’s a MUCH more detailed explanation I wrote for a friend. I have removed a few paragraphs detailing my involvement, profit rates from my activities and such. His view was from a market-trader perspective which doesn’t do it justice since it’s an entirely new construct.

      *****************

      What is BTC?

      It’s called Bitcoins which is a cryptographic currency.

      It exists ONLY as a construct of the internet. There is NO central authority. There is NO central bank. It’s entirely a peer-to-peer construct. Computers talking to each other to verify transactions and maintain the general ledger.

      Key points: developed to facilitate person-to-person transactions with LOW fees and non middle-men. It’s cryptographically maintained meaning it’s impossible to hack. (There is individual vulnerability if you don’t have strong passwords and have a compromised computer) The network itself is too huge to overwhelm at this point. It’s NON FIAT. It can NOT be deflated. Transactions are anonymous, but the ledger is public.

      How does it work?

      As per the BTC protocol, computers that contribute (mine) the network are the ones running (collectively) the general ledger of ALL transactions that have ever happened. The ledger is public, but the addresses are (account owners) are completely anonymous.

      It’s designed to facilitate person-to-person transactions WITHOUT a central clearing house.

      Additionally, to facilitate the slow introduction of currency to the market, and encourage gradual adaptation, there is a reward that’s paid to the computers (miners) who provide their processing power. The current block reward is 25BTC. And one is awarded approximately every 10 minutes. Additionally, the transaction fees (on every transaction which are decided by the SENDER) are paid out to the computers providing the network computational base.

      The currency has an imposed hard-limit of 21,000,000 coins. No more can exist. So once the dust settles, this may very well be a fantastic store of value as it will be impossible for any central bank/FED or whatever to simply keep printing.

      The value of the coins include 8 decimal places. I believe the protocol has provisions to include 16 decimal places so when the US FED, EUR zone, JPY have printed our FIAT currencies into oblivion, there will still be a reasonable way to transact in BTC for small amounts.

      Originally, the hardware used to participate in the network was CPU based. Later others discovered they could process more quickly using GPUs. Then in the past 2 years, FGPA chips (Field Gate Programmable Array) were the money makers. And just recently there are ASIC chip processors entering the world. (Application Specific Integrated Circuit)

      Here’s the catch: the more computational power the network has, the harder it becomes to get rewarded for your participation. So every new wave of technology spawns ripples like what we’ve seen recently.

      Mt. Gox put it best: we’re the victim of our own success.

      The current issues that have caused the BTC price to fluctuate?

      The run-up started with further adoption of BTC. Then Japan threatened to debase it’s currency sparking the “currency wars” issues that drowned the news-wires for weeks. Shortly after that, Cypress hit. It left people scrambling to find an alternative store for their money that the government couldn’t touch.

      At the same time, the ASIC hardware developers were edging closer and closer to releasing their products.

      The “profit calculators” online can not predict what the “difficulty” will be (the part of the formula that determines how often you get paid) so they show WILDLY huge profit numbers. My own conservative estimates indicate that the difficulty will increase by 100x.

      All of these factors together wound up triggering the parabolic price rise. But, due to the huge value opportunity, some individuals or groups did some DDoS for hire to attack the hardware manufactures websites, and then the various exchanges. Thus creating the trading issues and panic selling… Add to that the stick-fingers banking policy in Cypress getting struck down and you have a TONNE of people panic selling.

      The biggest exchanges are struggling under the current demand and are simply having growing pains… Add to that the current DDoS attacks they have some issues to sort out. All of them are single operators at this point. There are only a handful of them, and they are struggling to upgrade their infrastructure to become more robust.

      My conservative estimates is that the price may fall as low as $30 USD/BTC. $30 is the OLD trend-line before all this mess hit the fan in the past 3 months.

      That said, the more media attention it gets, the more people look into it sparking further adoption and demand for BTC and BTC mining hardware.

      What’s cool: the iphone app “blockchain” lets you pair your phone to your online wallet. You can transact in BTC wherever you take your phone. Bitpay.com which is the biggest payment processor. You just send them BTC and they deposit CDN in your account.

      The exchanges are less cool. They are all super primitive. But there is a CDN exchange and they are even starting to offer “funds” and “BTC based company offerings”.
      hungry hungry artist (@blerghhh) recently posted…PUT updateMy Profile

  4. says

    Hey, Hungry Hungry – what does mining equipment cost? I have a couple of old computers sitting around and my electricity costs are “free” (included in my rent.) How much could I expect to clear on a monthly basis? Do I need to check on the programs from time to time – or can I just set the programs off and let the millionths of Bitcoin accumulate?

    • says

      The newest gear is somewhat expensive and there are FEW manufacturers. Waiting time is about 2-4 months at this point.

      $275 is the entry level box from “Butterfly Labs”

      They also sell units that are $1299 and $2499.

      The latest generation of hardware is very power efficient. Unlike the multi-GPU systems that were previously dominant.

      If you just want to put your current computer to work, I suggest checking out “bitminter” as they have a VERY easy java client that takes all the “nerd” work out of getting setup.
      hungry hungry artist (@blerghhh) recently posted…PUT updateMy Profile

    • says

      You should check out the “profit” calculators from “bitcoinx”. But take the results with a grain of salt… It currently shows that $275 unit being able to break-even in a matter of days.

      The network makes itself more difficult based on the available processing power. So by the time it ships in a few months… who knows.
      hungry hungry artist (@blerghhh) recently posted…PUT updateMy Profile

      • says

        Not interested in purchasing any equipment. I just want to mine using my old PC. Is that possible?

        What about bitcoin mining pools, like Slush’s?

        The analog to the Gold Rush is pretty apt – only the mining equipment sellers can expect to earn any money.

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