Why Buyers Should Be Wary of Bitcoin Mania

There's a lot more to investing in the so-called 'virtual currency' than potential investors may know about

A bitcoin. (Photo: AP) A bitcoin. (Photo: AP)

Bitcoin prices topped at $1,000 last week on the second largest digital currency exchange, called Mt. Gox. That’s a tenfold jump from April, when bitcoin prices crossed $100.

Without much surprise, the public and big-name investors along with startups are jumping onto the bitcoin bandwagon.

Bitcoin was created in 2008 by Satoshi Nakamoto, a pseudonym for the person or group of people who designed it.

Let’s examine three common myths about bitcoin.

MYTH #1: Bitcoin is a Currency

In the media, bitcoins are often referred to as “digital currency” or “virtual money.” Elsewhere, bitcoins are being touted as a cash alternative to the U.S. dollar and other global currencies, including long-established assets like gold and silver. But is bitcoin really a “new world currency” as some argue?

Bitcoins only exist as software and their supply is controlled by complex mathematical formulas. Therefore, bitcoins are not a currency, and even calling them an “investment” is a stretch. Rather, bitcoins are nothing more than a technological innovation and are subject to the same risk and competition as all technology, including really nasty viruses.

MYTH#2: Bitcoin is Overtaking Traditional Currencies

There are more than 12 million bitcoins in circulation and the total bitcoin market size is just over $11 billion, according to Bitcoin Watch. That pales in size compared to the trillion-dollar foreign exchange market.

Trading in foreign exchange currency markets averaged $5.3 trillion per day in April, according to the Bank for International Settlements and the preliminary global results from the 2013 Triennial Central Bank Survey of Foreign Exchange and OTC Derivatives Markets Activity.

No matter how bitcoin enthusiasts try to portray it, bitcoin is far from mainstream and it has a very long way to go before establishing itself as a stable and proven mechanism for transacting commerce.   

MYTH #3: Regulators have endorsed Bitcoin

In a Senate hearing last month, the Department of Justice said that bitcoins can be a legitimate or “legal means of exchange.” While this is a promising development, it’s hardly an endorsement.

Bitcoins still aren’t supervised by any country or regulatory body, and that makes the bitcoin market ripe for abuse. Also, criminals use bitcoins to buy and sell drugs, firearms, and other illicit paraphernalia in an attempt to subvert their illegal activities. The exact percentage of unlawful activity in the bitcoin market is a mystery.    

Increasing Competition

The irony of bitcoin’s success is that as its popularity and price soars, so does the number of rivals that want to dethrone it. In fact, the list of bitcoin competitors and alternatives grows by the week, here are just a few: 

-Namecoin

-Litecoin

-PPCoin

-Betacoin

-AnonCoin

-PhenixCoin

-IxCoin

Which of these bitcoin competitors will succeed? Nobody really knows. But what we do know is that technological innovation (and that’s what bitcoin is) is rapidly and constantly improving. And as technology gets better, “the cost of a unit decreases exponentially over time,” says Moore’s Law.

Think about it this way: If Moore’s Law has proven to be a reliable indicator over the past 48 years in an established marketplace like semiconductors, what about the jungle-like world of techno-synthetic currencies?

In the end, Bitcoin’s ultimate worth will be challenged by new and improved digital technologies that are faster, easier to use, more secure and probably less expensive. And if you put on your thinking cap, you’ll realize none of this is a very bullish backdrop for bitcoin over the long run.  

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Ron DeLegge is the Editor of ETFguide.com, founder of the ETF(k) Retirement Group at LinkedIn, and publisher of the ETF Advisor Pro newsletter.

 

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