Update: Should You Invest in Bitcoin and Other Cryptocurrencies?

Among Bitcoin (and other cryptocurrency) buyers: North Korea

Perhaps you have heard of Bitcoin - the online "currency." I find that far more young adults know about it than older folks do. That makes sense since it's a digital currency used for Internet transactions.

Increasingly, Bitcoin has been in the news and making news more and more as its price climbs to ever dizzying higher heights. In December, 2017 the price of a Bitcoin breached the $17,000 mark.

Defining Bitcoin and Cryptocurrencies

So, what exactly is Bitcoin? For starters, it's not actually a coin - that's a marketing gimmick to call it a coin to make it sound like a real currency. Bitcoin and other similar cryptocurrrencies only exist in the online world. Bitcoin's creators have limited the number of Bitcoins that can be "mined" and put into online circulation to about 21 million (more on mining below).

As its promoters have talked up its usefulness and dizzying rise, many people who have Bitcoins continue to hold onto them in the hopes that the price will keep rising. Like shares of stock in the next Amazon.com or Apple, it's owners and promoters are hoping and expecting for further steep price increases. People don't hoard real currencies with similar pie-in-sky hopes for large investment returns.

Online Bitcoin transactions can be done anonymously and they can't be contested, disputed or reversed. So, if you buy something using Bitcoin and have a problem with the item you bought, that's too bad - you have no recourse unlike for example with a purchase made on your credit card. The clandestine nature of cryptocurrencies makes them attractive to folks trying to hide money or engaged in illegal activities (e.g. criminals, drug dealers, etc.).

As of December, 2017, about $500 billion is tied up in these cryptocurrencies according to CoinMarketCap.com which now tracks more than 1,300 cryptocurrencies. During that period, Bitcoin's market share has dropped from nearly 90 percent to 55 percent. CoinMarketCap.com tracks the 100 largest cryptocurrencies as measured by their market capitalizations - number 100 on the list recently had a market cap of about $87 million. 

Valuing Cryptocurrencies

So what is a given cryptocurrency like Bitcoin worth? Cryptocurrencies have no inherent value. Let's contrast that with gold. Not only has gold had a long history of being used as a medium of exchange (currency), gold has commercial and industrial uses. Furthermore, gold costs real money to mine out of the ground which provides a floor of support under the price of gold in the range of $800 to $900 per ounce, not far below the recent price of gold at about $1,280 per ounce. (Bitcoin does have a made up mining process whereby you need special computer equipment and end up using a bunch of electricity to solve complex math problems.)

The supply of Bitcoin is currently artificially limited. And Bitcoin is hardly unique - it's one of hundreds of cryptocurrencies. So if another cryptocurrency or two or three is easier to use online and perceived as attractive (in part because it's far less expensive), Bitcoin will eventually tumble in value.   

Ethereum is the second most popular cryptocurrency as people discover that it allows for incorporating "smart contracts" which are computer-based and enforced contracts that delineate specific conditions that must be met in order for the transaction to be completed.

Other Limitations and Concerns                    

Even though Bitcoin has been the most popular cryptocurrency in recent years, few merchants actually accept it. And, to add insult to injury, Bitcoin users get whacked with unfavorable conversion rates which adds greatly to the effective price of items bought with Bitcoin. This was well documented in a recent piece that CNBC did on the topic.

In India, a country with more than one billion people, a new frictionless payment system - India Stack - threatens to unseat Bitcoin there.

I can't tell you what will happen to Bitcoin's price next month, next year or next decade. But I can tell that it has virtually no inherent value as a digital currency so those paying thousands of dollars for a Bitcoin will eventually be very disappointed. With more than 1,300 of these cryptocurrencies, the field keeps growing as creators hope to get in on the ground floor of the next cryptocurrency which they hope will soar in value.