Bitcoin and Cryptocurrency: Long-term Potential or Short-term Buzz
Bitcoin is powered by a promising new technology, but many uncertainties remain
The meteoric rise in the price of Bitcoin, which represents more than half of the nearly $500 billion cryptocurrency market, has dominated headlines recently. But the price of Bitcoin and other cryptocurrencies has been extremely volatile due to significant uncertainties, including:
- Long-term supply-and-demand dynamics
- Potential impacts from government policies
- The question of which cryptocurrency, if any, will survive over time
Blockchain: the technology behind Bitcoin
Bitcoin is the product of a technology called Blockchain. The original intent of Blockchain was to enable peer-to-peer digital payments that do not require a trusted third party, such as a financial institution. The problem Blockchain solves is assuring the recipient of a digital asset that the asset is wholly transferred (as opposed to copied and then transferred), thereby eliminating the possibility of digital double-spending. Blockchain thus removes the need for a third party to verify peer-to-peer digital transactions.
How Blockchain works
Blockchain is a digital ledger, or record, of transactions managed by a decentralized network of computers. For ledger entries to be successfully added to the Blockchain, all computers on the network must agree that the entries are accurate. If they all agree, the ledger entries are added and Bitcoin is issued as a payment. In this way, Bitcoin serves as an incentive to add valid transactions to the ledger, removing the need for a central trust authority.
Blockchain potential applications
Blockchain allows for the exchange of digital value directly and securely. Thus, the technology has many potential applications, including:
- regulatory recordkeeping of any sort (health history, land title, etc.)
- financial transactions or transfers of value (payments, loans, etc.)
- personal control of online identity
- supply-chain optimization
- consumer-royalty programs
Risks to Blockchain and cryptocurrencies
While Blockchain solves an important technology problem, the value of any given cryptocurrency remains highly uncertain. Cryptocurrencies such as Bitcoin, Ethereum and Litecoin have all exhibited significant price fluctuations due to these high levels of uncertainty.
In addition, cryptocurrencies are not common stocks of companies and do not trade on stock exchanges. Unlike an investment in a stock or mutual fund, there are no underlying fundamentals (cash flows, profits, tangible assets, etc.) to support the valuation.
SEC's position on cryptocurrencies
SEC Chairman Jay Clayton recently issued a statement on cryptocurrencies. Clayton warned:
- Cryptocurrency markets offer substantially less investor protection
- Cryptocurrencies are not securities and therefore are beyond the SEC’s jurisdiction
Is Bitcoin a bubble in the making?
Many investors are questioning whether Bitcoin and other cryptocurrencies are the latest asset bubble at risk of bursting. While no one knows for certain, we do know that the over 1600% price increase year-to-date surpasses many other previous bubbles, such as the dot-com bubble of the late 1990s, and the recent U.S. housing market bubble. While predicting the near-term, or even long-term, direction of Bitcoin is impossible, we believe the one certainty is that extreme volatility is likely to continue.
While I believe Blockchain technology has significant promise, I view any investments in cryptocurrencies as highly speculative. We recommend following time-tested investment principles and - not letting the "fear of missing out" negatively impact your long-term investment strategy.
Remember to always do your homework before deciding on any investment, including emerging technologies and markets. Working together with your financial advisor can help you to determine whether a particular investment is suitable for your portfolio.