Confused About Bitcoin?

Confused About Bitcoin?

Well, that makes two of us. Until a couple months ago I knew virtually nothing about Bitcoin. I consider myself well versed in finance and economics, but even after researching this subject I admit that I’m still confused. Originally, I blew it off as some obscure currency used by gamers, online junkies, and possibly criminals (turns out I was right about criminals liking Bitcoin). But, as it has gained in popularity with the financial media, I thought it would be worth taking a closer look. Oh, and the price of Bitcoin is now approaching $10,000!

Bitcoin is a digital currency (cryptocurrency) that can be purchased in most countries in exchange for the local currency. Think of it as a digital token, with no physical backing, that can be sent electronically anywhere in the world. Unlike traditional payment networks like Mastercard or Visa, the Bitcoin network is not run by a single company or person. The system is run by a decentralized network of computers around the world that keep track of all Bitcoin transactions.

Allegedly, Bitcoin was first introduced by an unknown person using the online alias Satoshi Nakamoto back in 2009. To date, no one has been identified as the real Satoshi. Jeez, this sounds like a sci-fi movie.

The price of Bitcoin is constantly fluctuating and is determined by open-market bidding on the various exchanges. It’s similar to the way stock and bond prices are set on the exchanges.

I won’t go into detail here, but Bitcoins are basically stored in a kind of “digital wallet,” which exists in the cloud or your computer. It’s like a virtual bank that allows users to send or receive Bitcoins, pay for goods, or save money. These digital wallets are not FDIC insured.

How You Can Purchase Bitcoin

In the U.S., a company called Coinbase will link to your bank account and sell you the Bitcoins for dollars. Opening a Coinbase account is very similar to opening a traditional bank account, with various security and identification measures in place. There are also various other exchanges where you can buy and sell Bitcoin.

Who Uses Bitcoin and Why?

Anyone can use Bitcoin to buy merchandise where it’s accepted as a method of payment. And more and more mainstream companies are starting to accept it. The question of “why” would anyone use Bitcoin is very difficult for me to answer because this is a foreign world to me. Here are a few things I’ve learned that may help to provide an explanation:

Bitcoin Advantages

  • Transactions are made with no middle men
  • There are no transaction fees
  • Anonymous transactions – no name needed
  • Easily transfer money internationally within minutes (can take weeks through traditional channels)

None of these reasons are compelling enough for me to start transacting in Bitcoin, but apparently, it’s enough for many people. The other important thing to note is that most transactions are people buying and selling Bitcoins on exchanges, speculating on future prices.

Summary

I’ve been asked if Bitcoin is a bubble waiting to burst. I honestly have no idea, but we may find out soon enough. I don’t even know where it derives its value. It obviously serves a purpose for some, and it is being accepted by many retailers. It’s also highly speculative, but then again, so are most currencies. One thing is for sure – the government is keeping a close eye on Bitcoin as it is mostly unregulated. I suspect if this cryptocurrency has legs, it won’t be long until the government regulators step in, and this discussion could be heading in another direction.

Mike Minter

Mike Minter

Mike develops investment portfolio allocations, handles trading and rebalancing, and conducts research and analysis as a Portfolio Manager and Financial Advisor for the firm. As a perpetual student of investing and the markets, Mike considers himself obsessed with the subject. Mike has earned the CERTIFIED FINANCIAL PLANNER™ (CFP®) and Certified Fund Specialist® designations. He is also an active member of the Houston chapter of the Financial Planning Association (FPA).

 
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