The Big Questions: What is bitcoin and should I invest in it?

Key Points:

  • Bitcoin is attracting a lot of attention after its value increased tenfold in less than a year
  • For those unsure of whether bitcoin is worth investing in, or even what it actually is, we explain what you need to know

Is it time to join the ‘bitcoin bros’? The value of the digital currency is soaring (again), and across social media its – apparently mostly male – investors are boasting of their newfound riches.

The investment establishment, on the other hand, seems less than enthused. After the value of a single bitcoin rose from $4,000 to $40,000 in less than a year, experts say it is displaying all the symptoms of a bubble ready to burst. The financial regulator warned investors: “be prepared” to lose all your money. 

Many are likely stuck in the middle: unsure of whether bitcoin is worth investing in, or even what it actually is. For those considering diving in, here’s what you need to know.

 

What exactly is bitcoin?

Bitcoin is the best-known of a number of digital currencies (money which does not have a physical form like cash or coins). It was invented in 2008 by a still unknown person (or persons), under the pseudonym Satoshi Nakamoto.

Ever since it has attracted something of a mystery cult: a dedicated online community of “bitcoiners” who espouse its virtues over other currencies. But bitcoin is also drawing plenty of mainstream attention as it becomes more popular. Coinbase, one of the most popular exchanges for bitcoins and other digital currencies, claims to have 35m users.

 

How does it work?

Bitcoin is a type of digital currency known as a cryptocurrency, meaning encryption technology is used to securely record every time it is sent and received.

These transaction records are added to a digital ledger, known as a blockchain, that is open for all users to see. Every time someone sends or receives bitcoin it is registered permanently (hence the “block”) and cannot be removed from the ledger.

To its supporters, this makes bitcoin more secure and less vulnerable to fraud than other currencies, as its users can verify all historic transactions. As the ledger is produced automatically by computers, it is also supposedly less prone to the errors that occur when currencies are handled by human intermediaries, such as employees at banks.

Every bitcoin transaction is recorded anonymously, identifiable only by a unique code. This means it is more private than traditional currencies, but also makes bitcoin a magnet for people who are particularly keen to hide what they are doing, such as those laundering cash or dealing drugs.

 

How is bitcoin made?

Unlike physical money, bitcoin is not printed by a central bank such as the Bank of England or the US Federal Reserve. Instead, a set amount of new bitcoins are awarded to people for “mining”: the process of building the computers that verify and record its global network of transactions.

One of the alleged advantages of bitcoin is therefore that its creation is not controlled by state authorities – particularly those that are less trusted to protect their national currency. While many governments have stoked damaging inflation by using their technically limitless money-printing machines, the total number of bitcoins that can be produced was capped from the start by Satoshi Nakamoto.

Mining is incredibly complex and can require filling large warehouses with computers just to win a small number of bitcoins. The huge amount of energy this consumes has attracted criticism from environmental campaigners: the University of Cambridge has calculated that bitcoin’s energy consumption is greater than that of Switzerland.

 

What can it be used for?

Despite its many lauded advantages, you can’t walk into a supermarket and use bitcoin to buy your vegetables. Even online sellers rarely accept it as a form of payment.

This means many people simply hold bitcoin as an investment, hoping it will be worth much more in the future than when they bought it.

 

Why does the price keep changing?

The price of bitcoin, like other currencies, is subject to the laws of supply and demand: if the demand for a currency increases relative to its availability, so should its value. When demand for the dollar goes up, you will generally need to exchange more sterling for every dollar you get in return – provided the demand for sterling is not increasing at an even faster rate.

The demand for traditional currencies is influenced by a number of factors, including the amount of goods a country is exporting and its level of tourism. But the demand for bitcoin is not so closely linked to the wider economy, meaning its price is more subject to speculation about its inherent value by investors, whose feelings about the digital currency can change rapidly. One investor uses astrology to guess its future value.

Earlier this month, the value of bitcoin fell from more than $40,000 to nearly $30,000 over a single weekend. The pound makes headlines if it falls less than two percentage points during the same timeframe.

 

So, should I invest in bitcoin?

If you had spent about $4,000 on bitcoin at the right point in 2013, this year you could have become a millionaire. You would have more money than if you had spent the same amount on shares in any Big Tech company. That’s as long as you didn’t forget the password to access your digital bitcoin wallet. 

According to its promoters, the only way is up for bitcoin. Its rate of production will slow until it eventually stops altogether, making it more likely that demand will outstrip supply. JPMorgan (US:JPM) has suggested a peak price of $146,000. Some even suggest that bitcoin’s independence from governments and the real economy could eventually make it a safe investment in which to secure your wealth, like gold.

The digital currency nonetheless remains highly volatile and subject to the whims of its investors. The establishment’s warnings cannot be ignored: after reaching its last peak of nearly $20,000 in 2017, bitcoin went on to lose over 80 per cent of its value within a year.

But if you still feel ready to dive in, we’ve assessed the various ways you can start investing here.

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