The cryptocurrency bitcoin continues to make the news. What many New Zealanders don’t realise is that if they hold loyalty cards like Fly Buys or an air points card, they already own digital currencies.
However, when we read in December of a Wellington waterfront property for sale in bitcoin, and that bitcoin futures recently debuted on Wall Street, the subject of bitcoin and cryptocurrencies warrant consideration as a potential investment option.
What is a cryptocurrency?
Cryptocurrencies are digital currencies which use encryption techniques to regulate the generation of funds and the transfer of funds independently of a central bank.
What is bitcoin?
Bitcoin is one type of cryptocurrency that is produced and stored electronically. It has no intrinsic value – it cannot be redeemed for other commodities like gold – and it has no physical form because it exists only on a network of computers.
Bitcoin is not backed by any government or central bank, it is not regulated by any laws, and it is not universally accepted.
Bitcoin has a high profile because it was the first cryptocurrency. However, because they can be created with ease, as of writing there were more than 1,3001 other cryptocurrencies (including ethereum, ripple and litecoin) available on the internet.
Why is bitcoin valuable?
There is a cap on the number of bitcoins that can be created, limiting how much the currency can devalue through inflation. It can be seamlessly transferred between countries. A growing number of people are willing to accept it and to trade with it.
On a more sinister note, Bitcoin also enables crime and terrorist’s networks2, like ISIS, because it can be used for transactions that regular banks and governments would not allow.
How does bitcoin stack up as an investment?
Volatile is one of the first characteristics of bitcoin that comes to mind. The US Commodity Futures Trading Commission said in December that investors need to be cautious of an investment that surged more than 1,700% in 20173. Since the high of December 17, 2017, bitcoin was valued at $27,769 New Zealand Dollars. At the writing of this article (January 11, 2018), bitcoin devalued some 37% to $17,418 NZD on 22 December before going on to ‘recover’ to the current valuation of $20,776 NZD (9 Jan 2018) – still some 25% down on the earlier high4.
Dr Shane Oliver, AMP Capital’s Head of Investment Strategy and Chief Economist, labels bitcoin a bubble.
“To me, bitcoin has all the classic hallmarks of a bubble. It started off with some fundamental development, which is favourable, potentially revolutionising the payment system slashing the price of shipping money from around the world.
“But as the price goes higher and higher, investors are buying into it not because of the development but because it’s gone up… so it’s become very much a speculative bandwagon.”
Other financial speculators are now also drawing parallels to the Tulip Mania that gripped the Netherlands in the 17th Century, when some tulips sold for more than ten times the annual income of a skilled crafts worker, before dramatically collapsing.
What defines a good asset?
Before committing to bitcoin, or any other investment, ensure that it matches the definition of a good asset class. Ask yourself:
- Does it consistently earn on your behalf? e.g. interest bearing.
- Is it predictable? e.g. stable, not volatile.
- Is it widely accepted and in demand?
- Is it safe? For example, protected by regulation.
- Is it easy to buy or sell?
If the answer is no to some or all of these questions, talk first to an experienced financial adviser about what investments are best suited to your circumstances.
While investments that don’t have the above characteristics may provide opportunity for positive return, by and large, when dealing with peoples total combined wealth and financial goals, such investments fall more into the speculative and chance category, rather than forming the basis of considered and planned financial planning to meet one’s ultimate goals.
Tulips anyone?
Sources:
- https://fma.govt.nz/investors/ways-to-invest/cryptocurrencies/
- https://www.coindesk.com/u-s-think-tank-finds-rising-bitcoin-price-linked-terrorist- interest/
- http://fortune.com/2017/12/11/bitcoin-futures-contracts/
- https://www.cnbc.com/2018/01/08/cryptocurrency-ripple-crashes-30-percent-in-24- hours-bitcoin-also-dropping.html
- http://www.ampcapital.com.au/article-detail?alias=/site-assets/articles/insights- papers/2017/2017-11/all-aboard-the-bitcoin-bandwagon&audience=2
