If you’ve been following the financial markets closely this year Bitcoin may have caught your attention. And why not? While the stock market took a deep dive at the start of the pandemic, only to recover to its previous highs by August, Bitcoin saw something in excess of a 50% increase in price over the same time frame.
If you’ve been contemplating how to buy Bitcoin, you’ll need to learn all you can about this exotic investment. It’s not like any other asset – if it even qualifies as an asset at all. More than anything, it seems to be a concept, and that’s why you need to know exactly what you’re getting into.
What is Bitcoin?
Bitcoin is what is more generally referred to as a cryptocurrency. Cryptocurrencies are virtual currencies, meaning they exist only on the Internet. Despite the many pictures you’ve undoubtedly seen of what looked to be actual Bitcoin coins, no such creature really exists. The photos you see are merely a representation, which also explains why they seem to look a little bit different from one picture to another.
Bitcoin was first introduced in 2009 as open-source software. It was created by a software developer who goes by the name Satoshi Nakamoto, which is widely believed to be a pseudonym. Put another way, nobody really knows who invented Bitcoin.
The crypto was designed to be limited to no more than 21 million units. But much like dollars can be subdivided into pennies, Bitcoin can also be broken down into smaller units, called Satoshi – what else??? In theory, at least, as many as 2.1 zillion Satoshi can be created from 21 million Bitcoin units. That is, each Bitcoin is worth 100 million Satoshi.
Like all cryptocurrencies, Bitcoin can only be bought, held, spent, or sold on the Internet, hence the term digital currency. Originally, Bitcoin was created specifically to be a digital currency, meaning a medium of exchange for online transactions. It was seen as a currency alternative to government-issued money, like dollars, yen, and euros. Its value as an alternative is vested in the idea that it can’t be counterfeited, double spent, tracked, or even manipulated by governments. In other words, it was designed to be a free-floating currency.
However, virtually since its inception, Bitcoin has been much less a medium of exchange and more of a financial speculation.
Bitcoin is hardly the only cryptocurrency, though it is the biggest by far. Others include Ethereum, Litecoin, and Namecoin. Facebook has even attempted to launch its own cryptocurrency, called the Libra. The crypto was announced in 2018, with a targeted release date of 2020. But more than halfway through the year, the release of the Libra is uncertain.
Why Buy Bitcoin?
While Bitcoin is accepted as a payment method, the number of participating vendors and merchants in extremely limited. Its value seems to be primarily based on speculation – the possibility of the crypto rising to even higher prices.
In addition to its impressive performance in 2020, Bitcoin has provided incredible returns for early adopters. When originally introduced in 2009, it traded at no more than $1. But by the end of 2013, it had already rocketed to nearly $800. After that, it dropped down to close to $200, where it languished through most of 2015.
But by the end of 2016, it was trading at close to $1,000. And that’s when the real action started taking place.
On December 17, 2017, Bitcoin reached an all-time high of $19,783.06. But as impressive as that gain was, the price was back down below $3,300 by December of 2018. It briefly moved above $12,000 by the middle of 2019, then fell back once again.
That see-sawing price action with Bitcoin seems to be the attraction. It may be the ultimate buy low/sell high asset – if you can get the timing thing right.
The Risks of Buying Bitcoin
As exciting as the speculation potential of Bitcoin is, the downside risk is as obvious as the upside potential. Though many are fascinated at the possibility of buying the crypto at $5,000, then watching it launch up to $50,000, there’s no guarantee that will happen. It’s just as likely that you’ll buy at $11,000, only to watch it dropped down to $4,000.
That may be the biggest risk, but it’s certainly not the only one.
Bitcoin isn’t backed by anything. There’s no gold or silver sitting in a vault somewhere backing up the whole digital currency. And even though that’s true for national currencies, at least those have the backing of governments. That also means there’s no FDIC equivalent to protect your investment should something go wrong.
And speaking of governments, there’s always the possibility that one or more major governments will declare cryptocurrencies to be illegal. That’s not as far-fetched as it sounds, either. Cryptocurrencies, like Bitcoin, are designed to compete with national currencies. Thus far they haven’t been very successful. But should they catch on as a common medium of exchange, government bans won’t be out of the question.
There’s yet another risk that might be more philosophical than anything else. That’s the use of Bitcoin for its intended purpose, as a medium of exchange. In the 11 years that the crypto has existed, it hasn’t even made a dent in global economic activity. Even on the Internet, which Bitcoin was designed specifically to serve, it’s use in transactions is extremely limited.
With no asset or government backing, and no consistent purpose, Bitcoin has to be considered a pure speculation.
That holds the potential that the value may one day drop all the way down to zero. That’s certainly not a prediction, but it’s a very real possibility.
Decide Where to Buy Bitcoin
Okay, you’ve learned a bit about Bitcoin, including the risks, and you still want to take the plunge; where do you start?
You’ll need to buy Bitcoin, which is something you can’t do at a bank or traditional investment brokerage. Heck, even Walmart doesn’t sell Bitcoin.
For that reason, there are very specific platforms where you can buy Bitcoin or any other type of cryptocurrency. These are frequently referred to as cryptocurrency exchanges.
This isn’t a recommendation to purchase Bitcoin or any other crypto from the above exchanges. The entire industry is no more than a decade old, and numerous players have come and gone. You’ll have to do your own investigating to determine the integrity of any exchange you decide to purchase Bitcoin on.
Also, there are trading fees involved with cryptocurrency exchanges. You’ll need to investigate the current rates for each exchange, based on how much of the currency you want to buy, and how frequently you expect to be trading it.
Still another option is to use Robinhood. It’s an online investment service that offers free trading of stocks, but it also acts as an exchange where you can buy and sell cryptocurrencies.
Storing Your Bitcoin: Choosing a Digital Wallet
Since Bitcoin is a digital currency, you won’t be able to hold it in a bank account or brokerage account. For storage purposes, you’ll need to hold it in a digital wallet.
Digital wallets come in two temperatures, hot and cold.
With a hot wallet, your crypto is stored either by the exchange where you purchased your Bitcoin or by a cloud provider that you can access through your computer or a mobile app. In fact, a free hot wallet will often be offered where you buy your cryptocurrency. Fortunately, even third-party digital wallets, those that are cloud-based, are usually free as well.
The advantage with hot wallets is that transactions are much quicker, often instantaneous. However, that speed has the potential to sacrifice security. Hot wallets can be targets for hackers. This is a good time to repeat that cryptos are not covered by FDIC insurance or any similar coverage. If your Bitcoin is stolen, it’s gone for good.
Cold wallets are an actual portable device. You can use them to download and store your cryptos. They’re considered more secure than hot wallets because you actually have physical possession of the device were your currency is stored. They can be purchased generally for under $200. Popular cold wallets include Trezor and Ledger. (Once again, we’re not endorsing either, only reporting that those are known cold wallet options.)
This article is meant to be only an introduction on how to buy Bitcoin and not a recommendation. As noted in the article, Bitcoin is true speculation, in that its “value” is based entirely on the idea that someone else will pay a higher price in the future than you paid to buy it. This is also known as the greater fool theory, and even though it’s a strategy that ultimately is doomed to fail, plenty of people have made fortunes in speculations based on nothing more.
If you do plan to buy Bitcoin, keep your position small. A 5% allocation is probably plenty, and 10% is almost certainly too much. The vast majority of your portfolio should be invested in traditional assets, like stocks, bonds, funds, and real estate, with a small portion also held in cash equivalents for safety.
No matter how well Bitcoin seems to be performing at any given point in time, it’s important to keep a cool head. This is a speculation that tends to zigzag in short order. It can rise by 1,000% in a few months, then fall by 90% in just a few weeks, leaving you exactly where you started – if you’re lucky.