Are bitcoins a good investment?

The Momentum UK Team 15 January 2014

Earlier in the year IT professional James Howells threw away a hard drive containing 7,500 bitcoins. Now they’re worth around $1,000 each.

Lily Allen has also claimed that she’s missed out on millions as several years ago she was offered hundreds of thousands of bitcoins as payment for a gig, but she refused.

These are just a few of the many ‘what if’ bitcoin stories that are beginning to circulate on the net as the once near-worthless currency has skyrocketed in value- but what are bitcoins?

How do they work?

A peer-to-peer currency, the bitcoin uses cryptography to ensure security and validity. Bitcoins are stored on a ‘digital wallet’ on owners’ computers. New coins are begotten when an algorithm is decoded, and it’s possible to ‘mine’ your own bitcoins if you have a computer and the right know-how.

Bitcoins are essentially a long string of characters ‘mined’ via complex maths problems. Some people think of bitcoin as more than just a digital currency or payment method, but more like a commodity.

The bitcoin protocol and related software was developed by Satoshi Nakamoto, a pseudonymous programmer.

Favoured for their anonymity, bitcoins originally gained a bit of a reputation for illegal transactions, until online drug marketplace Silk Road was closed down. Trading with bitcoins has been heavily limited in China by recent legislation.

Initially bitcoins were limited as there were few things you could use them to purchase, in particular few ‘real life’ purchases. The currency is catching on quickly and gaming platform Zynga have stated that they will accept the currency in exchange for virtual goods, and there are places where you can exchange bitcoins for physical goods.

Are bitcoins a good investment?

Bitcoins may seem like a hot investment option with each one currently worth around a thousand dollars each, but their value is constantly fluctuating, making them a high risk commodity.

While it’s possible that investing in the bitcoin could pay off, you should investigate the potential pitfalls very carefully to ensure you understand the nature of them and the potential risks involved. Bitcoins aren’t the only virtual currency either- after all the technology used to develop the bitcoin is open source- and there may also be opportunities to invest in ventures that could help fuel the virtual currency economy.

What are the downsides of virtual currencies?

Virtual currencies are, as yet, unregulated and The European Banking Authority has been quick to bring attention to the potential pitfalls of the so called ‘crypto-currencies’. Virtual currencies have been around for several years, only recently falling into the public eye. As well as being a potentially unstable investment, virtual currencies are also not impervious to hacking and there have been several stories circulating of ‘digital wallets’ being breached. It’s also important to bear in mind that the currency could be taxable.

There are several potential downsides to virtual currencies such as bitcoins, including the fact that they are not protected by the same legislation as traditional currency, meaning that you may not have the same entitlement to refunds should you use the currency to pay for goods and services.

The European Banking Authority have issued a warning about investing money in this emerging currency type:

“Virtual currencies continue to hit the headlines and are enjoying increasing popularity.

“However, you need to be aware of the risks associated with virtual currencies, including losing your money. No specific regulatory protections exist that would cover you for losses if a platform that exchanges or holds your virtual currencies fails or goes out of business.

“The value of your virtual currency can change quickly, and could even drop to zero

“The price of Bitcoins and other virtual currencies has risen sharply. This has prompted some consumers to choose to invest in them. However, you need to be aware that the value of virtual currencies has been very volatile and can easily go down as well as up. Should the popularity of a particular virtual currency go down, for example if another virtual currency becomes more popular, then it is quite possible for their value to drop sharply and permanently.”