Is buying Bitcoins really investing?

Bitcoin millionaires seem to be popping up all over the internet, wherever you click. The more often this happens, the more people get interested in Bitcoin and other “cryptocurrencies”.

For good reason: in June 2013, one Bitcoin was worth less than US$100. Today if you’ve got one it’s worth US$6,629.75. And just in the past year, Bitcoins have jumped more than nine times in value.

15 Nov 2016: US$709.82

15 Nov 2017: US$6,629.75

Talk about a leap! It’s easy to feel like you’re missing out, wondering if you should have bought some when this digital currency came onto the scene in 2009, and be kicking back in Bora Bora sipping bubbles as we speak.

But is it really investing?

Have a look at another year in the life of Bitcoin.

30 November 2013: US$1,149.14

29 November 2014: US$378.91

That wasn’t that long ago. After a drop in value like that – imagine if your house had gone from being worth $1.2 million down to $379,000 – who would have predicted the recent skyrocketing of Bitcoin?

And what about all the other crypto-money out there? From 0x and Abjcoin to Zcash and Zurcoin, at this writing there are 1,279 cryptocurrencies and counting. Bitcoin is the oldest and biggest in volume, followed by Ethereum, Tether, Litecoin, Dash and Ripple.

Instead of the IPOs (initial public offerings) of the world of shares, now there are ICOs (initial coin offerings). These are typically unregulated campaigns to launch new cryptocurrencies, but instead of an equity share of a company, these offer the coins themselves.

Care to predict which will be the next Bitcoin? It’s anybody’s gamble, really.        

Sounds like speculation

The difference between investment and speculation is important, but it’s not always easy to discern. The simplest way I can put it is using the example of buying land:

• If you’re buying it to farm, growing produce that generates a profit each year – that’s investing.
• If you’re buying it to “land bank”, doing nothing but holding on to it until you can find someone else to pay more for it down the line – that’s speculating.

Hold on, you might say, investments can generate wealth both from the income they generate and from capital growth (becoming worth more). True.

But investments must produce regular income for you beyond a simple shift in market price – which is the key difference between true investing and mere speculation. It’s one of the reason the traditional kinds of investments of shares, property, bonds and cash get often mentioned here. These investments are always financially valued by their income.

If you’re just taking a guess on whether that market price of a cryptocurrency will soar, that’s more like gambling. Now I’ve got nothing against gambling in itself (unless you can’t stop). But if it’s a game, it should at least be entertaining, right?

“The line separating investment and speculation, which is never bright and clear,” says Warren Buffett, “becomes blurred still further when most market participants have recently enjoyed triumphs.” Which is of course what we are seeing with Bitcoin millionaires. “Nothing sedates rationality like large doses of effortless money.” Then he adds, somewhat ominously: “But a pin lies in wait for every bubble.”

Will your digital wallet get picked?

The world of cryptocurrencies – and the services wrapped around them – come with a slew of new risks for you and me. The Financial Markets Authority has just put out some new material to help investors (and speculators, I’m sure) to stay safe.

Here are key things to know about cryptocurrencies:

• Before you invest in cryptocurrencies or services like digital wallets, you need to understand the risks that come with them.
• Using cryptocurrencies may make you more of a target for scammers.
• Your digital wallet can be picked – or “hacked”, I should say – just like a real wallet. Have a look at this story where $300m of Ether was accidentally lost!
• Most cryptocurrency exchanges have no connection to New Zealand – they are unregulated and exclusively online. This makes it hard to find out who’s behind an offer, an exchange, and the buying and selling. It also means it will be much more unlikely for you to get your money back if things go wrong.
• As we’ve seen, cryptocurrencies can have huge swings in value that happen quite quickly.
• They aren’t accepted in the same way a traditional, non-virtual currency might be.

You’ll find more on cryptocurrencies, and the risks that come with them, on the FMA site.