Should you invest in Bitcoin? Four things you need to know

1. Don’t put your money into something you don’t understand. Tweets like the one above is what spurred me into realising I needed to write something. My very simple answer is if you don’t understand Bitcoin you should not be investing in it.

That doesn’t mean you must understand the nitty-gritty of the tech behind it, but you need to understand what you’re getting into – how it works as an investment, how liquid it is (ie, can you get out when you want to), the level of risk  and what can drive the price up and down.

So if you’re going to invest, you need to start doing research and reading. The mere fact that a friend has told you it’s a good idea, doesn’t mean it’s right for you.

2. The demand for Bitcoin right now is likely from speculators more than users. Bitcoin is a currency and there are now a few places allowing you to spend it. Yet most asking me about it are doing it as an investment for the future, or as a place to store value, not as a convenient way to shop.

The idea is that Bitcoin is the most likely payment platform to work with a predicted, but far from certain, blockchain online technology revolution (which the likes of Ethereum and others are also part of). To be created Bitcoins have to be mined and there are meant to be only a limited possible number to be found.

The fact it’s a scarce resource leads to the assumption that if demand rises so will the price.

Of course this does lead people to ask questions such as…

That’s very difficult to answer – almost philosophical! What is value? Well, food has it, because we can eat it.  Yet the primary use of gold, which has been a store of value for centuries, is just for jewellery. Its value comes from its scarcity, uniformity, and the fact many recognise it as a medium of exchange.

And then look at our paper money – it has no intrinsic value, but Government validates it so we recognise it as having such. So does Bitcoin have value?  Yes, but only because if people choose to accept it as a form of payment.

PS: The massive rise in the speculation price of Bitcoin could actually make it slower or even less likely to take off as a daily currency. People are far less likely to spend Bitcoin when the price is rocketing – they’ll likely just keep hold of it.

Yet as is always the case – and as the regulator would say if Bitcoin was regulated – past performance is no indication of future performance.

It may be that this spectaculative rise will continue. Which means if you put your money in now you will make a fortune. On the other hand, as we’ve seen often in history – whether it’s the canal mania of the 18th century or the first internet boom – this could just be a be a tulip bubble, and soon to burst.

Graphs like these can be read as “I need to get in there, the price is rocketing” or “It’s overvalued, I’ve missed the boat”. We’ll only know with hindsight – you have to accept the uncertainty – though there is a decent chance this is a bubble.

So while the upward curve looks appealing, remember what counts with any asset (especially if, like this, it doesn’t pay dividends) is the price you buy at, and the price you sell at. Buying then viewing a price rise only makes you rich on paper; deciding when to sell is as important as when to buy.

Bitcoin is now at a point where the mainstream public are becoming much more aware of it – rather than the tech and financial aficionados who were in at the start.

That means we may be at the point where the ‘greater fool theory’ is coming into play. That is when many people are buying, not because they think the valuation is realistic, but because they believe a greater fool than them will be willing to pay even more for it in future. The key then is not to be the final fool.

PS: Don’t you feel sorry for the chap who used Bitcoin to buy beer?