Why Investing In Bitcoin May Not Be The Best Idea

 yahoo.com  6/19/2017 3:00:01 PM   Sean Williams
Investing In Bitcoin And How To Buy The Cryptocurrency

This article originally appeared on the Motley Fool.

Chances are, you'll have a hard time finding an investment that's outperformed marijuana stocks, unless you've been keeping your eye on the digital cryptocurrency bitcoin. Since late March, bitcoin has risen from around $900 to, at one point, north of $3,000. In fact, over the past 60 trading sessions, the price of the digital currency has risen three-quarters of the time.

Here's why bitcoin is skyrocketing

Why is bitcoin soaring as much as it is? It's tough to say with any certainty given the decentralized nature of the currency, but it could have to do with a few key factors.

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To begin with, bitcoin's visibility is growing. Yes, its surging value has improved its media visibility, but last month's WannaCry ransomware attack certainly provoked bitcoin's emergence into the media spotlight. WannaCry was malware that locked up users' computers until they paid a ransom -- and the only form of payment accepted by the developers of the malware was bitcoin.

Another key point is that Japan declared the cryptocurrency to be legal tender earlier this year. As with other currencies, it meant bitcoin exchanges would have to comply with anti-money-laundering regulations in Japan, but it also opened the door to new investors and helped legitimize bitcoin as a potentially valid form of payment.

We may even be able to point to President Trump and his cabinet for bitcoin's astronomical rise in recent months. Trump has favored a weaker U.S. dollar, which would typically promote U.S. exports. However, a weak dollar could also send investors scurrying toward finite assets that hold their value, like gold, and perhaps even bitcoin. The total number of bitcoins is capped at 21 million, which could have some investors viewing bitcoin as an alternative to gold (since gold is a finite resource).

Likewise, the cryptocurrency's rise could be fueled by support from members of Trump's Cabinet, including budget director Mick Mulvaney, who's been nicknamed the "bitcoin congressman" by some bitcoin supporters.

Why I'll never buy bitcoin

As for this Fool, you won't catch him anywhere near the "buy" button when it comes to bitcoin. Here are four reasons I'm keeping my distance from bitcoin -- and all cryptocurrencies, for that matter -- and would suggest you do the same.

1. Its anonymity is its own worst enemy

Without beating around the bush, one of the greatest allures of bitcoin is that it's not backed by a government, and it allows its users to remain somewhat anonymous, even though their transactions are stored within blockchains. This "investor inconspicuousness" is a big reason why bitcoin has done as well as it has over the past couple of years.

However, this anonymity can also support fraud and other crimes. WannaCry is just one example of what happens when the cryptocurrency falls into the wrong hands. If global governments discover that criminals or terrorists are using bitcoin to fund their activities -- and at present there are very few checks and balances in place to weed out this sort of behavior -- it could prompt a crackdown. If governments around the world instituted regulations that made it difficult to own bitcoin, we could see prices plunge.

Likewise, added government involvement would reduce the prized invisibility that bitcoin holders love so much, which could just as well create an exodus out of bitcoin, hurting its value.

2. Security is a major concern

Another major problem with bitcoin is that its current and future security are causes for concern. One type of security concern was described above: the potential for an attack on the actual networks that handle bitcoin. But there's considerably more to worry about than just cyberattacks.

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For example, a 2015 Forbes article describes the problem of ensuring that bitcoin's networks don't become centralized, which would make bitcoin more vulnerable to a cyberattack and/or fraudulent activity. The network is currently decentralized because it's run by numerous miners (the people and businesses that run the computers and maintain the system behind bitcoin). These miners are currently paid by block rewards and transaction fees. However, block rewards account for practically all of their revenue for the time being. Over time, these block rewards will decrease in value, meaning that if transaction fees don't increase, the miners could stop profiting, and bow out. Doing so could centralize bitcoin, since there would be fewer miners, and make it more vulnerable to attack.

Additionally, a centralized network could allow one bad apple, or a small group of bad apples, who control a large percentage of bitcoin to disrupt the market.

3. There aren't any reasonable ways to invest in bitcoin

The third issue I have with bitcoin is there aren't any reasonable "safe" ways to invest. Choose to invest on a no-name exchange, and you risk losing your shirt to low liquidity or hackers.

Back in 2014, Mt. Gox, a Japan-based exchange that was handling about 70% of all bitcoin transactions at the time, filed for bankruptcy. In its February 2014 bankruptcy filing, Mt. Gox listed 850,000 bitcoins that had been hacked, worth about $450 million at the time, and said it had also lost the $27 million in cash it purportedly had in its coffers.

Another option that's perhaps slightly more liquid than an off-name exchange is the Bitcoin Investment Trust (NASDAQOTH:GBTC), an ETF operated by Grayscale Investments that owns 173,594 bitcoins, according to its shares outstanding and bitcoin-per-share conversion information on its website. However, based on bitcoin's closing price on Monday, June 12, and Bitcoin Investment Trust's market cap of $661 million, there's nearly a 50% premium on this ETF compared to what the bitcoin it owns is actually worth. And as icing on the cake, management charges an audaciously high 2% expense ratio.

Thanks, but no thanks.

4. Most people don't understand it

Finally, and perhaps most importantly, a lot of people really have no clue what bitcoin is. I know what you might be thinking: "Great, I can get in ahead of everyone else!" But a misunderstanding about bitcoin, or a complete lack of understanding, could actually yield terrible consequences.

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Want an example? How about heightened volatility like we're witnessing now, or perhaps back in 2013-2014 in the bitcoin marketplace? People might get the broader-stroke concept that bitcoin is a cryptocurrency, but they don't understand the bigger picture of how it's challenging monetary theory, or that bitcoin proponents are looking at new ways to secure data and currency transmission. If investors don't understand these concepts or the risks involved, we could see another Tulipmania-type collapse.

Simply put, at this point, the risks far, far outweigh the rewards.

Sean Williams has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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