The Three Biggest Bitcoin Myths
When the value of an investment suddenly soars, or collapses, it tends to get a lot of media coverage. In 2017 that investment has been Bitcoin. It started the year priced at $978, and as of the date of this writing is valued at more than $17,000. That’s an increase of over 1600% in less than one year. No wonder everybody is talking about it. The obvious question on most people’s minds is whether or not this is a good time to jump in and buy some.
The right answer, as is typical with many financial planning decisions, depends on your personal financial situation and goals. I thought it would be more helpful to explain what I believe to be the three biggest myths people have about this relatively new investment opportunity so that you can consider it in a more rational rather than in a more emotional manner.
Myth #1: Bitcoin is a currency.
A currency is a medium of exchange created to make the buying and selling of products and services easier than having to barter for them. That obviously requires that the value of the currency be relatively stable. In the case of Bitcoin, notwithstanding 2017’s stellar gains, its price has fallen by over 85%, not once but three times, over the last seven years. And it has experienced a drop of 20% or more every quarter since 2013. Never in history has any country’s currency fluctuated by so much in such a period of time.
What would be the consequences of using Bitcoin to purchase goods? Suppose you bought a $1000 4K TV using Bitcoin on November 30th. You would have paid $1000 (the price in dollars) divided by $9937 (the Bitcoin value per dollar on that date), or 0.1006 Bitcoins. Did you get a good price? If you had waited just one week, you could have purchased the same TV for $1000 divided by $16,858 (Bitcoin’s price on December 7th), or only 0.0593 Bitcoins. That’s almost half the price. Buyer’s remorse, anyone?
What if the store instead had chosen to keep the price constant in Bitcoins? In that circumstance buyers on December 7th would have paid 0.1006 Bitcoins for the TV, the same as the price on November 30th. But in dollars, that would have been 0.1006 times $16,858, or $1695. This time it would have been the December buyers regretting that they had ever heard of Bitcoins.
As a medium of exchange, Bitcoin is completely impractical. That’s why 90%+ of all purchases and sales using Bitcoin are taking place on the dark web. Presumably the lack of traceability is more important for illegal trading than price stability.
Myth #2: There are no tax consequences with buying and selling bitcoins.
The IRS considers so-called cryptocurrencies, including Bitcoin, to be intangible property, which is subject to capital gains rules. If you buy Bitcoins with U.S. dollars and later sell them for U.S. dollars, you have to report and pay taxes on any capital gain or loss on that transaction. If you trade Bitcoins or leveraged Bitcoin contracts on Bitcoin exchanges, you have to report realized capital gains and losses on each trade, even if you don’t convert the underlying Bitcoins back into U.S. dollars.
Myth #3: An investment in Bitcoin is an investment in digital technology.
There is an underlying technology supporting Bitcoin that is called Blockchain. It eliminates the need for an intermediary (like a bank) to ensure that transactions are properly recorded and that Bitcoins are not stolen. It is an interesting technology with possibilities in many different fields. But what does investing in Bitcoin have to do with investing in Blockchain?
Take artificial intelligence (AI), for example. It’s the technology behind self-driving cars, not to mention a host of other cloud-based software applications. Would you invest in Ford or Volvo if you wanted to invest in AI? Wouldn’t you expect to reap higher returns by investing in a company closer to the technology itself, such as NVIDIA (which produces chips used for AI), or in Google (which creates AI software)? In the same vein, wouldn’t it make more sense to invest in companies focused more directly on Blockchain itself rather than simply in one of that technology’s users?
So what’s an investor to do about Bitcoin?
When people become excited about some investment – especially one based on a new technology that has turned some lucky early investors into millionaires in just a year or two – it’s usually the emotional fear of missing out that drives their actions. Emotion, though, is a very poor rationale for investing. How do you know what Bitcoin should be worth? It is not a productive asset, therefore its price, just as with gold, is based solely on supply and demand. Right now that spiraling price and media exposure is fueling the demand. On the supply side it is the Blockchain technology that is the controlling factor. If you don’t understand how each works to impact the price, you wouldn’t be investing in Bitcoin, you’d be gambling. And there are actually hundreds of alternative cryptocurrencies in which you can invest, each with market caps greater than $1 million. Not to mention gold itself. Will Bitcoin ultimately win out, hold its own, or fall by the wayside? Caveat emptor.