Bitcoin and other crypto-currencies have been in the news lately, as their prices have soared in recent months, making those fortunate enough to have invested early wealthy far beyond their expectations, at least on paper. The question as to whether it is wise to invest in Bitcoin or other crypto-currencies such as Ethereum or Litecoin now, or ever, is another topic which I am not going to cover here. I have recently questioned whether Bitcoin is in a bubble, as if it were, it would be an extremely dangerous investment liable to incur a loss of 90% or more at some future time. If you do decide to invest in Bitcoin or other crypto-currencies, how should you do it? After all, crypto-currencies do not physically exist so you can’t take them home and put them in a safe.
Investing vs Trading
More and more Forex brokers are offering trading in Bitcoin, and a few are also offering other crypto-currencies. This means a possible solution is to open an account with one such broker and simply buy some Bitcoin and sit tight while your investment hopefully appreciates. Opening an account with a Forex broker is usually a relatively painless process and you don’t have to worry about owning the Bitcoins or other crypto-currency. You just have a position with the broker, and many brokers will allow you to open an account with a minimum deposit of $100 or less. They also offer leverage, which means that you can take a position bigger than your deposit. This brokerage route sounds like a simple solution, but there are two problems that probably make it a potentially poor proposition. First and most importantly, brokers charge a small fee each day for every trade that is kept open overnight. For a long Bitcoin position, you would typically pay a fee of at least 0.03% of your investment per day. That equates to just under 11% per year, which would be a large chunk out of the profit of any long-term investment gain. The fee can also be raised by your broker at any time, so you could end up paying even more. The second issue to consider is the security of the broker. If they are not in a country where the regulators provide deposit insurance, your investment might disappear and be unrecoverable if the broker goes bankrupt. Even where there is insurance, you might only get your deposit back, after a long waiting period – without the profit if the value of Bitcoin has gone up! Brokers would be more suitable for short-term speculation on crypto-currency price movements, rather than long-term investment.
Experts typically estimate that it will be possible to mine Bitcoins until approximately 2040, leaving plenty of time for prospecting. Bitcoin mining is the process of using specialized computer equipment to create your own Bitcoins over the internet. Unfortunately, effective mining is now out of reach of the hobbyist, as it now requires a very large cash investment in a lot of equipment. There are some websites offering investment in collective mining operations. These are technically feasible, and there are legitimate mining consortiums which pool the costs, but this again is a risky idea, particularly if you do not have perfect due diligence on the offering.
Shares in a Crypto-Currency ETF
Some assets are problematic to own as they incur storage costs and other issues, commodities such as crude oil, natural gas, and gold bullion being good examples. So why not buy shares in a fund which owns crypto-currency, giving you an exchangeable and easily ownable asset derived from the value of the crypto-currency you wish to invest in? The main reason why it might not be a good idea is that shares in these crypto-currency funds tend to trade at strong premiums to their underlying value because there is such heavy demand for the shares. For example, a fund owning $100 million of Bitcoin valued at the current market price might have 1 million paid-up shares trading at $150 each. If you buy one of these shares, you are paying 50% over their true value, and if the market were to cool off suddenly, you would find yourself down by 33% on your investment very quickly. Another concern with investing in a fund is the question of regulation and fraud, similar to the issue concerning Forex brokers.
For most investors today, the cheapest method is simply to buy the crypto-currency directly and store it, hoping to sell it later at a profit. This leaves you with the legal ownership of the asset and the responsibility of storing and protecting it. The worry is in protecting the code, as Bitcoin ownership is like a bearer share: anyone with access to the code can “spend” the Bitcoin. If you have the code on a piece of paper, and receive and store it by email, it is just as vulnerable to hacking as your email is. An alternative storage and protection method is to use a digital wallet and/or vault. These can be a third party’s server, a smartphone app, or a program you store on your computer. You can keep it in a flash drive or other device too. All these methods have obvious advantages and potential risks. There is always some risk of hacking or physical damage resulting in a total loss of the investment.
As for making the actual purchase, there are two main methods. There are ATMs in some cities which accept cash, debit and credit cards. A fee of up to 18% is charged on a transaction, and you must have a wallet set up before you can make the purchase. Alternatively, you can use an online crypto-currency exchange, which may also offer you a wallet and/or vault. These exchanges also charge a fee.
Before making any investment in a crypto-currency, please do your own thorough research into whether it is an attractive investment that can meet your long-term financial goals. Take care not to be panicked into buying in a hurry before you have thought it through. Investments that have enjoyed enormous price increases have historically shown some tendency to suffer disproportionately from huge falls in value. If you do wish to go ahead, outright purchase is probably the best idea, although a very well-regulated and insured fund trading at a modest premium could also be a good option.