Why Bitcoin Is a Horrible Investment Idea

The relatively new currency of bitcoin recently peaked to a value near $240 per bitcoin from less than $20 at the start of the year. This 1,200% return in less than five months would pique anyone's interest. Many call this a bubble, while others are still bullish on the possibilities of an even richer bitcoin. No matter what side you are on, beware of these bitcoin-specific risks that other traditional investments lack.

Source: bitcoincharts.com

Extreme dependence on sentiment
Any value of an item comes down to what someone will pay for it. Some items have an intrinsic value because they can help produce goods or services that can be sold. As Warren Buffett described in his 2011 annual letter, contrasting the value of farmland and ExxonMobil with all the gold in the world:

A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops -- and will continue to produce that valuable bounty, whatever the currency may be. ExxonMobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions. ... The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.

Gold, with limited utility, acts mainly as a store of value that is backed by humans' long-term fascination with the shiny metal. Bitcoin is much the same, but with a much less storied history, and much less physical presence. As such, any slight shock to the confidence of the market can greatly affect its value. A few days ago, when the largest bitcoin trading site, Mt. Gox, was attacked and couldn't handle all of its traffic for a short time, the value of bitcoins dropped from $142 per bitcoin to $120.

One of the supposed benefits of bitcoin is that it is a peer-to-peer currency that does not rely on any central bank. As such a distributed currency, it shouldn't rely on one organization to succeed. Whereas past digital currencies like Flooz, Beanz, and e-gold relied on a singular company and its success, bitcoin shouldn't. As Amazon.com's (NASDAQ: AMZN  ) Coins and Facebook's (NASDAQ: FB  ) Credits are only valuable if those companies survive, bitcoin is meant to be free of any single organizational tie to prosper. But, with a lack of credible, efficient, and secure exchanges, losing full access to the largest exchange for a short while means a definite hit to bitcoin's value.

And even when a currency has a juggernaut like Facebook behind it, it can fail to meet expectations. Facebook launched its Credits in 2011, but in 2012 announced that it would alter its system. In a post describing the changes, the company stated that "most games on Facebook have implemented their own virtual currencies, reducing the need for a platformwide virtual currency." Its ambitions for a lucrative application currency exchange failed, and many pointed to the difficulty of capturing users' credit cards and complicated exchange system between cash and credits, and credits and in-game currencies like those in FarmVille.

Amazon, however, has plenty of credit cards stored. And as it's much easier for users to spend branded coins, both psychologically and technologically, Amazon Coins will help fuel purchases in Amazon's Kindle ecosystem. Additionally, in stride with Amazon's usual low-margin, high-volume strategy, it plans to give away "tens of millions dollars' worth" of coins to customers in May.

A poor investment idea
Bitcoin might be fun to gamble on, but as a long-term investment, its current reliance on the largest bitcoin exchange makes it iffy at best. One of the important aspects of bitcoin is its distributed nature, but in its infancy, it has yet to fully realize that value due to a lack of trusted exchanges.

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  • Report this Comment On April 10, 2013, at 2:58 AM, ferroh wrote:

    " as a long-term investment, its current reliance on the largest bitcoin exchange makes it iffy at best "

    Do you not see the irony in this statement?

    The *current* reliance on a single exchange is decreasing (down from 80% total volume to on some days, 50%), and speculators feel that in the *long term* the decentralized spirit of bitcoin will prevail. You've completely failed to see what all the hype is about in the first place.

    This tech was worth a fraction of its current value 3 months ago. It takes time for current exchanges to ramp up to meet the new demand, and it takes time for new exchanges to pop up.

  • Report this Comment On April 10, 2013, at 7:20 AM, paulsnx2 wrote:

    Bitcoin will either go to zero, or increase by some really huge factor.

    I really can't imagine not taking that risk given the very modest exposure required...

  • Report this Comment On April 10, 2013, at 8:28 AM, Jankowitts wrote:

    Bitcoin won't go to zero. It's only going to become more valuable as fractional reserve banking and fiat currency bite the dust. Why can we embrace this rush into bitcoins. The idea is sound and so are the bitcoins themselves.

    Long term bitcoin is a wonderful investment. It will be over $500 a bitcoin in te next two month and will ride sporadic jolts up in value as we see more of the event that happened in Cyprus.

  • Report this Comment On April 10, 2013, at 10:51 AM, intera wrote:

    What the author seems not to see clearly (as every negative article on Bitcoin I've seen) is that Bitcoin by itself has real value. I would dare to say it has (or will have) even more REAL value than gold and silver.

    First of all there is all the "black" economy that needs a hidden money. Like it or not, this economy is real has millions of transactions every day and are a multi-billion demand out there.

    Besides that there are tens of countries (like Argentina, Venezuela and others) that has a very tight control over money going out and in the country and there it is another multi-billion market demanding it.

    Then there is the multi-billion dollar market of immigrants sending money to their families paying huge commisions just to move the money from one place to the other.

    And the list goes on and on...

  • Report this Comment On April 10, 2013, at 12:07 PM, memoandstitch wrote:

    When a bitcoin is worth $1550 and every mom and dad is buying it, it will be regulated. You may think VPN can't be blocked, China has done it.

  • Report this Comment On April 10, 2013, at 1:39 PM, thinhouse wrote:

    Litcoin will soon be sold at mtgox, it could follow bicoin. GBBG Fund will be selling both. http://www.bitbillions.com?refid=1JLb2hrECqSMfNhM32cskCqCUvkufK1bp5

  • Report this Comment On April 10, 2013, at 6:04 PM, xetn wrote:

    memoandstich:

    How do you know that China has blocked vpn? I lived in China for over 2 years and used vpn every day. My last trip was a year ago and used vpn.

    Oh, and what does vpn have to do with bitcoin?

  • Report this Comment On April 11, 2013, at 11:16 AM, MusiCali wrote:

    Hey guys wanna buy my new currency. Its awesome and what's even better is that its not even backed by any government or financial institution! Its called s**tcoin. Keep watch, coming to a trading platform soon.

    I smell Tulips.

  • Report this Comment On April 11, 2013, at 11:28 AM, atkinskd wrote:

    What a marvelous concept. Ultimately it could result in a fundamental fixed currency, where the games of washington and other governments have far less influence, and funny money does not exist. A currency that is 100% tracked, monitored and balanced. Very interesting. I'm sure hackers are pingin this thing daily but with a =0 check on all transactions, and a record of exactly where it went the idea is awesome.

  • Report this Comment On April 11, 2013, at 12:06 PM, drseusphd wrote:

    I agree with Buffet 100% if Aliens came to earth to take all our gold and then left, No one would even notice, I cant say the same for Copper, Steel or even Cement

    Bit coins? How can anyone that has any college degree even think of giving some one money for these? Yet we have financial wizards and pundits actually debating these things as if they have any credibility at all. Bernie Madoff would still be rich and never went to jail if he sold these worthless Ponzi Pogs

  • Report this Comment On April 11, 2013, at 12:13 PM, FelixCaliferous wrote:

    How do I sell short?

    Can I simultaneously buy a put and call to profit from a huge move in either direction?

    If I can no do these things then the market is too thinly traded and easily manipulated by a few insiders.

  • Report this Comment On April 11, 2013, at 1:51 PM, valari25 wrote:

    You are nuts if you think we wouldn't miss gold, drsuesphd.

  • Report this Comment On April 11, 2013, at 2:02 PM, UpFromDownunder wrote:

    @Jankowitts

    I fail to see why Bitcoin would survive if fractional reserve banking and fiat currency collapsed. Until bitcoin is accepted everywhere for any purpose, including the garage sale down the block and buying real-estate, bitcoin is nothing more than a proxy for cash and if cash fails, bitcoin will go with it.

    If you want to look at it another way, try this. At the start of the year, one bitcoin was worth $20 or so. Or to put it in terms of a tangible commodity, one bitcoin was worth roughly one pizza. Now that one bitcoin is supposedly worth $240 then one of two things must have happened:

    a) the bitcoin cost of the pizza is still one bitcoin, which means that same pizza must cost $240 in the non-virtual world, but this is patently false

    so

    b) the bitcoin cost of the pizza is now about 1/12th of a bitcoin, so the bitcoin has suffered a serious case case of hyper-deflation.

    or

    c) the "value" of a bitcoin has no relation to the non-virtual world whatsoever, and as such, it's value is entirely in the mind of the holders and has no real worth. Can you say bubble?

  • Report this Comment On April 11, 2013, at 2:53 PM, abulia wrote:

    You can do lots of financy and economicy stuff to value the $. Unfortunately bitcoins have no way to calculate a fair value. It makes for some great trollbait.

    Chartists love it. Gamblers love it. "Techies" (people with iphone but no knowledge of computers other than how to use the latest user interface) love it.

    Also this weird end of the world crowd.

    Personally I love the idea of a virtual currency. There is just no way to calculate an intrinsic value, so it can't be an investment.

  • Report this Comment On April 11, 2013, at 3:49 PM, whereaminow wrote:

    You miss the obvious.

    Bitcoin will likely go to zero, but you completely missed the reason, even though you mentioned e-gold, which should have clued you in.

    Bitcoin is going to zero because the government will smash it and likely charge many of the big players with money laundering.

    The government will smash it because it threatens their control of money. They will probably be very zealous about it as well, like they did when prosecution (persecuting) Liberty Dollar.

    If you have Bitcoin, I would get out NOW.

    David in Liberty

  • Report this Comment On April 11, 2013, at 3:59 PM, garyegray wrote:

    The Bitcoin creators released a limited supply with a slow incremental growth in the number of Bitcoins annually. As more people became aware of Bitcoins and that they could be used for illicit trade, the demand for the limited supply skyrocketed. This forced the overall value up since demand and supply determine price. I bet the Bitcoin creators are selling their holdings now! If you look at the curve on the price increase, its obviously in a bubble.

  • Report this Comment On April 11, 2013, at 4:54 PM, Solomon199 wrote:

    This sounds like that goofy plexiglass box the "artist" created a few years ago that constantly resells itself on ebay. That thing is still around because there are goobers who see real value in it.

  • Report this Comment On April 12, 2013, at 1:33 PM, JeffMLittle wrote:

    I love the idea of decentralized currency. I would caution that hyper-deflation can be destructive in the virtual world just like it is in the real world.

    For that reason, I would rather see, not 1 currency, but several currencies that are allowed to inflate/deflate against each other. The currency market could decide that farmville tokens should go up or down in price with respect to a "basket of virtual currencies" and this will allow for the avoidance of artificial monetary constraints on growth.

    (And yes, the Farmville traders could buy farmville over the 20 day moving average and sell it when it crosses back under, etc).

  • Report this Comment On April 13, 2013, at 1:35 PM, bali46 wrote:
  • Report this Comment On April 30, 2013, at 4:06 PM, ClydeRider wrote:

    Comparing Bitcoin to land and stock is irrelevant, but since the author brought it up... There are many things we humans value that don't produce squat. Precious metals, gemstones, and currencies are the most common. Even land and stocks are often valued by speculation and supply/demand rather than what the asset is capable of producing. Companies go bankrupt all the time without restructuring or getting bailed out (think Lehman Brothers and Enron). Investors lose their money in assets they thought were safe, because the company "produced something."

    Currencies tumble when inflation rises and economies struggle. Then llook at what the land market did between 2006-2011 in the Southwestern USA (CA, NV, AZ). Yet somehow those investment are supposed to be better/safer?

    Bitcoin is no more risky than having stock in a company or buying precious metals. What makes any investment worthwhile is whether there will be continued demand - precious metals, land, stocks and Bitcoins are all valued almost entirely by supply and demand. Where Bitcoins shines is that it will have continued demand through its many advantages, including lack of unsound fiscal management by governments, its ability to provide anonymity, and the capability to transact while avoiding country/state/local tax schemes.

    But please, go ahead and warn people away from Bitcoin. Those that understand the value of investments in terms of supply/demand will have more Bitcoin available to us. Anyone that doesn't understand the value of investing in terms of supply and demand should stick to working with a local financial planner and let them invest your money "safely." Right; let me know how that goes.

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