Some experts say bitcoin will reach $1 million by 2020. Others have gone so far as to call the digital currency a fraud. Whether you're in the optimistic group, the pessimistic group, or somewhere in between, there's a reality check that anyone who invests in bitcoin or other digital currencies needs to hear: Buying bitcoin with borrowed money is a terrible idea.
The biggest bitcoin mistake you can make
While many people have certainly made lots of money on bitcoin, that doesn't mean the price will continue to go straight up forever. Even if bitcoin does end up with a million-dollar price tag, as some experts have predicted, it won't get there in a straight line. And if things go sour, bitcoin's price can drop fast.
I generally advise people not to invest any money in bitcoin or other cryptocurrencies that they aren't willing to lose, but some people are using an even worse strategy -- borrowing money to invest in bitcoin.
I want to be perfectly clear. Borrowing money to buy bitcoin is the biggest mistake you can make as a digital-currency investor.
Major bitcoin exchanges allow customers to buy the digital currency on a credit card. Not only does this result in exorbitant interest charges, but it also generally comes with a large transaction fee. And if the value of the bitcoin you buy falls, you still have to pay the bill.
Some have gone so far as to take out mortgages and home equity lines of credit to buy bitcoin, according to securities regulator Joseph Borg. This is a terrible idea, similar in principle to the bad behavior that triggered the mortgage meltdown in 2008.
A short history lesson
Since many people seem to forget about bubbles and speculative euphoria about a decade after it happens, here's a brief recap of the last time people borrowed in the hopes of getting rich in a speculative frenzy, and why it's the same principle as buying bitcoin with a credit card or home equity loan.
In the early to-mid 2000s, banks were readily giving mortgages to anyone who wanted them. Many "investors" were buying several houses on credit simply because they hoped the value of those homes would continue to rise. Ideally, they would borrow $200,000 to buy a house, pay the mortgage for a few months, and then sell it for $250,000, pocketing the $50,000 in profit.
Well, when home prices started to fall, these people were left with houses they couldn't sell (or even rent, in many cases), and mortgages they couldn't afford to pay. As a result, many people lost everything, because they not only invested all of their available cash but also borrowed money on top of it.
The exact same logic applies here. Let's say you take out a $100,000 home equity loan to buy five bitcoins at $20,000 each, or whatever their value is by the time you're reading this. You get a nice introductory interest rate on the loan, and your goal is to sell your bitcoin at a profit to pay off the loan before the rate rises and you can't afford the payments. Of course, this would seem like a great strategy if bitcoin rises to $40,000 or higher by the end of 2018, as some experts have predicted.
Well, let's say bitcoin crashes to $5,000 instead. If you don't believe this is possible, you probably shouldn't consider investing in the digital currency at all. Now your bitcoin is worth just $25,000. If you were to sell, you'll still owe the bank $75,000, and your interest rate is about to rise, making the loan payments unaffordable and putting your home in jeopardy.
Would you take your money to Vegas to gamble?
The bottom line is that if you wouldn't be comfortable losing a certain amount of money playing the lottery, gambling in Vegas, or betting on your favorite sporting event, it's probably a bad idea to use it to buy cryptocurrencies like bitcoin.
Just as with any speculative investment, the right way to buy bitcoin is to only use money that you'd be willing to lose. If you have an extra $100 sitting around and you want to take a flier on bitcoin, go for it. While I'm not the biggest bitcoin bull in the world, I'm also not in the "stay away" camp by any means.
However, don't put money that you need into bitcoin, and certainly don't borrow money to buy it. That's a recipe for disaster.