It's irresistible, and painful, to play the what-if regret game with investments. What if you bought Apple or Amazon stock back in 1997? What if you bought a condo in that tough city neighborhood ten years ago? What it mom didn't throw out that full set of 1969 Topps baseball cards? Millennials didn't invent FOMO; investors have struggled with the fear of missing out forever.
Those missed opportunities pale in comparison to what's going on with Bitcoin, however. Price of a single bitcoin just passed $1,000 in February. It had climbed 15-fold by December, less than one year later. Travel back another few months, or years, and the windfall for early virtual currency buyers is almost unfathomable. Writer Kashmir Hill captured it well; four years ago, she lived an all-Bitcoin week for a story and found a restaurant where she could use the digital currency to buy her friends a sushi dinner. The price: 10 bitcoins. By the end of November, the coins she spent on the sushi would have been worth about $100,000. And now?
"That sushi dinner could have paid for an ivy league degree," she lamented on Twitter. Now, that's a regret.
How could a sushi dinner turn into a six-figure windfall? How can you buy a dinner with virtual "money" in the first place? And what should you be doing when it seems like the whole world has gone crazy for digital currencies?
We'll try to answer those questions for you here.
Before we get started, however, it's important to remember that the fear of missing out has driven people to make many bad choices in investing, and in life, (you should have stayed at that party and met your future wife, dummy!) for a very long time. So if you are tempted to dip your toe in this brave new world, it's critical that you understand what you think you are missing out on.
Tom is a virtual currency investor who agreed to speak on condition of anonymity. (Bitcoin hackers are very aggressive and scour the Internet for targets, finding them when people brag about their holdings; so if you invest in Bitcoin, keep it to yourself.)
Tom got in early, but he’s suffering from investment regret, too.
“That would be because I sold the bulk of it way back when it was $4000, because I very wrongly thought the bubble could not go much higher,” he said. “Crypto right now is like the wild west ... It really is.”
What is Bitcoin? A brief history
To start at the ending, Bitcoin took a big step away from the Wild West this week when a traditional market tied to the virtual currency allowed U.S. investors to make Bitcoin bets the old-fashioned way: through brokerage accounts. On Dec. 10, the Chicago Board of Exchange began the buying and selling of futures contracts on Bitcoin’s value. Investors don’t buy actual coins through these contracts; instead, they are making bets with each other about the future value of Bitcoin. Still, the event marked a remarkable step for an idea that was born from the musings of Internet radicals and almost killed by child pedophiles.
The birth of cryptocurrencies
In the Internet's early days, no one was really sure how people like Jeff Bezos would make money. To be specific, no one was sure how sites like Amazon would be able to collect money. Credit cards seemed like a risky way to transmit "cash" across the Web — anti-fraud systems were essentially unheard of — so there was a race to create a new kind of cash that could be sent digitally. "Currencies" with names like DigiCash, backed by MIT’s Nicholas Negroponte, and E-gold sprouted up to fill the void. Eventually, eGold would swell to 3.5 million users worldwide.
Virtual currencies offered the added digital-age benefit of making international transactions easier and far cheaper, as they can be used to circumvent transfer fees imposed by of traditional banking systems.
The philosophical origins of virtual currency predate these digital currencies, however, to a group of hackers with a libertarian vibe generally referred to as cypherpunks. They dreamed of creating a money system that was entirely beyond the reach of governments. They blamed much of the world's ills — inflation, poverty, concentration of wealth — on the power governments can exert by controlling national currencies.
By combining the secrecy of cryptography with a currency, cypherpunks imagined a world of free, anonymous money flows that drained traditional governments of their source of power.
Early hits and misses
Early supporters like Rik Willard, founder of Agentic Group — a consortium of firms that advocates use of blockchain technologies — have always had lofty goals for cryptocurrencies.
“To me, Bitcoin is a globally distributed proof-of-concept for a new understanding and subsequent reconfiguration of intrinsic value creation,” he says. “Like any radical technology before it, digital value will begin to shape us in unimaginable ways, with the end goal, hopefully, of more financial inclusion and an end to enforced scarcity and unnecessary poverty.”
Creating new currencies is tricky work, however, largely because criminals often flock to platforms that seem to be beyond the reach of law enforcement and traditional institutions. E-Gold ultimately collapsed, and its founder jailed, after a 2007 indictment on money laundering charges.
"The E-Gold payment system has been a preferred means of payment for child pornography distributors, identity thieves, online scammers, and other criminals around the world to launder their illegal income anonymously,” the Department of Justice said.
The age of Bitcoin
But the dream of a currency not issued by governments wasn't dead. About a year later, in August 2008, someone registered the domain name Bitcoin.org. Two months later, a paper attributed to “Satoshi Nakamoto” was posted to a cryptography mailing titled Bitcoin: A Peer-to-Peer Electronic Cash System, laying out the concepts for a new kind of virtual money. By January 2009, the first Bitcoin network came online.
What was different about Bitcoin?
When traditional currency is used for transactions, third parties are always involved. Cash changes hands, but a government provides that cash and promises it has a certain value. When money is electronically wired, banks add or subtract the money from balance sheets. More important, they supply “trust” that enables parties to believe they are getting what they deserve out of a transaction. Outside of old-fashioned bartering, there was no way to conduct business without invoking a third party institution to provide trust.
Bitcoin changes this model by allowing peer-to-peer transactions that don't require outside blessing and verification. Instead, all transactions are published online, in a completely transparent format as a shared ledger, so they are verified — not by a bank or a government — but by the network itself. No trust required. Blocks of data are continually added to a chain providing an audit trail that confirms every transaction. Ever. That's the blockchain.
The decentralized nature of the blockchain is key. Whenever there’s a discrepancy — say, someone tries to add inaccurate information — the many nodes on the network arm-wrestle over which data is correct and builds consensus. Then, the data is replicated across the network.
This decentralized-by-design feature means there isn’t one central authority which could be manipulated for fraud purposes, or by a government or corporation seeking control. It also means it’s virtually impossible to fake a blockchain transaction once it’s approved, or to remove one. This is sometimes called distributed “trustless” consensus. In anarchy, security.
The comeback cryptocurrency
Bitcoin’s timing was impeccable. The cryptocurrency’s radical libertarian (anarchist?) ideology found plenty of bedfellows in the early stages. The global financial crisis that began in 2008 stoked the flames of bank skepticism and helped create a population ready to consider dramatic alternatives. In 2011, Bitcoin immediately became popular with Occupy Wall Streeters, who used it to accept donations and run some operations.
But it was still a bumpy ride. While Bitcoin transactions are very public, the parties in the transaction can remain anonymous. They use a cryptographic key to access their money, hence the term cryptocurrency.
So Bitcoin predictably attracted the same crowd as eGold. In 2013, Bitcoin faced an existential threat when U.S. federal authorities cracked down on a criminal haunt called Silk Road, a popular site used to buy and sell illicit drugs. Bitcoin was the currency of choice for Silk Road criminals, and authorities seemed ready for another E-gold-like crackdown. The FBI seized 174,000 Bitcoins when it shut down Silk Road, leading many to fear that users would abandon the cryptocurrency.
While Bitcoin’s value fell briefly by about one-quarter after Silk Road’s closure, it quickly recovered (to $125…feel that pang of regret again?), and transactions kept flowing. Meanwhile, rather than marginalize Bitcoin, governments around the world slowly started to legitimize it.
Ironically, a decision in 2013 by the U.S. Treasury Department's Financial Crimes Enforcement Network to require Bitcoin exchanges to register as money-service businesses — like payday lenders and other non-bank financial institutions — probably helped Bitcoin along. It was seen as tacit admission by the U.S. that it could not afford to drive Bitcoin overseas and cede the development of cryptocurrencies to places like Asia.
Since then, numerous factors have contributed to the meteoric rise in Bitcoin’s value. Chief among them: copycats, called alt coins.
There’s hundreds of cryptocurrencies now, all trying to cash in on the Bitcoin craze through their own Initial Coin Offerings. When these occur, buyers leap in, usually investing with Bitcoins. Later, they often convert the new coins into Bitcoins.
All that activity pushes up the demand for Bitcoins. Other reasons are critical, too. Many startups are encouraging investments in Bitcoin. The echo chamber of financial media keeps focus on fantastic returns early investors are getting, whipping up the FOMO, which in turn leads to more investment, which whips up the price.
And finally, perhaps the biggest reason: Everyone from taxi driver to baristas to grandparents are now talking about Bitcoin. Cryptocurrencies aren’t just for early adopters any more; now they have attracted what Wall Street calls “retail investors.”
That means there’s a lot of more money from a lot more people kicking the tires on a Bitcoin investment. More buyers and more money mean higher prices.
How to buy and sell Bitcoin
So, how do you get in on this?
There are two ways to obtain Bitcoins; you can buy them, or you can "make" them, through a process called mining.
New Bitcoins are created, it would seem, out of thin air as a “reward” when computers compete to do the nuts and bolts work of confirming blockchain transactions. Anyone can mine —investor Tom, mentioned above, mines for alt coins using a network in his garage — but as time goes by, the processing power required to mine continues to swell.
Enormous server farms around the world are now devoted to “winning” Bitcoins, using copious amounts of electricity as they do it.
So most people obtain coins by buying them, usually on a Bitcoin exchange, where traditional currency, like dollars, can be traded for cryptocurrency.
The largest bitcoin broker is called Coinbase, which says it now has 13 million accounts — more than stock brokerage Charles Schwab. Coinbase works like an exchange for beginners, but it’s really a front-end for an exchange called GDAX, or Global Digital Asset Exchange, formerly called Coinbase Exchange.
To buy Bitcoin from Coinbase or another broker or exchange, you'll have to download software called a cryptocurrency wallet. The wallet will be used to store the cryptographic keys that are needed to unlock virtual currency value. Coinbase, like other brokers and exchanges, also supports some alt coins, like Ethereum and Litecoin.
People invest in alt coins because they are much cheaper, and theoretically offer a chance at greater investment returns, though they can also be more risky. Not all coins, or all exchanges, are supported by all wallets.
Selling coins simply requires reversing the process. Bitcoin holders use a broker or exchange to move transfer virtual currency back into traditional currency, like dollars. That money is then transferred back to a traditional bank account.
Can you buy Bitcoins with a credit card?
Yes. But only through a wallet application and an exchange.
To keep things simple, a new user who wanted to get started on cryptocurrency can download wallet software from Coinbase, link a traditional bank account (such as a checking account or a credit card) to the Coinbase account, and begin buying bitcoins almost immediately. There's a fee associated with each transaction (at Coinbase, it’s 3.99% for credit or debit card transactions).
No one gets rich on Coinbase in a week or two. New investors can only buy tiny fractions of Bitcoins — credit and debit card depositors are limited to $150 during the first week, for example.
But note,Buyers can't sell right away. They have to wait a week; that can be frustrating if the value of a coin investment rises quickly, as it has recently. Coinbase users can increase their buy/sell limits through a variety of steps, including identity verification and creating a history of transactions. The throttled on-boarding process helps prevent fraud.
Bitcoins can also be purchased and sold using ATMs that are scattered around the world. They aren't very practical, however. Transaction fees are high, and there are only a few thousand machines. They're more of a novelty.
Spending bitcoin is no picnic. Many journalists have imitated Hill's "live life for a week on Bitcoin" project; they usually come away frustrated. Yes, Bitcoin acceptance has slowly increased.
BitPay.com claims 100,000 merchants worldwide accept it. Earlier this year, Starbucks announced support for Bitcoin through its mobile app and integration with a wallet called uPayYou. Plenty of familiar online services, like Overstock.com and Expedia, take Bitcoin, too.
There are plenty of pain points along the way, however. If you thought waiting for chip-enabled credit card transactions was annoying, wait until you get held up making a Bitcoin-based purchase. Bitcoin transactions must be confirmed and added to the Blockchain, which can take several minutes, or even hours.
Risk & Rewards
There's an bigger challenge with larger transactions. Bitcoin is so volatile that it's risky to use for large purchases.
"Shark Tank" star Kevin O'Leary recently told CNBC that when he recently tried to settle a $200,000 international Bitcoin transaction, the other party insisted he buy insurance to guarantee the value of the Bitcoins wouldn't fall. The risk outweighed any savings that might have been earned by avoiding bank fees or currency conversion fees.
Bitcoin comes with an even greater risk, however: It comes with virtually no consumer protections. If Bitcoins are lost or stolen, they are gone forever.
Tom says he mined 100 Bitcoins fairly early on, but his hard drive crashed, so they are simply gone. Coin thieves are also hard at work hacking wallets, which don't necessarily come with built-in security.
Writing in Medium, Cody Brown tells the painful story of looking on helplessly while a criminal took control of his cell phone, opened his wallet, and drained $8,000 worth of Bitcoins. Users are so concerned that some have taken to purchasing physical “hardware” wallets they can essentially hide at home.
Worst of all, exchanges themselves have proven to be unreliable. The Japan-based Mt. Gox exchange, once the world's largest, closed in 2014 after $450 million worth of Bitcoin were lost or stolen. Dozens of smaller security incidents at exchanges are chronicled at the website Blockchain Graveyard.
To security expert Harri Hursti of Nordic Innovation Labs, this fragility is cryptocurrency’s Achilles’ heel.
"The one key feature of conventional financial systems is that pretty much any erroneous transactions or illegal actions can be unwound and reversed,” he says. “In a blockchain economy, your monetary value can disappear in a cloud of bits with a typo — not to mention intentional crime.”
Is Bitcoin an investment or a currency — or both?
Because there's still a lot of friction involved in spending Bitcoin — certainly more than many other methods, from debit cards to Apple Pay — Bitcoin is a poor currency at the moment. It's most practical use as a currency is probably in third-world countries and places where the existing currency is already volatile and Bitcoin provides an immediate benefit.
Outside of these extreme environments, there's plenty of debate about Bitcoin’s long-term potential as a currency. Brian Armstrong, founder of Coinbase, says that Bitcoin is largely an investment at the moment.
"Bitcoin is 80% people buying and selling as an investment and 20% usage. I think in five years those numbers could be inverted," he wrote last year.
That split isn't necessarily a bad thing. As an investment, Bitcoin also serves as a store of value, the same purpose traditional gold serves for people who think their government's policies will lead to dramatic inflation. You could also think of Bitcoin as the digital-age version of hiding money in a mattress.
Should I invest in Bitcoin?
It goes without saying that consumers shouldn’t invest money in Bitcoin that they can't afford to lose, or that they'll need for something in the next couple of years. Whether or not you can stomach that risk is a question only you can answer for yourself.
As a high volatility investment, impacted by hundreds of factors that create a calculus beyond the capacity of individual investors to compute, it really isn't much different from gambling.
A long list of investing titans, beginning with Warren Buffett, have warned consumers not to throw money at Bitcoin. Remember, fear of missing out can make you do dumb things.
One reason not to avoid investing in Bitcoin: Because you think it has no intrinsic value, it’s not worth anything in the real world, or any those similar arguments. All currencies have this problem. Why is a hundred dollar bill worth $100? Because Uncle Sam says so. If you recycled that piece of paper, you’d get a tiny fraction of that. So dollars have no intrinsic value, either. All currencies — including hard currency, like gold — are ultimately some form of group delusion.
It’s not the intrinsic value that matters; it’s the depth of the “delusion.” As long as people have faith a currency is valuable, it is.
Now, you might not trust the Bitcoin mania, or the exchanges, or your own hard drive, and those would all be sensible reasons to stay away — for now. But people like Willard believe virtual money, in some form, is inevitable.
"Whether Bitcoin, as a brand, lives or dies is ultimately inconsequential. The fact is that natively digital currencies are here to stay and a multiplicity of new digital value possibilities is inevitable," says Willard.
There is wide consensus that the blockchain technology underlying Bitcoin is of real and lasting value. As with so many gold rushes before, the only group nearly guaranteed to make money are — not people digging for gold — but companies selling the shovels to the diggers. While the metaphor is inexact, that's partly why Tom isn't buying cryptocoins, but rather mining for them.
The way he looks at it, even if the coins he mines fall to zero value, he still hasn't lost everything. He still has his servers in his garage.
"I can, as an example, build and sell gaming machines on top of them, and potentially recoup my entire investment if things went sideways,” he says.
In other words, if his cryptocurrency investment fails, there’s always video games.
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