Investing in Bitcoins!

By July 13, 2017 January 5th, 2018 Blog

Investor’s Query: Please let me know your suggestion investing into bitcoins since a lot of my friends and colleagues are investing in bitcoins?

Mr. Gerard Colaco: There is an utter lack of clarity about bitcoins, among common individuals.  I will never suggest investment in bitcoins for the normal investor.

First, bitcoins are supposed to be a form of currency or digital payment system.  They are not investments.  Just as the dollar and rupee are not investments, but only currencies, so also bitcoins are not investments.  The values of currencies fluctuate when traded in the currency markets.  But they produce no income in the form of either rent, dividends or interest.  Therefore, they do not qualify as investments.

Second, the main functions of money are that it is a medium of exchange, a unit of account, a store of value, and, sometimes, a standard of deferred payment.  As the old economics saying goes:  Money is a matter of functions four; a medium, a measure, a standard, a store.  Some ‘experts’ say that bitcoins fulfil all four economic functions.  I most certainly do not agree.

I believe that, in its current form, the bitcoin does not perform any of these functions satisfactorily.  It is not a universal medium of exchange.  In fact, a huge number of Government and private entities do not accept it.  The Indian rupee can be used to purchase goods across India, just as the dollar can be used to do the same across the US, and in many other countries, because it is almost considered to be the world’s reserve currency.  Can you buy normal goods and pay for services through bitcoins?

It is not a satisfactory a store of value, because it fluctuates very widely in value. This is not good for a currency, because it makes it a poor store of value.  In 2013, Forbes named bitcoin as the best performing investment.  In 2014, Bloomberg termed bitcoin the worst performing investment.  In 2015, it became attractive once again.

Third, its legal status is opaque.  Several governments have banned it.  In India, the RBI has given this warning about bitcoins, which is displayed on its website:

“The Reserve Bank of India advises that it has not given any licence / authorisation to any entity / company to operate such schemes or deal with Bitcoin or any virtual currency. As such, any user, holder, investor, trader, etc. dealing with Virtual Currencies will be doing so at their own risk.”

Subsequently, further warnings were issued by the RBI and the ministry of finance, which, rightly or wrongly, likened bitcoins to a ponzi scheme.  Warren Buffett sounded a caution about the bitcoin ‘bubble’.

However, it is the fourth reason that I have to offer that is probably the strongest argument against getting into bitcoins.  This argument is bitcoins’ association with criminal activity.  The use of bitcoin by various categories of criminals has attracted the attention of financial regulators, legislative bodies, law enforcement agencies and the media.

Some researchers maintain that the popularity of bitcoin is mainly because they can be used to purchase illegal goods and services.  In 2014, researchers at the University of Kentucky found robust evidence that computer enthusiasts and illegal activity drive interest in bitcoin.  There is no evidence that either political or investment factors are driving the prices of bitcoins.  Which means that the whole bitcoin thing can be a bubble, as Warren Buffett warns.

I agree that any currency can be used for illegal purposes.  But bitcoin is a ‘crypto-currency’.  It is secretive.  This makes it especially conducive to illegal activity.  This brings up an important question.  Should a normal, self-respecting individual acquire something like bitcoins which is looked upon with suspicion by a number of government, regulatory, and tax authorities?

The actual advantage of bitcoin has nothing to do with investment.  It has everything to do with technology.  Bitcoins are based on a technology called ‘blockchain’.  This is a distributed database used to maintain a continuously growing list of records.  This technology is expected to revolutionise software development in future and enable businesses to function much more efficiently and securely.

Until then, I admire the response given by one of my former students, who is an excellent investment adviser today.  A client asked him if he (the client) should invest in bitcoins.  The adviser replied: “You cannot invest in bitcoins. You can only speculate in bitcoins.”

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