Should You Invest in Bitcoin?

[Editor’s Note: Mark Ford has been an investor for a good portion of his career. We thought his advice on whether or not someone should invest in Bitcoin would be helpful for anyone who might be wondering if they should take leap to invest in cryptocurrencies like Bitcoin.]

A few months ago, a reader sent me a question about whether or not they should invest in Bitcoin. They said that even though investing in Bitcoin sounded exciting, it wasn’t a type of investing they understood well and, therefore, didn’t know if it was something that made sense for them to invest in.

Their question inspired me to write a short explanation about the pros and cons of this type of investment, and you can decide whether or not it’s the right path for you.

To start, very few people understand what cryptocurrencies are and how they work. I have a basic understanding, but I’m hardly an expert on cryptocurrencies, let alone currencies generally.

My beat is wealth building, which is a larger and, to me, much more important subject. Building wealth is not about becoming an expert in one or a dozen particular areas of finance. It’s about understanding basic truths about economics and personal finance and applying common sense strategies that are respectful of those truths.

I’ve been thinking and writing about building wealth for more than 40 years. I made my share of foolish mistakes when I began to make and invest money, but I did learn from those mistakes and put that knowledge into play as the years passed.

My strategy worked for me. I believe it can work for anyone. But you can decide if it makes sense for you.

I’m going to tell you, very briefly, what I’ve learned about Bitcoin and other cryptocurrencies. And then I’ll explain how I see them fitting into my overall wealth building strategy.

Some Definitions… 

Let’s begin with a few quick definitions.

Currencies: Currencies are units of exchange. In medieval times, grains were currencies. But using them as units of exchange was impractical because they were perishable, occasionally unavailable, and of only modest value. They could not be used for large commercial transactions for those reasons and because they were too bulky.

Hard Currencies: For commercial transactions, the Romans used gold and silver pieces. They had a thousand times more intrinsic value than grains per cubic meter, and therefore solved the problem of size. They were transportable, which meant they could be used for foreign trade. And when the face of the Roman Emperor was stamped on them, their credibility as units of exchange became universally accepted.

Paper Currencies: When the U.S. dollar was introduced as currency, its value was linked to the value of gold. This gave it the equivalency in value of gold, but with greater ease of use because of its relative weightlessness and its capacity to represent its value in printed denominations.

Fiat Currencies: When President Nixon abandoned the gold standard in 1971, the value of the U.S. dollar became tied not to gold but to a promise backed by “the full faith and credit” of the U.S. Treasury. This might have worked perfectly well had the supply of dollars been limited. But the plan was to create more dollars. To actually create more dollars out of thin air leaving politicians free to spend unlimited amounts of money on any sort of project they want.

Recently, the idea that federal debt is a bad thing has all but disappeared. And that meant, to anyone that understood monetary and fiscal economics, that eventually the U.S. would face a major collapse of faith in the dollar and most probably a massive hyper-inflationary depression.

Cryptocurrencies: Enter Bitcoin. Bitcoin was invented primarily to protect its holders from just such an economic collapse. It was done very simply by Bitcoin’s inventor who limited the number of “minted” Bitcoins to a specific amount: 21 million. (We don’t know who that inventor was, but we have ideas.) 

Because Bitcoins are limited to 21 million, they were (and are) exempt from the fatal flaw of fiat currencies like the U.S. dollar — i.e., the devaluation of each unit of currency when the total number of units is artificially increased.

Digital Currencies: A second benefit of cryptocurrencies is that they are designed to be exchanged without trackability. In other words, you can buy and sell them in a digital marketplace that is basically invisible. You don’t have to know who sells you their Bitcoin. Nor do you have to know to whom you sell your Bitcoin. And nobody — not even the government — can see what you are doing.

This feature is obviously very attractive to tax dodgers, drug dealers, and money launderers. But it’s also favored by law-abiding folks who believe in financial privacy.

In summary, Bitcoin is a relatively new currency. It’s entirely digital. It can be held and exchanged in total anonymity. And it is not subject to devaluation like the U.S. dollar and other fiat currencies.

Bitcoin is the best-known cryptocurrency, but there are many others. Most of them share two traits: They trade on decentralized platforms and offer anonymity. (Thus, cryptocurrencies.) And they are produced in limited supply. (Thus, no risk of devaluation.)

There are digital currencies that are not cryptocurrencies. For example, the digital currency that Amazon wants to introduce will offer some of the benefits that Bitcoin offers, but probably not anonymity.

Those are the basics about cryptocurrencies.

Now, here are the pros and cons of cryptos versus the U.S. dollar.

The Pros of Cryptocurrencies 

• When you own a cryptocurrency with a fixed supply, like Bitcoin, you don’t have to worry about its value crashing due to inflation.

• In fact, as demand rises, the value of your stash goes up. (This is what investors in cryptocurrencies hope will happen.) 

• Transactions are immediate, permanent, and very difficult to fake. This makes fraud and theft nearly (but not 100%) impossible.

• Transactions take place on a decentralized digital network. This makes it impossible for hackers (government or private) to invade or control the market.

• If Bitcoin ever becomes the dominant global currency, the value of any Bitcoin you own could skyrocket — by hundreds or even thousands of percentage points.

The Cons of Cryptocurrencies 

• Mining, holding, and trading Bitcoin is not free. There is a considerable energy cost involved in keeping it alive and kicking in the digital universe. There are other cryptocurrencies that are less expensive than Bitcoin. In theory, these could one day replace it.

• Bitcoin and other cryptocurrencies are safe, but not 100% safe. There have been instances of loss or theft. Such losses/thefts are unlikely, but possible.

• Because cryptocurrencies are exchanged on a digital ledger called a “blockchain,” every transaction is recorded. If you were forced to give your access code to someone (a thief or the IRS), they could get an exact blueprint of everything you have done on the blockchain since the beginning. 

• If the U.S. government declares Bitcoin or other cryptocurrencies illegal, their value could collapse entirely.

As you can see, there are, indeed, pros and cons of cryptocurrencies as currencies. But the reason so many people are interested in them is not their value as a commercial unit of exchange, but as an investment or speculation.

The Future of Bitcoin as a Currency

Early buyers of Bitcoin imagined a world where billions of people would be trading it on the blockchain, freely and anonymously. Many Bitcoin holders still hope this will happen.

I think it’s possible. But very, very unlikely.

There are two reasons.

First, a nation of people doing business anonymously — not just buying and selling goods and services but earning income, too — would be a disaster for the IRS and state and local tax authorities. They could collect Bitcoin for taxes, but they would have no way of doing reliable audits.

The other reason is that if Americans started preferring cryptocurrencies over the dollar, the entire scheme of printing fake dollars to fund the government’s overspending would collapse. Without the ability to print more Bitcoins, they’d have to make do with the ever-diminishing taxes they’d be collecting. Governments would go broke.

They are not going to let this happen.

So, no. I don’t see Bitcoin replacing the U.S. dollar. But if cryptocurrencies become more popular, I do fear the day when the dollar will be replaced by the U.S. Digital Dollar. (See below.)

Bitcoin and Other Cryptos: the Bottom Line

Is Bitcoin — or are cryptocurrencies generally — a smart investment? Let’s try to answer that question now.

I own Bitcoin and several other cryptocurrencies. But I don’t consider them investments.

They are not investments because they do not represent shares in growing and profitable businesses. Nor are they bank notes or debt obligations. They don’t produce income. They don’t create value. They aren’t tangible. And the value they have is based entirely on what Yuval Harari, in Sapiens, calls social myths: common beliefs that have no actual basis in reality.

Yes, the bottom line is that Bitcoin and other cryptocurrencies have no — zero — intrinsic value.

But we could make the same argument against the U.S. dollar, which, as I said, is a fiat currency, printed on paper with nothing behind it but the promise of a bankrupt government.

So Why Do I Own Cryptos? 

I own Bitcoin and four other cryptocurrencies. I bought them not because I believed they were destined to appreciate in value, but because I wanted to learn more about them. And I knew that if I bought a small stash, I’d take the time to do it.

I also thought that in the unlikely event that they could, one day, actually skyrocket in value, I’d be able to say, “Yeah, I bought Bitcoin back in the day,” and look smart.

I’ve read many of the arguments in favor of cryptocurrency’s ascendency. Most of them are based on the inherent advantages of either crypto-technology or limited supplies or both.

A recent essay talked about it as a technological innovation and predicted a great future for it based on historical patterns for disruptive technology. One example: It took 10 years, from 1980 to 1990, for PCs to gain 10% of the U.S. market. But between 1990 and 2000 — just another 10 years — it went from 10% to 90%.

That’s exciting stuff. But although cryptocurrencies are based on an amazing technology — the blockchain — they themselves are not the blockchain. They are digital currencies with some advantages over conventional currencies based on blockchain technology.

These advantages are real, and they are valuable to those that use them. And the more people that use them, the more valuable they become.

All that is true. And that’s the reason so many people are still interested in cryptocurrencies. It’s theoretically possible that they could replace the dollar someday.

But, as I said, I cannot imagine a scenario in which the U.S. government would allow it. The current system of fiat currency offers our politicians exactly what they need to maintain their power: a way to promise their constituents anything and everything they could possibly want, without a worry about who’s going to pay for it.

Just in the last year, the hustlers and moochers in Washington, D.C., have spent more than 5 trillion in fake dollars on a basket of fundamentally unproductive programs. Their ostensible purpose was to stimulate a stable and prosperous economy. But their ulterior motive — on both sides of the aisle — was to garner voter support.

There once was a time on Capitol Hill when fiscal conservatives — politicians that believed in sound money (currency backed by gold) and balancing the federal budget — represented as much as 50% of the elected officials. That golden era ended when President Nixon ended the gold standard. Of the 100 senators and 435 representatives now in Congress, I count only one that qualifies.

U.S. Monetary Policy If Cryptos Become Too Popular 

Now imagine what would happen if one day 70% — or even 30% — of the U.S. population eschewed dollars for cryptocurrencies. This Holy Grail of fiat currency would collapse and our good people in Congress would have no more promises to make. Our economy would tank and there would be nothing they — or the president or the U.S. Treasury or the Federal Reserve — could do about it.

Not to mention the fact that there would be no way for our elected officials to give themselves salary hikes and beef up their government pensions.

No, they won’t let that happen.

But what might happen is this:

The government will begin issuing its own digital currency. It would offer all the minor benefits of other digital currencies but without the anonymity or the limited supply. And since this new currency would be generated by the government and processed through a “government” blockchain, it would be even better than dollars for them. It would allow them to increase the supply quickly, easily, and anonymously, while also being able to track and trace every single monetary transaction of every single citizen (and non-citizen) in the country.

If such a digital dollar currency were proposed in Congress, I can’t see why it wouldn’t pass easily. The elevator pitch would be an end to white-collar crime and a simultaneous end to tax dodging. Who would have the courage to say no to that?

In summary, I don’t believe any cryptocurrency will ever be allowed to gain a significant hold in the U.S, economy (or any other major economy). Period.

But that doesn’t mean that, in the meantime, Bitcoin and other cryptocurrencies won’t enjoy a big spike or two in demand.

And if they do, those who have speculated in them might find themselves considerably richer.

So, Here’s My “Advice”… 

Think of these currencies as speculations. Treat them as a way of gambling on the very reasonable chance that in the next several years there will be spikes that boost the value of some of these digital gambling chips by hundreds or possibly thousands of percentage points.

Put a small percentage of your net worth — an amount you’d be willing to lose — into a basket of cryptocurrencies. My basket is about half Bitcoin and half others that have been recommended by colleagues of mine that know much more about this subject than I do.

If and when they do spike, claim some or all of your winnings. Play it like you’d play roulette or bet on a horse race. Enjoy the ride. Play the short game. Don’t count on it for your retirement.