Imagine a world in which no one has paper currency. No one has a bank account because there are no banks needed to back them up. Yet goods and services can still be purchased — online or in person, and without pesky transaction fees.
In this world, everyone has their money elsewhere, using a digital “wallet” that protects their finances the way Fort Knox lords over gold bullion. (Come to think of it, Fort Knox may only be filled with IOUs these days.)
This world isn’t so far away. In fact, it’s happening right now with Bitcoin, a peer-to-peer service that links networked computers competing for its limited currency – bitcoins. This “currency” can then be exchanged for real cash or goods on Amazon.com and from other online retailers.
The meteoric and sometimes-flawed rise of Bitcoin has truly been a spectacle to behold. For the first time since the currency’s nascent launch in 2009, venture capitalists and investors are lining up to participate by backing related products and tools to help process Bitcoin transactions. Startup companies are now introducing Bitcoin-backed debit cards to use on the street. Even a traditional, brick-and-mortar bank is joining the fray, further legitimizing the currency – which actually started as an online, open-source software project among hackers.
Now anti-money laundering authorities have passed new rules to allow Bitcoin purchases and trading to continue, so long as the businesses that process those transactions register with the authorities and collect information on their customers. And most recently, the economic upheaval in Cyprus has driven investors and traditional banking customers toward bitcoin because of the uncertainty over insured deposits there, creating another spike in its value (around $87 per bitcoin).
With this much attention and crazy returns – Bitcoin currency values hovered around $49 per unit, a jump of 40 percent in 48 hours last week – it’s normal for traditional investors to take notice. Theories abound about its rise.
Let’s compare the Bitcoin investment craze to traditional financial planning tools, such as annuities.
These products offer a guaranteed rate of return until death. Their interest rates, although conservative (say, 3.5 percent compounded) are practically constant. The payments depend on what an investor is willing to contribute over time. Payouts are flexible for monthly installments or a lump sum. And like 401(k) accounts and IRAs, annuities are tax-deferred funds. (To learn more about annuities, check out this June 2012 post.)
Life insurance also has striking differences to holding bitcoins. Investing in the right plan can provide your family with your lost income if you die. It can be earmarked for specific uses, like college educations or capital funds to start a business. It can also settle, medical, funeral and tax issues left behind from your departure.
Now let’s look at Bitcoin. Created by computer programmers, the currency is created by participating computers in the electronic network. Their users have these computers constantly working to solve an encrypted puzzle; once solved and verified by the network, the user is issued a series of bitcoins. This “mining” for bitcoins is a lucrative business. In March, there were roughly 11 million bitcoins in circulation, with a cap of 21 million coins that should be reached in about 150 years, according to BusinessInsider.com. This ceiling helps drive up the value of the coins.
Recent events, however, have occasionally hampered the currency. Since 2011, several Bitcoin transaction-handling companies have fallen prey to hackers, who have relieved their till of thousands of bitcoins. Even user data has unwittingly exchanged hands. In defense of Bitcoin, most of these victims were smaller companies that may not have had their security measures up to snuff. Yet other hiccups involved miners using the wrong version of the Bitcoin software, forcing its creators to briefly take the entire system offline. These controversies – including acting as the go-to currency for buying illegal drugs online to a very recent heist – have been enough to send Bitcoin values briefly tumbling. This graphic is a sobering reminder of Bitcoin’s technological vulnerability.
Bitcoin might make sense for investors like actor Ashton Kutcher, but does it work for you?
Rodrigo Benzaquen, 37, believes it has a bright future. Benzaquen, a former computer programmer who works for an online commerce network, says he has studied Bitcoin for the past eight months. In particular, he has looked at ways to mine bitcoins. He likes the model and the idea, but worries that government interference in the market – either through attempted legislation, lawsuits or the use of widespread computer networks to start mining for bitcoins and blow up the currency – could negatively impact the bitcoin market. Regardless, Benzaquen says it is an investment opportunity for people who like to take big risks and reap big rewards.
At Palma Financial Services, we have the expertise to advise you on bitcoin strategy and conservative investment approaches. Chastened by the recent economic conditions after the bubble burst in 2007, we encourage our clients to consider annuities and other tools with which they can guarantee a safe, happy and well-funded retirement.
And that, my friends, is worth a lot of bitcoins.