Bitcoin is all the rage – but what is it?

by Becky GINOS

More and more people are jumping on the bitcoin bandwagon but is it too good to be true?

“We believe that it’s a highly speculative investment,” said Josh Olson, equity analyst with Edward Jones. “It’s hard to value compared to other investments. There is a lot of volatility and price fluctuation.”

Sometimes known as cryptocurrency, bitcoin works through a computer network that allows peer-to-peer transfer of any value in the digital world without a central authority, or verifying body, said Olson. “But if you want to pay me in the digital world, how do I know without a verifying body that you didn’t just copy it on your own computer and send it to me?” he said. “That’s the problem, you don’t have a central authority (like a bank) to verify the transaction.”

Bitcoin comes from technology called blockchain, he said. “Basically the way it works is it is run by a decentralized network of computers with ledgers,” said Olson. “Every computer on that network has a copy of the ledgers and they all have to agree on the entry, which they are able to do because they each have a copy of the ledger. In order to make a ledger entry, a special type of computer (‘miner’) must solve a mathematical puzzle and in doing so, expend energy in the form of electricity.”

If all the computers agree, the block is added and the miner is rewarded in the form of bitcoin, said Olson. “If not, the miner has expended useless energy. In this way, miners are incentivized to add valid transactions to the ledger, removing the need for a central trust authority.”

Although it might sound good to cut out the middleman (financial institution), Olson said there are risks. “What happens if you are a victim of crime? There is no authority to guarantee the money. Banks are FDIC insured.”

He said another risk is simply losing the device the cryptocurrency is stored on. “You’re the custodian of your own bitcoin,” said Olson. “If you lose it you have no recourse, no one is there to talk to.”

The blockchain is pretty secure, he said, but if someone wants to buy it they have to go to an exchange place. “It could make you vulnerable to cyber attacks or hacks,” Olson said. “Recently, a company got hacked and lost $400 million in bitcoin. Also, the idea that I’m transferring money I could send it to the wrong address. The addresses are long and difficult. I could easily transfer it to the wrong address and it’s just gone. Those who own or have it make themselves vulnerable to hackers.”

There are other questions such as how it is taxed, he said. “There’s not a lot of clarity around it and the valuation is a huge uncertainty which leads to a lot of confusion.”

Anyone considering investing in bitcoin should only use a small portion of his or her portfolio, said Olson. “There is a lot of price volatility,” he said. “It can go up and down so they should be prepared to lose all their investment in one day – it can go to zero.  It’s highly speculative and volatile so we don’t recommend it to the average investor – it’s very risky.”



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