Unless you have been “off the grid” for the last 12 months, you’ve probably heard of Bitcoin. And you may well have heard of Ethereum, LiteCoin, Ripple and other digital coins too. The price of Bitcoin rose more than 1,000 percent in 2017, while Ripple’s price increased by 36,000 percent and Ethereum’s by over 9,000 percent. Considering this, you may well be wondering if you should be investing in Bitcoin or other new digital currencies.
It’s a good question. The total market value of all digital assets is now over $800 billion, which is close to what Apple, the largest company in the world, is worth. That’s the value the market is placing on these assets, but that doesn’t mean that’s what they are actually worth.
Placing a value on a cryptocurrency is very difficult. Apple Computers has a market value of about $890 billion, but then Apple made a profit of $48 billion last year. That means the share price is about 19 times its profit. It also pays a dividend equal to nearly 1.5 percent of the share price. That gives you an idea of what you are buying if you invest in Apple.
With cryptocurrencies, it’s a little trickier. Most of the transactions in Bitcoin and other digital currencies are speculative trades. In other words, most transactions are made by people buying Bitcoin as an investment, or as a short-term trade.
That’s not to say there is no one using bitcoin to buy goods or pay for services though. Hundreds of companies including Microsoft, Expedia, Overstock and Subway accept Bitcoin. There are also brand-new industries popping up that accept Bitcoin. One of the most active parts of the Bitcoin economy is gambling, where dedicated sites like VegasCasino allow players to wager Bitcoin on casino games.
But tying the value of Bitcoin back to the amount of commercial activity is tricky. Conventional currencies pay interest which allows investors to compare one currency against another and to compare currencies to bonds and stocks.
The price of a cryptocurrency is a function of supply and demand and nothing else. The supply of most cryptocurrencies is limited, and in the case of Bitcoin, there will never be more than 21 million coins. Since the supply is limited, the price is all about demand. Right now, the demand for cryptocurrencies is based on the idea that the demand in the future will be higher. But that demand cannot continue to rise forever. At some point, it will have to be based on people needing to buy bitcoin in order to perform certain transactions.
Will every company in the world be forced to accept Bitcoin or Ethereum in the future? They might, but it’s also possible they won’t have to. On the other hand, to use the service of a company operating on a blockchain or decentralised network, you will need to use tokens or cryptocurrencies. And if you need to buy the tokens for a specific network, the easiest way to do that will be with Bitcoin. That’s where the real demand for Bitcoin will come from.
So, back to the original question: should you invest in Bitcoin? Well, there is a strong case to be made that real demand will eventually justify the current price. The problem is that at some point when speculative demand runs out and real demand takes over, the prices will probably fall a lot.
That means that regardless of when you invest, you are going to see a lot of volatility. So if you are going to invest you need to be able to tolerate a bumpy ride, both financially and emotionally.