Richard ReedYou will have heard stories of people making a fortune trading Bitcoin – so how do you cash in on cryptocurrencies without getting your fingers burned?
A lot of people have lost a lot of cash playing with digital currency investments – but Bitcoin and others are currently riding high.
So can you really make a killing out of random numbers generated in the ether?
Closing on Netflix
It’s certainly tempting. With Bitcoin’s market cap now hovering around the $70bn mark, it’s fast approaching Netflix’s valuation of $78bn.
Bitcoin’s value has risen from $997.69 on 1 January to $4,237.05 on 12 September – that’s an increase of 320% in just under nine months.
However, there have also been some big falls. On 11 June 2017 it hit a high of $3,018.54, then plummeted to $1,938.94 by 16 July.
It has since bounced back – but it would have taken nerves of steel not to sell when the fall started. We’ve seen in the past that Bitcoin can be subject to big fluctuations.
So can you trade Bitcoin and other digital currencies safely?
How cryptocurrencies work
First, it’s important to understand how they work. Everyone is familiar with the concept of a hard currency such as the dollar or the pound, issued by a central government.
A digital currency such as Bitcoin is generated by an opensource, peer-to-peer network.
Bitcoins have soared in value during 2017 Photo: ShutterstockAll cryptocurrencies make use of what is called distributed ledger technology, or ‘blockchain’ – a database in the cloud that is continuously updated and certified.
Each new transaction creates a ‘block’ of data that is completely tamper-proof thanks to complex cryptographic algorithms that give the currency its name.
New bitcoins are ‘mined’ using special software, with rival teams competing to solve complex mathematical problems. They are paid with new bitcoins, generating new currency that has an intrinsic value – the financial effort put into producing it.
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Other contenders
There are actually more than 700 different cryptocurrencies in existence, though only a dozen had a market capitalisation in excess of $1bn as of September 2017. After Bitcoin, which has a market cap of nearly $70bn, the biggest are Ethereum ($28bn), Ripple ($8.2bn), Litecoin ($3.4bn) and Dash ($2.4bn).
Ethereum is the main contender to Bitcoin, which some critics say has some serious (and highly technical) issues over its ability to keep generating new transactions.
Litecoin, launched by Charles Lee, director of digital exchange Coinbase, is a proven, maths-based cryptocurrency seen by some as a dark horse to take the overspill if Bitcoin gets to a technically unmanageable size.
Trading digital currencies
If you want to trade digital currencies, there are several ways to do it:
- You can mine it – geeks only need apply, and it’s seriously hard work with no guarantees you will actually create any, because the competition is so fierce
- You can buy it through a digital currency exchange, though these are not without risk – in 2014, Japan’s Mt Gox, the world’s biggest exchange handling 70% of global transactions, admitted it had been hacked and 850,000 bitcoins had been stolen – valued then at $450m
- You can invest in a fund that holds it, which is arguably safer than using a currency exchange. Britain’s biggest broker Hargreaves Lansdown has recently given investors access to the Bitcoin Investment Trust, but because the Bitcoin price is in dollars and the fund provider is a Swedish company, you are liable to fluctuations in the dollar/krona exchange rate
- You can trade it on ‘spread betting’ sites that track the movement of real bitcoin prices – there is no commission as such, but they will take a percentage of your initial purchase, known as the ‘spread’
- You can buy it from an ATM – though it goes into your digital wallet, not your real one. If you hold it long enough, by the time you come to spend it, or sell it, the price might have gone up dramatically – or down
Greater regulation
One of the big problems with digital currencies is that because they are encrypted, they can be used to hide ill-gotten gains, whether it be from drug smuggling or trying to defraud the Inland Revenue or IRS.
Governments around the world are taking action to regulate the growth of cryptocurrencies, with China recently going so far as to shut down new Initial Coin Offerings (ICOs) and cryptocurrency exchanges altogether.
On the other hand, the crisis over North Korea’s nuclear weapons testing has sent Bitcoin prices soaring alongside gold.
Like any investment, there are no guarantees. There are some who argue that Bitcoin is now a ‘momentum investment’ – in other words, in danger of becoming a bubble – and has been likened by some experts to the Dutch tulip bubble of the 17th century.
A Bitcoin bubble in the making?
A futures market created for tulip bulbs saw eager investors push the price of a single bulb to more than ten times the annual income of a skilled craftsman.
Some people argue it doesn’t matter if you make a ‘foolish’ or highly speculative investment, so long as the price keeps going up – as there will always be a bigger fool to buy from you. However, all bubbles burst eventually.
So is Bitcoin a bubble? Only time will tell. It does have an intrinsic worth, and it does seem to be behaving rather like gold in times of global turmoil.
If you want to be adventurous, it might be worth a small investment. Just don’t put your house on it.
