Betting on the Future with Bitcoin

~ By Gerald Rome, Colorado Securities Commissioner ~

You may have heard about bitcoins and be wondering what they are, or you may know what they are and wonder if they might make a good investment. Let me answer the second question first: Are they good investments? The simple answer is NO! Well, if you like to go to Las Vegas to gamble, and you like to place large bets on the roll of the dice, or four aces showing up at the right time, knowing you may well lose your entire bet, then investing in bitcoins may be right for you. For the rest of us, stay as far away as you can from bitcoins. Let me try to explain a little what bitcoins are, why people are investing in bitcoins, and why they make such bad investments.

Gerald Rome, Colorado Securities Commissioner

Gerald Rome, Securities Commissioner

Bitcoins are an alternative form of money. But they have some very strange qualities for money. They do not exist in a physical sense. I cannot hand you a bitcoin. They exist only electronically. They can be transferred from one person to another person only online through a computer. Bitcoins are accepted for some transactions by merchants, but generally they are used only privately online as simply a form of currency.

Where do Bitcoins come from?
Bitcoins are produced through running a very complicated computer program which you have to create. It runs until it matches a certain pattern defined by the people who created the original bitcoin program. When a match is found, the person who found it owns that bitcoin. There are only a certain number of valid bitcoins, and once they are all taken – no more can be produced. If you don’t know how to create bitcoins yourself (it is expensive and time consuming to do), the obvious next step is to buy one. You can do this by using a website. You first have to get an electronic “wallet” where you can put the bitcoin. Then you can purchase a bitcoin, using real money, and place it in your so-called wallet. You have to admit this all sounds pretty strange.

Can I make money from Bitcoins?
Bitcoins are especially risky investments since there is nothing of value underlying the currency. Bitcoins are literally only worth what people will pay for them, and if they stop wanting them, the value will disappear altogether. There are currently about 17 million bitcoins in existence. Right now, you can buy one bitcoin for about $3,500, meaning all the bitcoins are worth, amazingly, about $60 billion. So, why are people willing to pay $3,500 for one bitcoin. They are “betting” that the price will go up. The only way it will go up in price is if more people want to buy it. And if it does, they will make money. In our business, this is what we call a market bubble. There is an irrational excitement and energy from people who firmly believe that bitcoins are the wave of the future. And they are willing to continue to bet that the price will continue to increase. If history teaches us any lessons, and it always does, then sooner or later the bubble will burst and the value of the bitcoin will fall dramatically, leaving the last people holding bitcoins with empty wallets.