What is all the fuss about Bitcoin?

"Lack of Clarity gives Birth to Disappointment" ~ Dan Rockwell

Bitcoin's meteoric rise

What Is Bitcoin?
Everyone is talking about it, but what is it? At the most basic level it is an electronic voucher that says you own it (sounds redundant, no?). It is an electronic record stating who owns how many "bitcoin". There is no physical thing that is a Bitcoin, no one has ever seen, or touched, or tasted one. Its power comes from something called the "blockchain" which makes it (to date) impossible to hack or replicate.

So although it is nothing, it is not (currently) replicable or hackable and it is transferable (kind of like money without the paper and metal). The blockchain allows for the exchange and creation of more Bitcoin without a third party middleman. No bank is needed to verify the transactions or to store the Bitcoin or validate their authenticity. No one but the blockchain "system" can validate exchanges or create new vouchers. This has two big benefits.

1. Very cheap cost to transact (no middlemen, no banks, no government needed)
2. Scarcity - the amount is fixed and will only grow very slowly, at a predetermined rate

Relative to currencies it has some big disadvantages:

1. It is not (currently) recognized or backed by any Government
2. It cannot be used to buy most things
3. It is dependent on electronic devices (you cannot carry it in your pocket, or use it when the power is out)

A couple of other interesting tidbits:

1. It was purportedly created as a way to get around using cash for paying for illegal activities. 
2. Governments are not likely to back it because crypto currencies would eliminate monetary policy as an economic tool.

Should I Invest?
This is a tougher question. There are many examples of manias that take simple things and blow their valuations beyond anyones imagination. Right now Bitcoin fits very clearly into that camp. The problem is that it could go up a lot more before it drops. The bigger problem is that when it drops it will be worth nothing (or very close to nothing) and there will be no one to sell it to on its way down. The drop could happen in 5 years or tomorrow. If you want to take that chance then I will help you see the risks so you can go in with your eyes wide open.

I love investment history and there are many relevant examples of bubbles. The tulip bulb craze in the early 1600's had rare tulip bulbs selling for the price of a home near its peak. People were trading options and futures on them and built businesses around trading them (all things that have begun to happen with Bitcoin). Then one day the hype was over and the price plummeted. Most people who invested heavily lost everything. For a detailed review of this and many other more recent bubbles I would refer you to the book "A Random Walk Down Wall Street". Chapters two through four give example after example of similar events. It is a fascinating read.

Is this a Bubble?
I believe it is. Why? There are many indicators but I will highlight three.

Intrinsic value: The worst bubbles have been built on things that have little or no intrinsic value (like a tulip bulb). The only intrinsic value Bitcoin has is its scarcity. New Bitcoin cannot be created except through the Blockchain which creates them at a very slow pace. Its scarcity is also linked to its notoriety. There are actually hundreds (maybe thousands) of other crypto currencies which are identical to Bitcoin except they are not as well known. If they become viewed as equals, then Bitcoin doesn't even have scarcity going for it anymore.

A shred of truth: The worst bubbles are driven by something true even if spuriously related. Bitcoin's popularity comes because it was the first use of Blockchain - it is why Blockchain was created or maybe vice versa. Blockchain is revolutionary and will likely transform many industries. I believe it will make trade less expensive and will destroy many middleman jobs (bankers, real estate agents and car dealers beware).  There is a lot of hype around Blockchain that is probably somewhat deserved, but Bitcoin is not Blockchain. However, it is viewed as the main way to invest in Blockchain. At some point this view will de-link.

Momentum/Notoriety: The worst bubbles gain such momentum and notoriety that everyone is talking about it. Even people who do not usually invest get sucked in. Today, companies are being created to do nothing but trade crypto-currencies. I read a Bloomberg story yesterday about a man who became a billionaire almost overnight because of a company he started to trade crypto currencies. Bitcoin now has futures and options which allow people to leverage their exposure.  I have been approached by people who have never talked to me about investments before, to ask about Bitcoin (this is why I am dedicating this post to it).

What Should You Do?
My goal with this post is to shed light on the subject, share what I am doing and help others see potential pitfalls. What you do with that information is an individual decision.

This craze has been spectacular (and could be for awhile longer), it has spread beyond the original idea, it is loosely based on something that probably will have a large impact on finance, and its value is only in the minds (dreams) of its owners. At some point, maybe tomorrow, maybe next week, maybe in five years, I believe it will crash spectacularly. Not the 10% or 20% drops we have seen so far (those are tiny compared to 1000%+ gains). It will drop to nothing and be forgotten except in the history books where it will be honored as the first use of the blockchain and added to the list of crazy bubbles.

As for me, I choose to ignore it (I won't invest) and will watch the fireworks in fascination. I know I will look like a fool for awhile and people may question my judgment, until it collapses, then I will be glad I abstained. The problem with a speculative bubble like this is that it feeds on greed. Greed is a wolf whose appetite cannot be satisfied; the more it eats, the hungrier it gets. Almost everyone who invests will see some upside that will draw them in further. Those who get completely sucked in, will lose everything. I don't want to put myself at risk of getting sucked in.

I hope this is helpful and am happy to discuss further in the comments section below.