A friend of mine recently asked if he should invest in Bitcoin. He was astonished with its growth; he said, "I can't believe it. You could get one Bitcoin for $100.00 not too long ago, and now that looks cheap!"
He asked if there will be growth in the digital currency in the long run, and if he will be able to make money for his portfolio. My response was simple: "I don't know." He didn't like my answer at first, but when I explained further, his perspective toward Bitcoin changed.
You see, I am a big believer in investing in what I know. For example, I like to look at companies whose business I understand—I understand how they make sales and generate their profits. When it comes to foreign exchange, I look at currencies of countries that I know I can learn more about and the data sources are reliable.
But when it comes to Bitcoin, I am still uncertain about how it is priced. With stocks, you can get a general idea about where the stock prices might be headed. You can look at analysts' expectations and the like. With Bitcoin, it isn't mainstream just yet. There are some analysts who are saying the digital currency will skyrocket, while on the other side, there are those who are saying it will die as quickly as it became famous. At the very core, there's too much noise.
On top of this, there's too much volatility in Bitcoin's value. I was watching a live chart of Bitcoin prices compared to the U.S. dollar not too long ago, and in a matter of minutes, the digital currency's value increased roughly $30.00, then declined, then came back up to its original value, and then it declined even more. This can be problematic, because it pretty much turns an investor's portfolio into a roller coaster ride. Investors might see massive gains one minute, but huge losses the next. Simply put, gains and losses are very uncertain.
When it comes to investing for the long run, instead of just getting caught up in the noise, and running for "what's hot" in the market, investors should do their own due diligence. The idea behind long-term investing is to have a portfolio that grows over time with minimized risks. By investing in securities like Bitcoin, this is certainly not achieved.
I believe the digital currency is currently in the price discovery mode. This is when the prices of a certain asset are evaluated through the marketplace. In this phase, there are wild fluctuations, because not a lot is known about the asset.
Will Bitcoin ever be recognized as a stable currency without a central authority?
This may become the case sometime in the future, but for now, there's scrutiny around it. For instance, the central bank of China has banned third-party payment companies from doing business in Bitcoin. (Source: Spaven, E., "China Bans Payment Companies from Working With Bitcoin Exchanges, Sources Claim," CoinDesk, December 16, 2013.)
Similarly, the European Banking Authority (EBA) has said that "Currently, no specific regulatory protections exist in the EU that would protect consumers from financial losses if a platform that exchanges or holds virtual currencies fails or goes out of business." (Source: Jones, h., "EU banking watchdog warns of risks from Bitcoin," Reuters, December 13, 2103)
A portfolio that is well-diversified can go a long way. When it comes to Bitcoin, investors should wait and see how this all turns out. Getting involved in the digital currency now could drastically hurt their portfolio, and this can eventually set them back on their goals.
Bottom line: invest in what you know.