5 questions you need to ask yourself before buying Bitcoin

At the Sunrise Christmas party I was having a drink with one of our young studio floor crew who was constantly checking his smartphone and trading Bitcoin. I then had a drink with one of our wardrobe stylists who told me she was trading… a derivative of Bitcoin called Ethereum.

Alarm bells started to ring so I asked them a couple of simple questions;

What are they? “They’re a crypto currency”.

What does that mean? “I’m not sure.”

Who makes them? “Powerful computers”.

Who owns the computers? “No-one knows”.

Are they regulated? “No”

The alarm bells started to ring even louder.

Over the years we’ve seen a string of investment fads from avocado plantations and prawn farming to exotic futures contracts and collectibles.

We invest in start-ups and alternative investments so are pretty open minded about new trends. But these crypto currencies do worry us. They have all the signs of an investment bubble, and reports of people mortgaging their house to invest is just plain crazy.

Hey, if you can make big bucks investing in a fad… great. Just don’t be over exposed when a crash comes. Take profits along the way, try to get back your original investment and then just play with the profits.

Regular readers know we’re disciples of investment guru Warren Buffett who makes his decisions based on 5 simple criteria. So we thought we’d put crypto currencies (we’ll use Bitcoin as representing them) through the Buffett investment filter.

. Do I understand the business?

Bitcoins were invented by a mysterious computer genius called Satoshi Nakamoto who decided there would only be 21 million ever created.

Bitcoins are created or “mined” by super-computers which solve complex algorithms and, in return, receive a unit. The closer the number of Bitcoins gets to 21 million units the harder it is to mine and the bigger the supercomputers need to be to solve the puzzles.

The Bitcoins are then held in digital wallets of investors which are numbered and password protected. Some describe it as a peer-to-peer electronic cash system.

The Bitcoins are then traded on markets using “blockchain” technology. This is simply a decentralized network of computers around the world which monitor and record all transactions.

Even the Australian Stock Exchange is looking to replace its CHESS share trading platform with a blockchain system, so this technology is certainly getting into mainstream use.

Basically a Bitcoin is a means of trading value. Think of it as a digital version of money or before that shells or rum during the Rum Rebellion when Australia was an early colony. It’s used as a means to pay for good and services.

Its value is determined by good old supply and demand.

. Is it run by people I admire and trust?

Mmmm… no idea.

Crypto currencies started out on the “dark web” as the favoured currency of drug cartels and arms dealers. The reason is because it operates completely outside the control of governments, banking systems or regulatory authorities.

Everything is basically anonymous. Bitcoin miners and investors are completely anonymous.

As the price of Bitcoins has skyrocketed, mainstream investors have taken an interest to try and make profits.

Coin Base seems to the biggest Bitcoin exchange platform in Australia where you can buy and sell. But there are other exchanges like Etoro and AvaTrade.

. Does it have a sustainable competitive advantage?

While Bitcoin was the first, and best known, of the crypo currencies there are now a whole range of them… Ethereum, Dash, Ripple, LiteCoin, Monero.

As this crypto currency investment rage continues there is every likelihood the number of different alternatives will grow as well to meet that demand.

So while Bitcoin had the market to itself in the beginning from being the first mover, the supply will grow as competitors multiply.

. Is it the right price?

In July 2010 one Bitcoin was worth US8cents. By January this year it had risen to $US800. On December 18 it topped $US18,000.

No that’s not a typo. $US800-18,000 this year is correct.

As you’d expect that sort of return has attracted a fair bit of attention. The more investors wanting to compete for the limited number of tokens available means the price skyrockets.

Like all markets, the right price is what someone else is prepared to pay for it. But when this digital token has no underlying foundation of value it’s near impossible to work out whether it’s over or under valued.

It seems to simply be based on demand and supply. We’d suspect the more competitors are that are created, producing more supply, the heat will come out of the market.

. If yes to all the above then do the deal.

While we sort of understand how they work, we’d have to say the rest of the answers to the Buffett investment filter are all a no.

Yes there’s lots of money being made, and lots of people bragging about it, but our considered opinion is to be extremely careful. Only invest what you can afford to lose and certainly don’t take on debt to finance it.

Lets leave the final word to our corporate watchdog the Australian Securities and Investments Commission;

“ICOs are highly speculative investments, are mostly unregulated, and the chance of losing your investment is high. Consumers should understand the risks involved, including the potential for these products to be scams, before investing.”

Update: There have been a number of scam emails and social posts going around since writing this article. You can read more here about Does Kochie invest in bitcoin?