Crunching the Numbers Surrounding Bitcoin Fever

Dec 10, 2013

Have you been swept up in bitcoin mania?

Bitcoins purchased at the beginning of this year were valued at $13.50. As of Dec. 9, they were trading at close to $900. That’s a rise of more than 6000 percent!

Many folks are eyeing the virtual currency as an easy way to make huge profits. But KPLU financial commentator Greg Heberlein urges caution. Bitcoin prices may very well continue their march into the stratosphere. Or the bubble could burst.

When the world financial crisis struck in 2008, someone whose identity remains anonymous decided that currency issued by governments could no longer be trusted. So a virtual currency called bitcoin was created. It began trading in 2009.   

Bitcoins are created in a complex manner that is so beyond our technical expertise that we won't attempt to describe it. Instead, try David Perry's Bitcoin Mining in Plain English.

Since Bitcoin owners are anonymous, trading became popular with illegal drug dealers and for gambling activities. Silk Road is the most infamous example.

More recently, legitimate businesses have begun to recognize bitcoins. 

Billionaire Richard Branson beamed a spotlight on virtual currency when he said those who wish to reserve seats on his Virgin Galactic spaceship could use bitcoins.

At the other end of the spectrum, Geekwire reports a grilled cheese sandwich truck in Seattle recently began accepting bitcoins as payment.

Governments are feeling their way into bitcoins. 

In August, Germany recognized bitcoins as a private currency, subject to taxation. 

China recently decided to restrict its banks from using bitcoin due to concerns about volatility and money laundering.

Bitcoins and gold bear similarities. Both are not official currencies of governments, so governments do not control their value. They lack intrinsic value, rising and falling only on whims. They are inconvenient in a number of ways. You can’t use bitcoins or gold when you go to a grocery store or get an oil change (but bitcoin advocates are working to change that).

Gold has an edge. It has a few thousand years of trading value over bitcoins. It has at least some reason to exist, since it is used both for jewelry and certain industrial applications.

Neither hounded by government regulation nor transaction fees, bitcoins have appeal. Over time, bitcoins may be recognized as legitimate money. 

But consumers should be careful. The wild valuations are reminiscent of tulip mania

Four centuries ago, in Holland, a tulip bulb costing pennies suddenly skyrocketed in value, to as much as what an average worker would earn in 16 years.

The negatives are daunting. With bitcoins’ price variations, how can you accept bitcoins for payment and know where you stand? 

Consider that if you acquired a bitcoin on November 1, 2013, it was worth $191.58. Just one month later, on December 1, it was valued at $946.92 (according to the CoinDesk Bitcoin Price Index Chart). That’s a 494 percent profit!

However, the volatility can swing both ways. You could have bought a bitcoin Dec. 3 for $1147.25. But if you tried to spend it just three days later, it was only worth $694.47, a 39 percent loss.

Dollars, Euros and other currencies fluctuate, but less severely.  

Bitcoins are unregulated. They are subject to hoarding; why use them for purchases when you can make more by holding them for a better price tomorrow? 

Bitcoin users relish freedom from government, but if government begins to regulate them, what do you have? And bitcoins have competition. A dozen or more virtual currencies are also seeking recognition.

At present, bitcoins appeal more to the greedy than for commercial use. Consumers are better off waiting for the dust to settle.

As for investors, bitcoin is a gamble. According to CoinDesk, some analysts estimate a single bitcoin could someday be worth $100,000 or even $400,000.

But there’s always the very real possibility it’ll wind up being worth less than a tulip bulb.