Harvey Jones October 14, 2016
In another volatile year for global currencies, one has stood head and shoulders above the rest. It isn’t a traditional currency such as the US dollar, Japanese yen and certainly not the British pound. In fact, this year’s big winner isn’t a currency at all in the traditional sense, but a digital currency, otherwise known as a cryptocurrency – the Bitcoin.
Bitcoin began the year priced at around US$430. By October 12, the price had risen to $641, a rise of almost 50 per cent.
This is no flash in the virtual pan. In January 2011, you could buy a Bitcoin for just 25 cents. Growth since then has been a spellbinding 2,564 per cent, reaping large rewards for early adopters. That isn’t bad for a paperless currency that exists only on computers, with none of the traditional underpinnings and the security of a state, government, central bank or regulatory authority. No wonder ordinary investors have been sitting up and taking notice. Is this something you should be investing in?
Before you even consider investing in Bitcoin or any other digital currencies that have followed in its wake, such as Litecoin, Namecoin and Ethereum, you have to understand what it is and how it works.
What is Bitcoin?
It is a decentralised digital currency created by a small group of hackers and developers in 2008. Their identity largely remains unknown. It is an open-source software that no one person actually controls.
The coins are made by computers solving a series of complex maths problems, with so-called Bitcoin "miners" using their computers to make coins and record transactions. Users trade Bitcoin on exchanges such as San Francisco-based Coinbase, with all transactions recorded on a public ledger, called the blockchain.
A key feature of Bitcoin is that it has a finite supply of 21 million coins, of which more than 15 million are now in circulation.
Its growing army of supporters say this limited supply means its value will inevitably rise over time, with some claiming the price could hit $10,000 a coin. If correct, this could make Bitcoin a fabulously rewarding investment, but there are no guarantees. Fans also claim that Bitcoin is inherently more stable than government-backed "fiat" currencies that can be devalued by central banks printing money, as we have seen with quantitative easing.
Obi Nwosu, managing director of London-based Bitcoin dealing exchange Coinfloor, says investors believe Bitcoin is the most perfect form of money ever invented, because it is portable, divisible, durable and scarce. "Therefore, in time more people will come to use it over less perfect alternatives, unless a sufficiently superior alternative comes along."
The Investment Case
Bitcoin has two practical uses. The first is as a global online payment method, which allows expats to send money home faster and more cheaply than by using their bank or a conventional money transfer service. A growing number of businesses now accept Bitcoin, including Tesla Motors, Virgin Galactic and Dell, as well as The Pizza Guys restaurant in Dubai, while Umbrellab launched Dubai’s first Bitcoin ATM in 2014.
Bitcoin’s other key attraction is as a long-term investment, which you buy and hold in the hope that its value will increase dramatically over time. Early adopters have been well rewarded, but you are effectively speculating on future price movements and must brace yourself for plenty of volatility.
For example, while Bitcoin peaked at more than $1,000 in 2013 the price soon trailed downwards to as low as $225, hurting those who bought at the very top of the market. It has recovered over the last 18 months but the volatility continues, helped by a couple of high-profile hacking scandals.
In August, for example, almost 120,000 Bitcoins worth around $78 million were stolen from Hong Kong-based Bitfinex, one of the most popular cryptocurrency exchanges. When the news broke, Bitcoin fell 20 per cent as panicked investors sold up, although it has picked up since.
Mr Nwosu says investors should put some of their money into Bitcoin as part of a balanced portfolio. "It has had extremely good returns, outperforming all other world currencies for all but one of the last five years," he says. "Some consider it digital gold."
Lex Deak, chief executive of alternative investment aggregator Off3r, says investing in Bitcoin isn’t for the fainthearted. "You should only invest a small proportion of your money and be prepared for massive swings in value."
Buyers shouldn’t treat it as a get-rich-quick scheme and must be aware of the risks. "You could double your money within a year, but you could easily lose it all," Mr Deak says.
Dave Hrycyszyn, of digital agency Head, which advises companies on new technologies, says the lack of regulation appeals to some, but also means it has none of the stability mechanisms typically associated with a currency, which can make it volatile.
Bitcoin is also an anonymous way to make large cross-border money transfers, so has inevitably become linked to illegal goods and services. The first people heard of it was when it was used on the online black market site Silk Road, known as a platform for selling illegal drugs.
However, Bitcoin cannot be blamed for that outcome any more than the US dollar can be blamed for drug dealing.
How to buy it?
The currency can be bought via online exchanges and platforms, with an increasing number of UAE options, notably BitOasis, which allows you to buy via bank transfer in the UAE, Qatar, Kuwait and Bahrain.
You can buy fractions or "bits" instead of a whole Bitcoin, with investment from as little as $10 on some sites.
Globally, there are dozens of online Bitcoin exchanges and brokers, including Coinbase, Poloniex and LocalBitcoins in the US, Coinfloor and CoinCorner in the UK, Vaultoro in Switzerland and Coinhouse in France.
Transaction fees vary according to the exchange or broker, but typically range from 0.2 to 1 per cent of the currency bought, plus bank transaction charges. Fees of up to 1 per cent can apply on sales.
You store your Bitcoins in a "digital wallet", either in the cloud or on computers, which can be linked to your bank account. You must be sure you can trust the provider, because if hackers breach its security measures, the Bitcoin could be stolen and your chances of compensation are slim.
Typically, you can pay by bank transfer, mobile payments or with a Visa or MasterCard, or at Bitcoin ATMs such as one based at Dubai Media City.
Ola Doudin, the Jordanian founder of Dubai-based broker exchange BitOasis, says UAE residents with local bank accounts can sign up to its platform and buy vouchers to exchange for the digital currency. "We have Bitcoin and are looking to add Ethereum and other digital assets soon. Investors can safely store their assets with our secure multisig wallet security and we are also looking to provide insurance and other safeguards in future."
Ms Doudin says the Bitcoin technology and network is itself secure but the exchanges where you hold your coins can be vulnerable so you need to find one with strong security measures. "We always incorporate the latest security policies to make sure our users are well protected."
Bitcoin has been a successful investment for Ms Doudin, who suggests the price is now stabilizing.
In September, the Swift Institute published a new research paper saying that Bitcoin is unlikely to crowd out traditional fiat currencies such as the US dollar.
It predicted that it will mainly be used as a speculative investment rather than a medium of exchange. It added that there is no correlation between Bitcoin and traditional asset classes such as stocks, bonds and commodities, either in normal times or in periods of financial turmoil.
Mr Hrycyszyn warns that Bitcoin may be superseded at some point. "As with all computer technology, something better will come along. When that happens, it’s going to collapse in value to near-zero, probably in a matter of hours or minutes, in a spectacular ball of flame. It has no support structure to prop it up, as a normal currency does."
And it may have some limited uses, he adds. "As a weird short-term investment to bore people at parties? Maybe. As a long-term store of value that will see you through to retirement? Not a chance."
Tarik Kaddoumi disagrees. He is a Bitcoin enthusiast and the co-founder of Umbrellab, a consultancy and software company that launched the UAE’s first Bitcoin ATM in Media City in 2014. "Bitcoin is an attractive investment vehicle, but as with any investment offering high returns, it comes with high risks," he says. "So you need to look closely at it and learn how the price is affected by movements in the market, for example, acceptance by a large company, a blockade by a bank, or a fiat currency crisis."
Bitcoin has attracted its share of visionaries and skeptics. If you are tempted start with small amounts, and remember the old investment mantra that continues to apply to radical new ideas like this one: never put all your eggs in one basket, as Bitcoin is just a little bit risky.