Should You Invest in Bitcoin?

If you get wistful imagining the American penny discontinued, a topic that makes the rounds every once in a while, imagine the thought of getting rid of the penny, nickel, quarter, dollar and the rest of American currency--and using bitcoins instead.

Bitcoins have been around for a few years, but there has been buzz in the mainstream media lately due to the digital currency recently both shooting up and plummeting in value.

It can be hard to comprehend at first, in part because Bitcoin, in upper case, refers to the software code that makes the digital currency and the network that distributes it, and bitcoins, in lowercase, refer to the currency itself. Then there's simply grasping the concept: Although bitcoins have a logo that looks like a coin, you will never actually hold one in your hand. Still, with debit and credit cards and online and mobile banking, a consumer these days could theoretically go weeks, months or perhaps years, if they never tip, without touching actual money.

Some people think bitcoins are the wave of the future, a digital form of money that could someday be a universal form of money that replaces the dollar, euro, yen, rupee and onward along the international currency chain. "If even modestly successful, Bitcoin could wind up being the tipping point of a sea change regarding how we are paid and how we pay for things," says Thomas Way, a computing sciences professor at Villanova University in Villanova, Pa.

Others think its future will fall more along the lines of the recent housing bubble, or even the Beanie Babies craze of the 1990s, when some people bought hundreds and thousands of the stuffed toys, planning to sell them one day to fund their retirement or kids' college education.

"People shouldn't invest in Bitcoin. And I think writing about Bitcoin will cause people to lose more money than if the media simply ignore it," says Peter Cohan, who teaches business strategy at Babson College in Wellesley, Mass., and has a background in management consulting and venture capital.

[Read: 2 Simple Steps to Make Your Retirement Savings Leap.]

Bitcoin was created in 2009 as a software code project, with the goal to verify and safeguard financial transactions without the assistance of a centralized bank or government treasury. These digital dollars are "mined," as the lingo goes, involving a complex computer system that creates and verifies bitcoins, which are essentially strings of numbers. Due to the authenticated history attached to this virtual money, counterfeiting is virtually impossible.

Once you have a bitcoin, or some BTC, as more lingo goes, you can give it to someone else--a friend, family member, an online storekeeper--over the Internet. You can also exchange the bitcoin into a dollar, euro, yen, rupee and so on.

Moreover, Bitcoin is modeled after some of the ideas behind gold. For instance, the computer systems that "mine" for bitcoins create new coins every 10 minutes and will continue until the total amount reaches a limit of 21 million bitcoins in the year 2140, a number and year that was chosen by an algorithm. Just as there is a finite, if unknown, amount of gold on the planet, there is, or will be, a finite amount of bitcoins, which makes them valuable.

The fact that a computer algorithm dictated the concept of bitcoins, versus the idea of human beings deciding monetary policy, drives their popularity among many enthusiasts. "The idea behind Bitcoin, the most popular instance of cryptocurrency to date, is generally a good one primarily because of its decentralized nature," Way says. "Democratizing some, and perhaps one day all, of the global financial system by using this decentralized digital-currency approach should have a similar effect on the financial market to what the Internet in general has had on information, communication and entertainment."

Way thinks "cautious adoption is likely," and he is likely to get little argument there. There are probably too many skeptics out there for the general public to embrace bitcoins any time soon. Ian Comisky, a partner at Blank Rome, a multidisciplinary law firm with offices throughout the world, is one of those. He believes consumers could face inadvertent tax fraud by investing in it, mostly because some taxpayers might not realize that you have to report any investments in bitcoins as capital gains.

But he also sees a darker side of Bitcoin. As Comisky points out, the anonymous nature of the digital currency means there is scant evidence that you've used it. With conventional money, Comisky says, "there's a paper trail. You make a deposit, and you have a copy of the item, and the money's in your bank account, and a government agency can subpoena that if they need to."

[Read: How to Spot Counterfeit Money.]

But with bitcoins, because of the almost anonymous nature of the money, "If you're a bad guy, there are a lot of uses for it. You can use bitcoins for tax evasion, launder money with it or use it for narcotics," Comisky says.

Indeed, last year, the Federal Bureau of Investigation came out with an unclassified report, which was immediately leaked online, asserting that at least one online service, a market place called Silk Road, has taken bitcoins as payment for illegal drugs.

Dodi Glenn, director of AV Labs at ThreatTrack Security, a Clearwater, Fla.-based firm that specializes in helping identify and stop sophisticated malware and cyber attacks, points out another problem. "Bitcoin-targeted malware, like viruses and Trojans, can do several bad things to your PC," Glenn says. "For example, hackers can steal account information, such as your username and password, which gives them access to your Bitcoin wallet. They also can hijack your computer and use it to help spread their Bitcoin-stealing malware to other PCs."

Of course, malware can get access to a bank account, too. But banks will give you your money back. "Bitcoins aren't insured with an agency like FDIC, or with an actual bank," says Glenn.

Even if you're confident you are hack-proof, and you're a perfectly good citizen with no interest in money laundering or narcotics, you may wonder why you'd want to pay for anything with a bitcoin. That's the million-dollar question--sorry, the million-bitcoin question. Right now, you can't buy much with bitcoins. It's estimated that only about 100 retailers throughout the world accept them, all arguably obscure businesses like PhoneSomeone, an Australian telephone wholesaler of second-hand equipment, and Grass Hill Alpacas in Haydenville, Mass.

Still, the appeal for some is that with Bitcoin, you can pay friends and family on the Internet for free (although in some cases, there may be a small fee) and without a lot of hassle, once you have digital money in your Bitcoin online wallet. A friend can scan your cell phone with his cell, or you can touch the two smartphones together, provided they both use Near Field Communication technology, and pay each other that way. In fact, you can pay anyone anywhere in the world, within about 10 minutes, according to Bitcoin's website.

But it may take a while for consumers to get comfortable using bitcoins. For instance, the New York City bar, EVR, recently gained a lot of press for being the first New York bar to accept bitcoins. As CNN reported in mid-April, at its then-current value, a $15 martini cost .08 bitcoin. Wrapping one's head around what would be a fair cost for a purchase with bitcoins may take some time.

As the New York bar scene suggests, some businesses and consumers are embracing bitcoins, as are some investors, who clearly hope they can buy low, or low enough, and sell later. Currently, bitcoins aren't pegged to the dollar or any international currency, and their value fluctuates--sometimes wildly. In the past, it has traded for less than a penny. For a time in 2012, each bitcoin was worth less than $5. As of this writing, the exchange rate for 1 bitcoin is 140 American dollars; by the time you read this, it may well be different. You can find the current exchange rate at bitcoinexchangerate.org.

[See 10 'Digital Utilities' You Need Every Day.]

In other words, this isn't an investment for the cautious investor, or anyone who doesn't have money they can afford to lose; nobody should feel confident about putting their life savings into bitcoins. On the other hand, if digital currency isn't here to stay, it's nonetheless making a valiant attempt. It's worth noting that there are other cryptocurrencies vying to be the next Bitcoin, notably litecoins (www.litecoins.org) and PPCoins (www.ppcoin.org).

For those who are intrigued, investing cautiously in bitcoins seems the way to go for now. And if you're someone like Harlan Platt, finance professor at Northeastern University's D'Amore-McKim School of Business, you shouldn't touch it at all.

"Bitcoins are a bit like pixie dust, the substance that Tinker Bell used," Platt says. "It only exists if you believe it exists. Unlike formal currencies, there is nothing that stands behind them such as the full faith and credit of the United States government. Like other schemes, though, it is somewhat like musical chairs. As long as you're not the last person to sit down, the game is fun. The last person left holding these instruments only has a story to tell and no value."



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