Laila Keith
Bitcoin is a decentralised virtual currency, which has been one of the best investments in the world since its creation in 2009. However, it is a highly volatile asset, and investors need to be aware of the risks involved. While some experts compare Bitcoin to gold, critics argue that it doesn't work as a currency due to its volatility, energy usage, and use in illegal activity. Nevertheless, Bitcoin's popularity is growing, and it remains the world's most valuable cryptocurrency. So, is it worth investing in Bitcoin with little money? The general consensus is that you should only invest in Bitcoin if you have a high-risk tolerance and are financially stable enough to lose some or all of your investment.
| Characteristics | Values |
|---|---|
| Volatility | Bitcoin is highly volatile, with daily fluctuations of 5% and occasional double-digit price moves. |
| Efficiency | Bitcoin transactions take 10 minutes on average to process, compared to seconds for credit cards and cash. |
| Energy consumption | Bitcoin requires massive computing power, with energy consumption higher than that of some countries. |
| Illicit use | Critics argue that Bitcoin enables illegal activity, including dark web purchases, money laundering, and other illegal activity. |
| Value | Bitcoin is not backed by any meaningful value, and its price is inflated by hype. Scarcity is one factor that contributes to its value. |
| Competition | Alternative cryptocurrencies could eventually overthrow Bitcoin due to their ability to innovate and add new functions. |
| Regulatory environment | The regulatory environment for crypto is currently uncertain, and crypto holders do not benefit from the same regulatory protections as registered securities. |
| Insurance | Crypto is not insured by the Federal Deposit Insurance Corporation or the Securities Investor Protection Corporation. |
| Investment amount | It is possible to invest small amounts in Bitcoin, but transaction fees should be considered as they can eat into returns. |
What You'll Learn
Bitcoin's extreme volatility
Bitcoins Extreme Volatility
Bitcoin's price volatility is well-known, and there are several reasons for this. Firstly, as a relatively new asset, Bitcoin is still in the price discovery phase. This means that its price is yet to stabilise and will continue to fluctuate as investors, users, and governments navigate the initial growing pains and concerns.
Secondly, Bitcoin's price is heavily influenced by supply and demand. With a limited supply of 21 million coins, the price is affected by how many are in circulation and how much people are willing to pay. As supply decreases and demand increases, prices will likely climb.
Thirdly, Bitcoin is an asset that is quickly adopted by investors and traders, so speculation about price movements plays a critical role in its value at any given moment. Media outlets, influencers, and industry moguls can easily create investor concerns, leading to price fluctuations.
Fear and greed are also primary drivers of Bitcoin's volatility. Due to its reputation for unpredictable price swings, investors fear missing out on gains or falling victim to losses, causing panic buying or selling and further influencing demand and prices.
Lastly, varying beliefs in Bitcoin's utility as a store of value and method of value transfer impact its volatility. Many investors view Bitcoin as a hedge against inflation and an alternative to traditional stores of value like gold. However, others are unsure of its long-term viability, contributing to the uncertainty surrounding its price.
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The risks of investing in Bitcoin
Bitcoin is a risky investment due to its high volatility and unpredictable market. There are several risks associated with investing in Bitcoin, and it is important to be aware of these before making any investment decisions. Here are some key risks to consider:
Volatile and Fluctuating Market
The price of Bitcoin is constantly changing and can be extremely volatile. This makes it difficult to predict whether you will get a return on your investment. For example, on November 6, 2018, one bitcoin was worth $6,461.01. Just over a week later, on December 17, 2017, the price topped $20,000. However, by December 24, buyers could not sell their investment for more than $14,626. To avoid massive losses, it is recommended to make small and cautious investments.
Cyberattacks and Fraud
As a technology-based currency, Bitcoin is susceptible to cyberattacks and hacking. There is a constant threat of losing your investment through hacking or fraudulent exchanges. Additionally, if you lose or misplace your wallet key, retrieving your coins can be challenging.
Little or No Regulation
The Bitcoin market currently operates with little to no major regulations. The lack of taxation and government stance on cryptocurrency adds uncertainty to the market. The future of Bitcoin is unpredictable, and it may face increased regulation or even competition from government currency in the years to come.
Technology Reliance
Bitcoin is entirely reliant on technology, and any issues or advancements in technology can significantly impact its value. Unlike traditional currencies or investments, Bitcoin is not backed by any physical collateral. This makes Bitcoin owners more vulnerable to cyber threats and online fraud.
Block Withholding
The process of creating new bitcoins involves solving mathematical equations called "blocks." However, this system can be manipulated by a select few to benefit themselves while leaving others with nothing. This practice is known as block withholding and further contributes to the unpredictable nature of the Bitcoin market.
Environmental Impact
Bitcoin mining has a significant environmental impact, producing about 40 billion tons of carbon dioxide annually. This is a critical consideration for investors who prioritize environmental, social, and governance (ESG) principles.
Legal and Tax Implications
The legal standing of cryptocurrency is still evolving, and investors assume certain legal risks when buying and selling bitcoins. In the US, the IRS has defined cryptocurrencies as property, subjecting investors to capital gains tax laws. Additionally, there are ongoing discussions about whether cryptocurrency wallet owners must report their holdings using specific forms, such as FinCEN Form 114 or IRS Form 8938.
In summary, investing in Bitcoin carries significant risks due to its volatile nature, technological reliance, regulatory uncertainties, and potential environmental and legal implications. It is crucial to thoroughly research and understand these risks before considering any investment in Bitcoin or other cryptocurrencies.
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How to invest in Bitcoin
Investing in Bitcoin can be risky, so it's important to do your research and understand the process before getting started. Here's a step-by-step guide on how to invest in Bitcoin:
- Choose a Cryptocurrency Exchange: Select a reputable and well-known cryptocurrency exchange that offers a wide range of currencies and has low fees. Examples include Gemini, Kraken, Coinbase, and Crypto.com.
- Create an Account: You will need to provide personal information and verify your identity to register on the exchange.
- Fund Your Account: Before buying any crypto, you need to deposit funds into your exchange account. You can use fiat money, such as US dollars, to fund your account.
- Select Your Cryptocurrency: Decide which cryptocurrency you want to invest in. Besides Bitcoin, there are thousands of other options, including well-known ones like Ethereum.
- Place a Buy Order: Follow the exchange's instructions to submit and complete your buy order for the chosen cryptocurrency.
- Store Your Cryptocurrency: Once you've made your purchase, store your crypto in a digital wallet. This can be a wallet provided by the exchange or an independent wallet provider.
- Understand the Risks: Cryptocurrency prices are highly volatile, and there is a possibility of losing your entire investment. Only invest what you can afford to lose, and be prepared for price swings.
- Review and Rebalance: Periodically review your portfolio to assess if you need to adjust your crypto holdings. This may involve increasing or decreasing your crypto allocation based on your investment goals and financial situation.
- Tax and Regulatory Considerations: Stay informed about tax consequences and regulatory changes that may impact your crypto investments. The regulatory environment for crypto is currently uncertain and evolving.
- Consider Diversification: Instead of investing directly in Bitcoin, you can also gain exposure through crypto-related stocks, ETFs, or funds. This can help diversify your portfolio and potentially reduce risk.
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The future of Bitcoin
Bitcoin is a risky investment, and its future is uncertain. However, it has been one of the best investments globally since its creation in 2009.
Bitcoin's future is dependent on several factors, including institutional adoption, regulatory changes, and macroeconomic trends. Some experts believe that Bitcoin will continue to gain legitimacy and attract more investors, while others argue that it is a bubble that will eventually burst.
One of the key factors influencing Bitcoin's future is the halving event, which happens roughly every four years and reduces the rate at which new coins are created. Many investors view this as a significant factor affecting Bitcoin's price. Additionally, Bitcoin's decentralized nature and limited supply make it attractive to individuals seeking a store of value and protection against economic volatility.
The environmental impact of Bitcoin mining has also been a concern, with critics arguing that it consumes a lot of energy. Regulatory changes and increasing scrutiny from governments could also impact Bitcoin's future.
Despite the uncertainties, some experts remain bullish on Bitcoin's future. They argue that Bitcoin's potential as a global digital currency and its ability to provide financial services to underserved populations will drive its growth.
In conclusion, the future of Bitcoin is highly debated, and it remains to be seen whether it will become a universal digital currency or face increased regulatory challenges.
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Bitcoin's potential as a non-correlated asset
Bitcoin has a relatively loose correlation with other asset classes, making it a potentially attractive tool for portfolio diversification. Its fixed supply may also eventually make it a hedge against inflation and a store of value. However, its extreme volatility has limited its appeal in this regard.
Bitcoin's correlation with other assets is measured using a correlation coefficient – Pearson's correlation coefficient – a statistical measure that ranges from -1 to +1. A correlation coefficient close to +1 indicates a strong linear positive correlation, meaning the assets typically move in the same direction. A correlation coefficient of zero indicates no relationship, and a -1 reading indicates a strong linear negative correlation (inversely correlated).
Bitcoin has had moments of non-correlation with the S&P 500 in the last decade, but it has yet to prove itself as a truly non-correlated asset. In 2022, it had a positive correlation with stock prices, which is troubling news for investors when inflation is on the rise.
Bitcoin's correlation with "risk-on" assets such as the S&P 500 Index, Russel 2000 (small-cap stocks), QQQ ETF, HYG High Yield Corporate Bond ETF, and the FANG Index (high-growth tech) has been strong in recent years. These indexes have also had a strong correlation with each other, indicating that all assets are strongly correlated in the current macroeconomic regime.
Bitcoin's CME futures have also shown a strong correlation with these risk-on indexes. Bitcoin has ultimately acted as the riskiest of all risk allocations and as a liquidity sponge, performing well when there are hints of expanding liquidity coming back into the market.
However, it is expected that this dynamic will change over time as the understanding and adoption of Bitcoin accelerates. This adoption is the asymmetric upside to how Bitcoin trades today versus how it will trade in 5-10 years.
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Frequently asked questions
Bitcoin is a risky investment with high volatility and is generally recommended only if you have a high-risk tolerance, are in a strong financial position, and can afford to lose some or all of your investment. However, you can start investing in Bitcoin with as little as $10, and some sources recommend investing a small amount at regular intervals to combat the high volatility of cryptocurrencies.
Bitcoin is highly volatile, and it can be challenging to predict when values will rise or fall. The drivers behind large swings in value may not always be clear. Additionally, Bitcoin is not currently subject to much government regulation, so transactions do not come with legal protection.
Bitcoin is the world's most popular and valuable cryptocurrency, with a market cap of more than $360 billion as of September 2022. It has a relatively loose correlation with other asset classes, making it a potentially attractive tool for portfolio diversification. It also has a fixed supply, meaning investors will not be negatively impacted by dilution.
You can buy Bitcoin on cryptocurrency exchanges such as Robinhood, Coinbase, PayPal, and Cash App. Alternatively, you can use a crypto wallet, either "hot" (accessible via the internet) or "cold" (a physical storage device that keeps your cryptocurrency keys completely offline).
