Tam Hunt: Investing in Bitcoin (for Dummies) | Opinions

By Tam Hunt | August 30, 2017 | 1:30 p.m.

Now that Bitcoin has been achieving new price records weekly during the past few months, worldwide attention has been focused like never before on this new technology, a digital currency that seems to have achieved a staying power that few expected.

So how do you invest in this new technology? I’ll go over the main investment options, including ways that you should avoid, based on hard-learned lessons.

First, the punchline: The easiest and perhaps the best way to invest in Bitcoin is to simply buy some and sit on them. There are many sites where you can buy Bitcoin, but probably the easiest and safest is coinbase.com. Given the eight-year history of Bitcoin, we can’t have great certainty about where it will go. But that history is good support so far that the price will keep going up steadily.

Bitcoin is a “deflationary” currency by design, which means its value has to go up over time unless it’s outlawed or knocked from its perch by some better technology. Only 21 million bitcoin can ever be “mined,” which means using specialized computers to solve very difficult math problems. Mining all 21 million will take more than another 100 years. This schedule is fixed in the currency’s algorithm in that the difficulty of mining automatically increases as more and more people mine the currency.

If you’d bought some bitcoin (we use a small “b” to talk about bitcoin as specific currency and big “B” to talk about Bitcoin as a technology) just a couple of years ago, when it was at $200, you would have seen a 23-fold return on your investment. That’s very hard to beat.

There’s no guarantee at all that this level of growth will continue, and many people believe that Bitcoin and other cryptocurrencies are going through an unsustainable bubble. However, as just mentioned, Bitcoin is by design a deflationary currency and replacing the global currency market is the potential market for Bitcoin.

If all the world’s currency became bitcoin (unlikely, but certainly possible), each of the 21 million bitcoin would be worth about $4 million. That’s a healthy improvement over the current $4,600.

What this means for you as a buyer of Bitcoin is that there are two main possibilities for the value of Bitcoin over time: 1) the price will continue to steadily rise as interest grows in this new currency, based on the laws of supply and demand; 2) the price will fall to a far lower level and stay there if (and only if, in my opinion) governments around the world work together to make Bitcoin illegal. The first scenario is far more likely than the second. So far, almost no governments have attempted to make Bitcoin illegal.

A third scenario is possible: A new cryptocurrency will replace Bitcoin because it’s simply better in the ways that matter. There is some possibility of this happening with Ethereum, a newer type of digital currency and one that is more versatile because it’s focused on “smart contracts” rather than just digital currency.

Smart contracts are to business transactions and law as Bitcoin is to fiat currency — they’re both about getting rid of the middleman and creating smoother markets. The fancy term is disintermediation, and it’s all about creating value by getting rid of those pesky lawyers and bankers who always take their pound of flesh in today’s economies.

The best way to deal with the potential for other digital currencies to replace Bitcoin is to diversify a little in this new space by also buying some Ethereum, which has increased even more than Bitcoin in the past year.

Cloud mining?

Another way to invest in Bitcoin is to buy a cloud mining contract. Cloud mining means you buy a share of an existing mining operation and collect the coins as they’re mined. I’ve used Genesis Mining’s “unlimited” Bitcoin mining contract for a few months, and I’ve made my money back already, which is great, but that’s mainly because the price of Bitcoin has more than doubled in that time frame.

I paid $1,950 for 15 gigahash/second of mining capacity at a farm in Iceland that uses geothermal power to mine. The daily payout already has dropped by one-third in just 2½ months because Bitcoin mining has become so popular, and thus the difficulty of finding new Bitcoin through mining has gone up.

I can at this point expect to double or triple my money invested in this cloud mining contract before it expires from the difficulty rising too high. That’s a great return if it does happen; 200 to 300 percent returns in a single year is unheard of in “normal” investing. This obviously isn’t, however, normal investing, and rewards are generally commensurate with risk. So the higher the rewards, the higher the risk. In this case, the risk is that the value of Bitcoin plummets and stays low. That could happen, but I think it’s unlikely.

Now, as good as 200 to 300 percent returns are from this cloud mining contract, it would have been easier and less risky to simply buy bitcoin with my initial $1,950 investment. At the time of my investment, that would have bought about one bitcoin, which is now worth $4,600, more than doubling my money.

My cloud mining contract might return one bitcoin before it expires, but probably not much more than that. If that’s the case, I will have waited about nine months to get that full bitcoin when I could have had it at day one, and the end result is the same.

That said, my hope when I invested in the cloud mining contract was that it would return far more than one bitcoin. It’s an “unlimited” contract, which means that it keeps returning bitcoin in perpetuity. But there’s a big catch that I didn’t look into when I bought the contract: There are daily “maintenance” fees assessed on my payouts. And once the mining daily output falls far enough that it can’t cover the maintenance fee, the contract expires.

Based on the current pace of declining payouts, it looks like the contract will expire in less than a year.

Long story short: While this particular cloud mining contract will be highly profitable, it would have been simpler and probably more profitable to just buy the bitcoin directly and hold it.

Self mining?

What about owning mining equipment directly and operating it yourself? Well, I’ve done this, too. I bought a Bitmain Antminer T9, the latest and greatest miner, for exactly one bitcoin back in April, when one bitcoin was worth only about $1,200. I also had to pay a couple of hundred dollars for the power supply and cord, so my total investment in dollars was about $1,500.

I worried about the noise of mining in my own home because I’d read about the fan noise being loud. So it was: In my relatively warm garage in Hawaii, the two high-powered fans built into the shoebox-size machine ran very high and put out a lot of noise. I really prize my quiet at my house, since I’m in the country and I’m a bit of a noise snob when I’m here, so I shut it down after just a couple of days.

Well, to be entirely accurate, it kept on going offline for some unknown reason, and after I struggled to get it back online to no avail I just let it stay off and counted my blessings for some peace and quiet. It’s now in my garage storage locker, and I’m looking to sell it.

The key for profitable mining is low-cost power, and this I do have. I have a large solar system on my house that was installed before I bought the house. It’s far too large for my needs, so I send a lot of excess power to the grid each month. This means that my cost of power for Bitcoin mining is free.

Based on today’s difficulty level and a 1 percent pool fee (joining a pool is a good way to increase your chances of finding the right hash keys to earn bitcoin on a steady basis), the Coinwarz.com mining calculator tells me that I’d be able to mine about 1.3 bitcoin a year, for a return of almost $6,000 per year. Even if I had to pay normal rates for electricity for this mining, I’d still be making almost $4,500 a year. This is a great return on a roughly $1,500 investment.

The machine might even keep producing significant bitcoin in years two and three. But the big “x factor” here is again the difficulty level, which increases as more and more miners join the system. Unfortunately, difficulty has in the past few years risen faster than the price of Bitcoin, so it’s a bit of a treadmill speed game where you need to run faster and faster to stay still.

Returns on personal mining operations are still likely to be at least two to three times your investment before the machines become obsolete — and that’s great. You could buy a new top-of-the-line miner today for $1,500 to $2,000, and that would probably get you at least 2½ bitcoin before it became unprofitable to mine; 2½ bitcoin today is worth almost $6,000. And if you hold this bitcoin for a few years, it’s entirely reasonable to expect it to become worth more than $10,000 each, for a total of $25,000.

This personal mining option, in summary, can be about twice as profitable as the cloud mining option, if you have the personal skills to set it up and can handle the loud noise. It may, however, still just be better to buy the Bitcoin directly and sit on it, particularly if you’re not very tech savvy.

How not to invest in Bitcoin

The last option I’ll discuss is what I’ll call (charitably) “Bitcoin trading.” There were a number of operations that sprang up in late 2016 and early 2017 that claimed to be able to use arbitrage between Bitcoin prices on the many different exchanges around the world to increase your Bitcoin and share these earnings with you. These scams (yes, they were scams) asked you to send them your bitcoin and the amount you gave would dictate the level of daily payout. The more you invested, the more you’d get back as a percentage each day.

These companies — Gladiacoin, ecoinplus and jet-coin, to name the three that I tried — also had affiliate programs that encouraged participants to invite others to join, with incentives to you for getting others to join your network. 

The rate of returns promised seemed too good to be true, and generally when something seems too good to be true it is. Not always, as we’ve seen above with other ways of investing in Bitcoin being indeed highly profitable. However, in this case the returns promised, such as doubling invested bitcoins in just 90 days, or as little as 40 days in the case of jet-coin, through trading arbitrage, seemed fishy.

I decided to give Gladiacoin a try after a friend encouraged me to try it and explained how it worked, in a way that made it seem plausible that it wasn’t just a pyramid scheme. The arbitrage model was plausible, and is actually possible to do yourself. But what should have tipped me off is the degree to which the site was anonymous and unaccountable. Live and learn. In this case, I lived, made my mistakes, and now you can learn from my mistakes.

I received the payouts as promised for the first week or so, but shortly after things began to go awry. And eventually the site just went dark. I tried the two other sites in the meantime, and before long all three went dark. The end result: I had lost about three bitcoin. This was irritating and disappointing, but it didn’t break the bank. I had only invested funds that I could afford to lose.

The take-home lesson here is this: Make sure that any company you invest with has clearly defined points of contact, a help desk and real people behind it. This should be obvious, but I have to admit the large dollar signs (or bitcoin symbols) clouded my judgment on this. Hopefully I’ve learned my lesson. They were indeed pyramid schemes.

Is Bitcoin a pyramid scheme?

Which brings me to the broader question: Isn’t Bitcoin itself just a pyramid scheme? It’s a good question because Bitcoin’s success does depend on people buying into it. And the vast majority of interest in Bitcoin now is as an investment (based on expectations of additional price increases) rather than people using the bitcoin they buy to use as a currency.

Is Bitcoin’s only or main value as an investment vehicle? If it was, we could argue validly that Bitcoin is a pyramid scheme. However, I would argue that there’s a lot more to Bitcoin than as an investment vehicle. A few other major features are:

» Its use as a digital currency, which is increasingly widespread, though admittedly at a low level still. More and more stores and websites are offering Bitcoin as a payment option. You can also get Bitcoin credit cards and debit cards now, allowing you to use Bitcoin to buy anything.

» A real store of value. A key feature of any legitimate currency is that it is a reliable store of value. We increasingly hear about Bitcoin replacing gold as a reliable store of value “just in case” something happens to the U.S. or other major economies. The global gold market is worth about $6 trillion. Bitcoin and other cryptocurrencies are now more than $160 billion, so a long way shy of gold’s value. But at recent growth trends — all cryptos were at just $20 billion last December — it’s not hard to see cryptos passing gold as a preferred store of value before long.

» Another real value for Bitcoin is its ability to eventually replace fiat currencies like the yuan or Venezuelan bolivar. Nations that can’t control their own currency can’t wage war using debt, and can’t use economic warfare against other nations. Libertarians have long loved Bitcoin because of this feature, and as Bitcoin and other cryptos grow in prominence, this is looking less and less like an idle pipe dream. Nations probably won’t willingly turn to Bitcoin as an official currency. Rather, it will probably happen with adoption by normal citizens reaching the point that Bitcoin becomes the preferred transaction and savings currency. At that point, it would become very hard for a nation to maintain its own fiat currency, and it then may have to accept Bitcoin as a national currency. As Bitcoin grows and becomes more stable, this “Bitcoinization” of a nation’s currency could also bring serious benefits. Nations with very low-cost power could mine bitcoin and create their own store of value.

I would argue that these and other benefits of Bitcoin make it clearly not a pyramid scheme. But time will tell.

I will end with a broad warning: Bitcoin is still a new technology, and don’t invest more than you are willing to lose in this new investment niche. Returns have been and will in the future be very high, but for any rewards there are always risks.

— Tam Hunt is a writer and lawyer based in Hawaii.

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