Bitcoin is one of the most sought after currencies worldwide. A bitcoin exchange even describes the currency as something as valuable as gold, yet as convenient as a credit card to use.

But what is the fuss about this digital currency that people are stampeding to ride the bandwagon? Is it too late for you to join the fray? Is it good to include in your investment portfolio? We’ll help you answer these questions as you read on.

What is Bitcoin?

Bitcoin is a form of digital currency that has been circulating for almost a decade now. It enables two people to perform online transactions without the interference of banks. Although it’s a virtual money that exists only online, it can be used to pay for real-world goods and services just like how you use typical paper money. A number of online stores are now accepting it as a mode of payment.

Bitcoins can be earned by accepting them as payment for sold goods or services. A special exchange platform, which is similar to a real-world stock exchange, exists to handle trading activities. Trades also have fees but since there are no banks to act as the intermediary, the fees are way lower compared to other banking services. Fees are typically used to pay for the servers running the network.

Bitcoins can also be created by ‘mining’ the network. Mining refers to the validation of transactions throughout the network to ensure no fraudulent activities occur in the system; miners are paid with new bitcoins for successfully completing a task. Machines capable of handling intensive computing are used to get this task done. This is why there’s been a sudden rise in demand for video cards since they’re the best computing workhorse for mining cryptocurrency.

You can choose which online platform to participate into to start mining and trading bitcoins. Each participant in the bitcoin exchange holds a virtual wallet where bitcoin transactions are stored. There are also special ATMs you can use to buy or sell bitcoins.

The bitcoin platform adopts a decentralized structure, meaning there’s no single entity lording over the entire system. Unlike banks which are governed by regulating bodies mandated by laws, no one – and at the same time everyone – controls the value of bitcoins.

However, there are few rules set to avoid defrauding the system. One is the limit of bitcoins that can exist in the world – only 21 million bitcoins can be mined. Around 11 million are already in circulation making the race to mine more of them tighter.

How It Works

It’s hard to understand how the system works when we immediately use jargons to explain things. Let’s make it simpler by substituting a single bitcoin for a candy.

You have a candy and your friend has an apple. You both agreed to make a trade and you now have the apple and your friend has the candy. Bitcoins, in the same way, can be used to trade with someone willing to have it in exchange for another object or a service.

In this example, a fixed number of candies exist in the world. Since the number of candies is limited, it becomes pretty scarce and its value rises according to how others perceive its worth. Bitcoins, in the same fashion, exist in limited numbers – only 21 million can exist on the planet.

Now, when you give your friend a candy, you both know that you’ve given them the candy and you don’t need another person to confirm it. You know that the candy you used to hold is the same candy your friend now has. However, on a much larger scale, let’s say a group with 10 of your friends, you won’t know where the candy is and what has been traded for it when your friend starts exchanging it with the others in the group. You also won’t know if the same candy you first gave to your friend is the same candy you’ll receive when someone in the group trades it with you. You need to form a circle to allow everyone to see how the candy gets from one hand to another and see what has been traded for it.

The bitcoin platform confirms transactions and safeguards the system by implementing a similar concept the candy group applied to monitor their trade. In the bitcoin system, all transactions are written on a virtual ledger, also known as a ‘blockchain’, and is given to every participant in the platform. It would be nearly impossible to cheat the system because hackers have to tamper every copy of the ledger which probably exists in millions around the world. It’s like an outsider convincing everyone in the candy group that they’re holding the authentic candy and the candy the ten people have been using is a fake.

Investing in Bitcoins

The value of bitcoins has seen a stellar rise from when it started. From a few cents in 2009, it skyrocketed to almost AU$3,700 this 2017. At the time of writing this article, a bitcoin costs AU$2,562.

The story of how someone who invested a few bucks on this currency years ago now sits on millions of dollars heightened the appetite of speculators and investors to dive into bitcoin mining and trading. Everyone wants to be rich with minimal effort and many find investing in bitcoins the path to achieve this dream.

Before you plunge into any opportunity offered by bitcoins, let’s take a look at the currency’s strengths and weaknesses.

Advantages

• Freedom of use

You can transact with anyone participating in the exchange no matter where they are and what time it is. There are no transaction limitations, no bank holidays, and no currency conversion issues.

• Security

The blockchain system makes it harder for frauds to make dubious transactions and introduce fake bitcoins.

• Transparency

Every transaction is monitored by all units in the network through the blockchain to prevent double-spending.

• Privacy

You don’t need to provide any personal information to complete transactions, making you anonymous and protected from identity theft.

• Low fees

Additional charges to process transactions are way cheaper compared to using credit cards or wire transfers. Since there’s no bank to act as the middleman between traders, the system is able to keep rates lower.

Disadvantages

• Volatile prices

Everyone knows how hard it is to mine a bitcoin. This, combined with the info on how many of bitcoins are already in circulation, make prices exhibit strong fluctuations. You may be sitting on a pot of gold today until you realize the next day that the pot is now full of poop.

Its value depends on how people see its use in current market conditions. Prices will stabilize as time goes by, but for now, expect high volatility each day.

• No guarantee

Money in the banks is protected by a layer of laws implemented by the government. On the contrary, since the bitcoin network is decentralized and unregulated by a legal entity, there’s no assurance you’ll retain your bitcoins when the platform gets compromised.

Bitcoin platforms feature several layers of security. However, even the most heavily guarded banks can be robbed if the criminals are really determined to do it. Once your bitcoin is stolen, your chances of getting it back is close to nil.

• It attracts criminal activities

Since transactions are anonymous, criminals may use this platform for illegal trades and money laundering activities. Bitcoin accounts cannot be monitored and controlled by banks and regulatory boards, making it harder for them to track criminal activities.

• Under development

It’s still an infant compared to real-world currencies. It has yet to establish more features, increase security layers, improve accessibility, and include other important aspects that all stable currencies have. Bitcoin as a digital currency has yet to realize its full potential.

• Small market participation

Only a few online shops, like TigerDirect and Overstock, accept bitcoins as payment. More industries need to participate in this digital currency trade to cement its presence and relevance in the market.

Aside from these points, there are also tax regulations you should take note of in case you want to invest in bitcoins. The ATO placed special taxation rules for virtual currencies like bitcoin when it’s used in trading, business operations, mining, exchange services, trading, and as an investment vehicle. You may be held accountable to pay capital gains tax when your keep bitcoins as some sort of investment.

If you’re only using bitcoins for transactions involving personal consumption like buying a pizza or getting a good massage at a spa, you’re exempted from paying taxes. However, transactions should be less than $10,000 in this manner. Exceeding this amount allows the government to treat your transactions as a form of business or investment activity.

Conclusion

People have yet to learn more about digital currencies like bitcoin before we realize its full potential and possible implications in today’s current banking system. It’s still in the infancy stage and the platform needs to improve its security layers, trading rules, and checks and balances.

Depending on your risk appetite, bitcoins can either be a sound or bad investment. It has its highs and lows and it has yet to find stability and worldwide market acceptance. This makes it a speculative play for investors who are willing to take the risk of volatility for potential gains.

What makes things interesting is the result of a research conducted by a group of finance experts. Their findings show that only 2.5% of bitcoin participants use it to trade for goods and services; the rest keeps bitcoins as part of their investment, hoping they can convert it for more than what it’s worth today. This may be a good sign for investors since many are racing to amass as much as they can, embarking on the theory that this will be the future of banking.