We also discussed this very topic in a recent Money Mentors podcast episode (tune in here).

So, should you invest in Bitcoin?
For me, investing in an asset means understanding what you are investing in and based on this knowledge, having confidence that the value of that asset would appreciate over time.

The reason I won’t be putting any of my money into Bitcoin as an ‘Investment’ is simple, it breaks three of my fundamental investment philosophies:

1. Don’t follow the herd
2. Don’t overpay for an investment
3. Do invest in things I understand

This is why I consider Bitcoin punting or speculating rather than investing.

As the price of Bitcoin keeps rising, the more the Fear Of Missing Out (FOMO) is setting in. And the more people want to buy. This continues to drive the price higher as buyers outnumber sellers.

Warren Buffet has famously said “never invest in a business you cannot understand.” Warren Buffet has amassed his fortune investing in companies he understands inside out, such as Coca Cola, American Express and IBM.

Bitcoin is difficult to understand and even more difficult to value.

Alternatively, you could invest in a growth asset such as a company share that is much easier to understand and to value. The value of this company share is underpinned by its earnings. Should its earnings fall, the share price may fall. Should earnings rise, the share price would be expected to rise. Yes, shares can be volatile in the short term but if you invest for long enough, fundamentals should eventually value a company at its fair or intrinsic value, which is underpinned by its earnings.

For example, one popular method of valuing a company is by discounting future earnings back to a present value. This exercise simply can’t be conducted with a crypto currency that has no earnings. Its value is effectively driven by the forces of supply and demand.

For its price to keep rising, Bitcoin needs more people to adopt the technology and more buyers to outnumber the sellers. This is speculation and very difficult to predict. There is every chance that euphoria could continue to push the price of Bitcoin higher. However, it could easily fall sharply too. If you invest in Bitcoin you might get very rich in the short term like many people already have. But will it continue? That is anyone’s guess.

A key part of an investment is understanding its risk. Aside from the irrational nature of the market, a major risk to Bitcoin is governments can change the game. And change it quickly. Governments like to understand the flow of money.

In the Financial Review last week, currency expert Kenneth Rogoff warned that Bitcoin is “totally a bubble” and likened Bitcoin to “MySpace before Facebook”. He argues that governments ultimately won’t tolerate its use in the long term given its anonymity.

I don’t want to sound negative on Bitcoin, as I said in my last blog, the technology behind Bitcoin and other crypto currencies is revolutionary. However, I caution people following the herd and putting money into something that they may not fully understand. My main fear for Bitcoin is if the buyers dry up and the sellers set in, the price of Bitcoin may spiral down.

If you want to put some of your hard earned into Bitcoin there’s nothing wrong with that, just be prepared for volatility and what may be a rocky road of bumps and dips. And I’d highly recommend you spread your risk by maintaining a diversified investment portfolio.