Bitcoin. Until a month or so ago, it was something that most of us had heard of, but essentially none of us understood. It was a mysterious, nerdy thing that existed on the internet and every so often an article would pop up mentioning it and further deepen our confusion.
That all changed at the end of last year, when bitcoin suddenly seemed to become extremely valuable. Then apparently it stopped being valuable. Then really valuable again. For a brief flurry, it dominated the news. So, what exactly is it?
Bitcoin is a cryptocurrency, a very fancy word that essentially means online money. Think of it like Amazon credit; you can’t hold it physically, you can’t withdraw it, but it has value. The only difference is, bitcoin can be used outside of a single place, and it can be traded for actual cash – £8550 worth of cash at this current moment in time. It is real currency, just like dollars or pounds, but only for online.
Now, you may be asking why this stuff is worth so much, and that is where it starts to get a bit complicated. Simply put, it has value because we believe it to have value, the same as all money. We all know that the £5 note in our pocket isn’t actually £5 worth of material, but we all happily believe that it is worth that amount of money because it benefits us all. To keep this belief working, our money is printed by a central authority, the Bank of England, who make sure there is the right amount of money circulating around to keep us all convinced our notes are worth the amount the bank says they are. It’s an odd system to work your head around, but it works. Bitcoin, however, is a bit more complicated. Bitcoin doesn’t have a central authority deciding how much money is out there. Instead, it manages the amount of bitcoin out there by making it harder and harder to access more. How it does this is more complex than it is worth explaining in this piece, but essentially this means that bitcoin remains scarce, and when something that people want is scarce it becomes valuable. The more valuable it becomes, the more people want it, which makes it even scarcer, which increases its value further and so on and so forth. And that is why bitcoin has been successful.
If you’ve managed to stick with me through all that, you may be asking what the catch is. After all, it has been the case so far that, if you just invest into the scarce resource now, ten years later your money will have been doubled. Pretty good deal right? Naturally, nothing is ever that easy. Bitcoin has only really risen in value so far, but there is nothing behind it keeping it this valuable. If tomorrow everyone decides that they are going to call it quits and sell off their bitcoin while it’s worth lots, its value is going to start to drop. This sudden drop in value may cause other bitcoin holders to panic and sell before it drops any further, and suddenly the value of the stuff is plummeting. This is called inflation, and it can happen to physical currencies too. However, physical currencies have their central authorities to manage any crisis. Bitcoin does not. If bitcoin collapses, and collapses hard, there is nothing to stop it becoming essentially valueless. And just like that, it will all but disappear. Will this happen? Who knows? Maybe bitcoin will continue to grow in value for decades to come. But if you are thinking of investing in the stuff, just remember: it’s not risk free.