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Bite on Bitcoins Or Get Bitten?
Perspective | 08 April 2014
By: Peter Ng
Articles (81) Profile

When asked about Bitcoins, “Stay away. Bitcoin is a mirage.” were the words of warning given by legendary investor, Warren Buffett.

What has triggered him to rebuke with such strong words against Bitcoins? Before that can be done, let us try to land on a common page and discover what Bitcoins are exactly.

What Bitcoins Are
We need to be clear that Bitcoins with a capital “B”, by definition, refers to a network of computers which allows for the verification and transfer of data ownership without the need for a trusted third party.

With a lower case “b”, bitcoins, on the other hand, is the unit of the network, or essentially the dollar and cent of a currency.

To put all these simply, one can make sense of this “digital currency” by imagining a typical scenario of a person withdrawing cash in a bank, only with the exception that the other party handing the dollar bill over is not a bank teller but another person.

Further, this transaction is witnessed by a group of people and recorded in a network called the block chain, which is a massive and so called transparent ledger of each and every bitcoin transaction on earth.

Refering back to our bank scenario, given that bitcoins do not have a physical form, the block chain prevents the person who has handed money over from using them again (since the money has already left his wallet).

Why Bitcoins then?
Since the 2008 global financial crisis, countries around the world have been enthusiastically loosening monetary policies through methods such as quantitative easing and interest rate adjustments etc., which as a result, have caused currencies to de-value.

In response, bitcoins are created as a store of value, one without the involvement of a central authority, where they are free from the grasp of any government or central bank who might attempt to de-value them.

A tourist visiting Singapore from the US could be in limbo to discover that the US dollar has depreciated as much as 25 percent against the Singapore dollar within the last five years, essentially eradicating his purchasing power by 25 percent.

But what if he had bitcoins, wouldn’t his purchasing power maintain, or better still, spiked multiple folds driven by the appreciation of bitcoins?  Let us just agree to disagree for now.

Source:  LocalBitcoins(SGD)
Price of bitcoins rose to as high as $1392/bitcoin in November 2013, and crashed more than 50 percent to $609.4/bitcoin by April 2014

What Bitcoins Aren’t
According to Eric Posner, a Professor of Law at the University of Chicago, bitcoin is not a plausible substitute to fiat currency. Despite no government or central bank interventions, this could potentially be the fallacy of the bitcoins argument since control over money supply gives the government control to steer the economy away from potential pitfalls like recessions or even asset bubbles.

Devaluing a currency’s value might appear to be disadvantageous from a domestic household’s perspective, however, devaluing a country’s currency with the intention of avoiding a recession while boosting a country’s level of competitiveness, is a rational course of action.

Investment Merits

  • Offers a potential diversification to traditional investment approaches.

Investment Risks

  • Block chain, the backbone of Bitcoin, has not reached the level to be considered reliable.
  • A massive target of cyber-attacks that can cause bitcoins to be stolen from owners.
  • bitcoins are highly volatile where its volatility has exceeded other currencies and even gold.

SI Research Takeaway
Despite its diversification benefits, there is no doubt that investing in bitcoins is a risky business. Warren Buffett gave the analogy that other than being an effective way of transmitting money, bitcoins are just like cheques, but are cheques worth a lot of money because they can transmit money? I believe most would fill in “no” as an answer, which explains the sweeping statement he made to keep out.

At this juncture, bitcoins are regarded as delinquents to a functional currency, where they can be considered as vouchers at best.

What do you think one’s response would be if his or her next pay cheque is issued in bitcoins?

Backed by a strong interest in investments, Peter's research spans across a range of industries, with his focus placed on companies listed on the SGX.

Please click here for more information about this author.

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