Bitcoin Mania (and bubble burst?) has struck!!  Just take a look at this price chart…

From $433.59 on Jan 2, 2016 … to … $13,744.13 on Jan 2, 2018.  That’s a 3,170% gain over 2 years!!  (I wish I had bought back then, or even 5 years ago when the price was only $13.96!)

But before we get too carried away, let’s peel back a few of the layers here to have a more informed discussion about cryptocurrencies, and money in general.

 

The History of Money

I think to understand Bitcoin and other cryptocurrencies, we should have a basic understanding of the theory and history of “money” as a concept.  What is “money” anyways?  There are some great resources that already exist, so rather than trying to rehash it all out here, let me direct you to some of the best ones I’ve found.  I recommend you start with the video by Open University and then keep exploring if you have further interest.

Videos

Articles

Books

 

What is Money?

We all know what “money” is, but it’s surprisingly hard to define.  Investopedia defines money like this…

“Money is an officially-issued legal tender generally consisting of notes and coin, and is the circulating medium of exchange as defined by a government. Money is often synonymous with cash and includes various negotiable instruments such as checks. Each country has its own money that is used as a medium of exchange within that country.”

In my opinion, that definition is insufficient and does not capture the true essence of money.  I believe it’s more helpful to define money in terms of its Functions and Characteristics.

 

The Functions of Money

Economists agree that there are essentially three primary functions of money…

  1. Money is a store of value … you don’t have to spend it now and it won’t expire
  2. Money is a unit of account … standardized tool to set values/prices on other objects
  3. Money is a medium of exchange … you can use it as an acceptable method of payment

 

The Characteristics of Money

The primary characteristics of modern money include…

  • Durability … it won’t expire, rot or erode over time
  • Portability … it is easy to physically move
  • Divisibility … it can be divided into smaller portions to account for a wide variety of prices
  • Scarcity … there must be a limited supply
  • Uniformity … the value of the unit of money must be universally agreed
  • Stability … the value of the unit of money should not fluctuate excessively
  • Acceptability … it must be universally accepted throughout society as a form of payment
  • Verifiable … it must be possible to establish the authenticity of the money

 

So, if you can imagine a thing that satisfies all of the Functions and Characteristics of money, then you’ve got Money!!

At the moment, we primarily use Legal Tender Currencies which are created and issued by governments as our primary form of money.  This money can be physical banknotes and coins, or represented digitally in various accounts which we use as ledgers to track the value of the money in our possession.

Finally, in regards to the definition of money, you should notice that none of the Functions or Characteristics of money require it to be tangibly useful in a physical sense.  I mean that it’s not important for money to be edible, or used as a source of energy or material for construction.  Modern money is not required to be inherently useful in its own right.

The most interesting and thought-provoking definition of money I’ve seen is…

“Money is a story that everyone believes in.”

I think this definition is true and incredibly helpful.

 

“Fiat” Money

The United States came off the “Gold Standard” in 1971, which means that after that time, it has not been possible to exchange US Dollars for physical gold.  Now, the US Dollar is considered a “fiat” currency, which means that it is only given value by the “full faith and credit” of the United States government.  As long as the US continues to exist and be solvent (have good credit), then the value of the USD will persist.

According to my research, the last country to abandon the Gold Standard was Switzerland in 1999, and now there are currently no countries in which the currency is supported by physical gold to establish its value.

Hundreds of books have been written on this subject, so I won’t try to capture it here.  Also going any further down this rabbit hole starts getting into the territory of conspiracy theories, and that is certainly not what this blog is about.

However, what is not really debatable is that all modern currencies are perceived to hold value because that mass public believes in the ability of governments to maintain solvency and keep the system flowing smoothly.  We all believe in the story of modern money.

 

So, with that as background, how does Bitcoin and other cryptocurrencies fit into the picture?

 

Cryptocurrency: A Modern Money

Enthusiasts and supporters of Bitcoin and cryptocurrencies would like you to believe that they have found the holy grail of money.  They would have you believe that cryptocurrencies are the inevitable future of money and that they will eventually replace fiat currencies issued by governments around the world.  Lofty visions, huh?!

Check out this quick (1:36) video from Bitcoin.org which gives a very high-level overview of some of the benefits and infrastructure of Bitcoin…

For a more in-depth overview of Bitcoin and Blockchain technologies, I recommend that you read this article: BlockGeeks – What is Cryptocurrency?

Here is a list of some great resources where you can explore the intricacies of cryptocurrency as much as you like:
General Information about Blockchain, Bitcoin & Cryptocurrencies

Blockchain Thinkers & Influencers

 

Characteristics of Cryptocurrencies

Proponents of cryptocurrencies assert that in addition to fulfilling all of the Functions and Characteristics of money listed above, cryptocurrencies ALSO provide these following benefits:

  • Irreversible … A transaction can‘t be reversed after confirmation, by anybody, ever
  • Pseudonymous … Neither transactions nor accounts are connected to real-world identities
  • Fast and global … Transactions are propagated and confirmed nearly instantly
  • Secure … Cryptocurrency funds are locked through strong cryptography algorithms
  • Permissionless … You don‘t have to ask anybody to use it
  • Decentralized … No one organization, entity or person controls it

 

Isn’t Bitcoin just a BUBBLE?

Most believers in Bitcoin are bullish on the massive jump in valuation in 2017, and assert that this is the natural result of supply and demand, as the mass public becomes informed and then engaged with cryptocurrency technology.

Others are quick to claim it’s a BUBBLE and that Bitcoin is not really a form of money at all!  Here’s an interesting video from The Independent which essentially makes the claim that Bitcoin may not be a real currency because of the high volatility (the rapid and uncertain) of the value of a single Bitcoin.  How could you possibly transact in Bitcoin if you can’t be certain of the value of your currency from day to day or even moment to moment?!  Clearly, they are claiming that Bitcoin fails to meet the “Stability” characteristic of money.  This is an entirely fair criticism.

This is why I might recommend that you own some Bitcoin, but not transact in it for daily purchases until the price action volatility decreases … possibly several years from now.

Before I share my strategy, let me say one more thing about the Bitcoin “Bubble”… I don’t believe that the value of a Bitcoin will go to $0.  Here’s why…

The following things will not make the price of Bitcoin go to $0:

  • If it becomes REGULATED and TAXED … this could legitimize it and drive demand (and therefore the value) higher
  • If it becomes CRIMINALIZED … this would likely drive value down as demand decreases, but there will still be a latent demand based on the characteristics of cryptocurrencies which protect its users from discovery
  • If another cryptocurrency DOMINATES the market … the value of Bitcoin may decline at a floating exchange rate in comparison to another currency, but it’s unlikely to go to $0

So what could lead to a bitcoin crash to $0?  I think the only way Bitcoin goes to $0 is if a fundamental flaw in the software is identified.  Meaning if the integrity of the blockchain technology supporting the Bitcoin is compromised in any way, then the faith in Bitcoin as a currency could dissolve and the value would go to $0.

 

So … Should You Buy Bitcoin or Other Cryptocurrencies?!

To answer that, let me first share a few of my personal perspectives on blockchain and cryptocurrencies…

  • Blockchain technology is here to stay … more use-cases will be developed and implemented over time, and the software will continue to improve
  • Cryptocurrencies are now a permanent member of the financial universe
  • Bitcoin, Ethereum, Ripple, Litecoin have first-mover advantage with mass market adoption, but they may not be the eventual winners in the cryptocurrency space

 

With this in mind, if you want to purchase Bitcoin or any other cryptocurrency, then I would only recommend you do so under the following conditions:

  • You have first completed all the core personal finance objectives … established a 6-month emergency fund, have no high-interest debt, are living within a clear budget, have a savings & investment plan developed and are executing on it
  • You can afford to LOSE 100% of the money you allocate to the cryptocurrency (seriously, don’t depend on this money for anything!)
  • You only allocate a MINIMAL portion of your Total Net Worth to cryptocurrencies (very low single-digit percentage, at the maximum)
  • You are patient, and do not intend to day-trade or swing-trade cryptocurrencies (I’m not currently a Forex trading advocate)
  • You are committed to trying to stay educated on the high-level trends and developments in the cryptocurrency space

I believe that this strategy will allow you to participate in the potential upside gains of cryptocurrencies as they continue to gain mindshare and market share of the financial instrument space, while at the same time limiting your downside risk.

 

How Might You Get Started in Buying Cryptocurrencies?

In Dubai, you might decide to use BitOasis to buy and sell Bitcoin and Etherium.  And if you are interested in exploring other cryptocurrencies you can exchange your Bitcoin or Etherium for other cryptocurrencies at Binance.

New cryptocurrencies are launching almost daily now.  You can find details about new currencies that are becoming available through Initial Coin Offerings (ICO’s) at these websites:

I’d say that the majority of these are extremely high risk, and that most of them will be worth absolutely nothing in the future.  You should exercise extreme caution with new ICO’s and only allocate a small amount of money that you wouldn’t mind losing 100% of.

 

What Has My Personal Experience with Cryptocurrencies Been Like?

I’ve personally been curious about Bitcoin for a long time and I sent a family member a one-line email in November 2015 that said … “What do you think of Bitcoin?  Interesting or a scam?”  That relative never responded to my email and I didn’t take any action on it (what a shame)!

Early in 2017, I opened a CoinBase account and purchased 1.6 Bitcoins when the price was approximately $1,200 per Bitcoin.  I’ve never transacted or sold any of the Bitcoin in my account.

Then I recently purchased 2.4 Ether when the price was approximately $450 per Ether.  I’ve never transacted or sold any of the Ether in my account.

So that’s it … just two purchase transactions.  Not a huge amount of money, but I wanted to expose myself to the asset class and learn about it in the process.

My plan is to HODL (“Hold On for Dear Life”) and not sell either of my cryptocurrencies.  I also don’t have any current plans to purchase more of either currency … but I might do so if there is an even larger price drop over the next few months.  We’ll see what happens.  In any case, I’d be perfectly fine if both Bitcoin and Etherium go to $0, but I’d prefer that they both go to $1,000,000!!  We can all dream, can’t we?

 

I hope this information and perspectives on Bitcoin and cryptocurrencies have been insightful and helpful for you to better understand the core concepts as well as a few practical points about how you might start to dip your toes into the world of cryptocurrencies.  Good luck and allocate your assets wisely!

 

As always, check out these additional resources below…


Matt Nobles is the founder of Dubai Personal Finance.  In addition to being a certified Personal Finance Education Instructor, Matt also has 10 years of Corporate Finance experience, working for a large multi-national company.  Matt is passionate about helping people like you learn how to make wise money management choices, so you can achieve Financial Independence and focus on living the life you’ve always wanted.


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(Disclaimer: This article contains information for your reference and explains options you may have, but it is not intended to be specific advice or a personal recommendation. DubaiPersonalFinance.com exists to provide general guidance and education, but your situation may vary from the one discussed here, so please seek a licensed professional for tax, legal, financial planning or investment advice.)

 

Please let me know what you think of this post.  What has your experience with cryptocurrencies been like?  Are you bullish or bearish?  Have I missed something important in my analysis?