Buyer beware when it comes to Bitcoins

ANDREW Heaven, an AMP financial planner at WealthPartners Financial Solutions, tells us about Bitcoins; what they are and how they work.

Question: Can you please explain what Bitcoin is and how it works? Is this something that I can invest in or should consider?

Answer: Bitcoin is a form of digital currency. Created in 2009, it is the first example of a category of money or store of value referred to as cryptocurrency.

Cryptocurrencies are a $US112 billion market that is currently turning over up to $US5 billion a day.

Allegedly there are more than 900 different cryptocurrencies in existence which is more than physical Sovereign or Fiat (legal tender) currencies.

The two most dominant and commonly traded cryptocurrencies are Bitcoin and Ethereum.

On current market valuations, the entire Bitcoin network is valued at approximately $US48 billion and Ethereum's is around $US35 billion.

Software developer Satoshi Nakamoto devised Bitcoin as an electronic payment system.

The idea was to create a currency independent of any central authority. Unlike conventional currencies, Bitcoin is unique in that it is decentralised. No single institution or country controls the Bitcoin network.

There are only 21 million Bitcoins in existence. However, these coins can be divided into smaller units. The smallest unit is one hundred millionth of a Bitcoin and this is referred to as a Satoshi.

You buy Bitcoins either through cryptocurrency exchanges or directly from others via Bitcoin marketplaces.

Bitcoins can be traded by exchanging cash or other currencies, services or goods.

The Bitcoin system is peer-to-peer. Transactions can take place between users directly, without an intermediary. These transactions are verified by computer network nodes and recorded in a public distributed ledger called a Blockchain.

To buy Bitcoins, you must first establish a Bitcoin wallet to store your Bitcoins. As there is no physical currency, the value is stored electronically.

There is a range of wallet options available; a software wallet stored on your own computer, an online web based wallet service or a vault based service.

Each option has varied ease of access and varying levels of security. Trying to keep it simple, the equivalent would be keeping cash at home, having money invested in a bank account or having cash stored in a vault at a bank.

The process of establishing a wallet in Australia is akin to opening a bank account and subject to conventional banking requirements verifying identity and the source of funds.

There is a range of exchanges that you can trade Bitcoins through, but be aware they do not offer the same capital protection as banks.

The ATO has stated that income and profits derived from Bitcoin transactions are taxable.

The value of cryptocurrencies changes depending on typical market influences; supply, demand, and sentiment.

Whilst a large market, it is still early days and the market can be volatile and subject to intense speculation.

The value of Bitcoin and Ethereum fell as much as 33% from record highs. Trading around $US3,000 at June 12, Bitcoin plunged to a low of $US1,938 on July 16 before finishing the week above $US2,300.

The recent volatility in the value of cryptocurrencies is a warning.

The primary function of any currency, crypto or otherwise, is to be a reliable store of value. With rampant speculation and competition from alternative cryptocurrencies having a large bearing on the setting of value, cryptocurrencies are far from being a reliable store of value.

Cryptocurrencies should be considered a frontier market with the inherent risks and extreme volatility.

Over time the market will mature as legitimate uses by mainstream companies increase and are supported by appropriate government regulation.

For now, though it is a case of buyer beware.

Q&A with The Coach story first appeared on the WealthParners website. Any general advice in this story doesn't take account of your personal objectives, financial situation and needs. For more information from WealthPartners, go to www.wealthpartners.net.au.

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