6 Reasons Why You Shouldn't Invest In Bitcoin

| About: Bitcoin Investment (GBTC)

Summary

My take on cryptocurrencies and Bitcoin is in flux.

I've already argued why you should invest in Bitcoins.

In this article I articulate the "bear" thesis.

My personal preference regarding investing in Bitcoin has has shifted from a skeptical wait and see approach towards having one toe in the water. Why you should invest in Bitcoin has been discussed in an earlier article. However, there are several arguments against an investment in Bitcoin as well:

Tax situation is a mess

The tax situation around Bitcoin is a real mess. IRS Notice 2014-21 says Bitcoin should be treated as property, not as currency. That means Bitcoin investors pay the lower long term capital gains tax rate on their appreciated Bitcoins but it actually slows down the development of Bitcoin as a usable currency. It means merchants and consumers have to keep track on every transaction (tiny transactions are not exempt) and this is a huge headache. In turn that's a bad thing for investors as it slows down the adoption of Bitcoin as a method of payment. Potentially a large base of users would dampen volatility of the emerging asset class. Marvin A. Kirsner wrote a more detailed and interesting article on the subject.

Hard to invest at scale

It is still fairly hard to invest at scale. There is The Bitcoin Investment Trust (OTCQX:GBTC), sponsored by Greyscale, that trades on the exchange but it trades at a fairly large premium to its underlying net asset value. That means you are buying overpriced Bitcoin. People are still doing it as you can hold GBTC in a tax advantaged account unlike Bitcoin itself. You could just hold Bitcoin directly through U.S. based platforms like Coinbase or Kraken or even on a hardware Bitcoin wallet you disconnect from the Internet like Trezor or Ledger. All come with pro's and con's are far as security goes. In the defense of Bitcoin, that problem really isn't exclusive to Bitcoin. Gold investors, or investors wanting to hold cash, face some of the same problems.

Extreme volatility

You can argue volatility will subside all you want but it is a fact the exchange rate of Bitcoin vs USD is fairly extreme compared to the exchange rate vs USD of some of the more established currencies in the world. It's hardly a surprising fact but not everyone has an appetite for it:

Source: Coinbase Bitcoin price chart in USD

Competing currencies

If the case for Bitcoin is fairly strong, the case for digital currency as a whole is even stronger. Bitcoin inspired a host of competing digital currencies each with its own distinct features. Some prominent competitors are Ripple, Litecoin and Ethereum. Bitcoin is clearly a leader and there are first mover advantages as the technology benefits from a network effect. However, the competition is right there and it is possible a different digital currency will end up as the global preferred technology. The reason this might happen is that the different digital currency have different sets of features. One particular set of features might just end up being even more powerful. Bitcoin seems to have all the key features down. It is decentralized, it can function as a medium of exchange, it can be stored and it is in limited supply.

Difficult to understand

As one reader pointed out on my previous article the places you can spend Bitcoins are still limited compared to any other currency but then again, not that many places are taking U.S. eagles. Bitcoin is a very new invention and it isn't immediately intuitive. Argentines, Venezuelans and Chinese, to name just a few, need less convincing. To the person on the street, in let's say Houston, it's less obvious why he or she would need Bitcoin. You could say it isn't screaming killer app at most people at this point. That problem is exacerbated because the technology isn't super easy to use. Increasingly Digital currency exchanges and wallets are becoming more user friendly but there is still a way to go. One example of a barrier to entry is the security issue. The way I understand the cold-storage option on dedicated hardware with a back-up it is very secure. I would say it is much easier and efficient to keep your Bitcoins safe than it is to keep an equivalent fortune of U.S. gold bars safe. However, almost everyone has the know-how of how to keep his gold bars safe but how to keep your Bitcoin safe requires an arduous learning process while the stakes are high. Can you blame people for giving up?

New normal going back to the old normal

Perhaps Bitcoin is benefiting a great deal from the global delevering that is taking place. There is economic pain or difficulty in almost every part of the world; from emerging markets to the U.S. and from Europe to South-Korea. This results in political extremes gaining traction, both left and right, in all sorts of countries. It may also be a boost to Bitcoin which resembles digital gold. The times are advantageous to Bitcoin although a severe global crisis would be better. However, what if we get past the great delevering cycle. We are eight years in since 2008, how many more years to go? How attractive will Bitcoin remain when the global economy is humming along and people's pensions are doing fine, their salaries are rising and fiat currency appears to work just fine. Will Bitcoin lose its appeal to everyone but its strongest supporters? A solid global economy is a risk to Bitcoins short term success.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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