Re-Released: Bewildered by Bitcoins

Re-Released: Bewildered by Bitcoins
Eileen St. Pierre, The Everyday Financial Planner

Over the past two weeks, I have been asked quite a few questions about bitcoin now that the price has risen to such dramatic levels (as of the writing of this post, the price for one bitcoin just hit $19,000). Futures trading in bitcoin will start on the CBOE December 11 and the CME December 18. Even though this Forbes article describes six reasons futures trading in bitcoin is better than buying bitcoin outright, I do worry about wide-eyed individual investors getting in over their heads. They may be out of their league with professional investors – speculators – waiting to take advantage of them.

Futures contracts are marked to market every day.

This means that every trading day, your gain or loss is realized. If the price of a bitcoin drops dramatically, which it has been known to do even in a single day, you can lose big time. If you do not have enough money in your margin account to cover this drop, you will get a margin call. This is different from the stock or options market, where paper losses are not realized until you sell the stock or options.

On January 20, 2014, I published this post about bitcoin. It is still relevant today so I decided to re-release it:

You may have heard some of the stories about bitcoins, like the British man scouring the dump for his discarded laptop when he realized the bitcoins stored on it were now worth $9 million. Introduced in January 2009, bitcoins are a form of digital currency that is used primarily over the internet, but some brick-and-mortar stores are now starting to accept them. An excellent column written by Raghu Kumar explains bitcoins in layman’s terms.

[3/25/14 Update: IRS announces bitcoins will be treated as property, not currency.]

To put it quite simply, I am bewildered by bitcoins.

Bitcoins fluctuate wildly in price.

According to LocalBitcoins.com, on 1/17/14 the cheapest bitcoin purchased online (via a Western Union money transfer), costs $810.29. If I want to purchase a bitcoin locally with cash, the cost really varies. In my home state of Oklahoma, a bitcoin currently costs:

  • $923.01 in Edmond
  • $877.83 in Oklahoma City
  • $873.84 in Tulsa

It costs 14% more to purchase a bitcoin in Edmond than to purchase it online. If I am going to purchase something that costs that much money, why would I use a form of payment that varies so much in price?

bitcoin-coins

Buyer Beware.

Proponents argue there are lower transactions costs with bitcoins since sellers do not have to pay the typical 2-3% transaction fee for credit cards. As a buyer, I have some concerns:

  • What happens if my bitcoins are lost or stolen?
  • There are government regulations protecting consumers who use credit cards. These protections do not exist in the Bitcoin network.
  • What recourse do I have if the transaction goes bad?

Some people may say that using bitcoins is just like using PayPal but without a physical company serving as the middleman in the transaction. There is no Bitcoin company – it is simply a network of users. There is no toll-free number to call if you have a problem. There is no asset or entity backing the bitcoin.

Remember what happened when the mortgage market collapsed.

When markets run smoothly, everybody is happy and no one is complaining. But in times of trouble, there’s comfort in knowing there is an institution, whether it be a government agency or corporation, to help us out.

In the time it took to write this column, the prices of bitcoins on LocalBitcoins.com changed quite a bit. Now the cheapest bitcoin purchased online costs $784.90. The same seller in Edmond lowered his/her price to $918.83. Perhaps in the future we will all be asking ourselves how we could live without the bitcoin. But for now I’ll stay bewildered by bitcoins.