BITCOIN: Great investment or risky gamble?

13 December 2017

Author: Naomi Gaston
Practice Area: Banking & Finance

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This year has seen an unprecedented rise in the popularity of cryptocurrencies, such as bitcoin.

What was once seen as a slightly bizarre investment choice reserved for people who had a deep understanding of technology has now transferred into the mainstream and is attracting everyday investors. The value of bitcoin increased by around 50% last week, with a 150% increase in value last month and an overall 2,000% increase in value over the last year.

Dr Garrick Hileman of the Judge Business School at the University of Cambridge estimated in April of this year there were between three and six million people using cryptocurrency around the world. Today, this figure is closer to 20 million.

The technology behind Bitcoin and other crypto currencies, Blockchain, is considered by some commentators to be ground-breaking and potentially as revolutionary as the internet in a few years’ time. This is hard to imagine when you consider the day-to-day impact that the internet has on social, commercial and financial interactions.

Investment in cryptocurrencies is now being treated like an investment in gold. Trading patterns to date suggest that bitcoin is purchased not necessarily to finance day-to-day living costs but in the expectation that there are other investors out there who will pay more for them in the future.

Unlike the notes or coins in your pocket, cryptocurrencies largely exist online. There are some specialist ATMs which issue bitcoins as virtual currency tokens in corner shops, for example, however there is currently only one such ATM in Northern Ireland. This is perhaps representative of a slower uptake outside of London.

In the first week of December several financial columnists suggested bitcoin’s popularity has started to knock the shine off traditional safe haven investments like gold and silver. However, at the same time other commentators have described the bitcoin market as a bubble and warnings around it continue to grow louder even as the value of cryptocurrencies soar.

Speculators are investing heavily in the hope that they will make significant returns in the future. Some say it's a classic economic bubble with frenzied investors paying far more for an asset than it's worth for fear of missing out.

It is being described by some as a perfect example of the ‘greater fool theory’ which states that the intrinsic value of an object does not determine its price in a market but rather its price is determined by irrational beliefs and expectation of market participants. A very high price may well be paid even if it seems “foolishly” high because an investor may rationally expect the object to be re-sold to a “greater fool” later.

Others, extolling the benefits of the currency, point to the growing prospect of bitcoin crossing over into the financial mainstream. Often Blockchain is used to eliminate intermediaries and middlemen thereby increasing efficiency and speed of transactions. In the finance sector it is anticipated that Blockchain may soon be used to minimise the involvement of financial intermediaries.

Several banks operating in Northern Ireland including Danske, Barclays, HSBC and RBS (the parent company of Ulster Bank) are involved in R3, a consortium of financial institutions, to develop an application of Blockchain to facilitate quicker financial transactions at reduced costs. Other local banks are exploring the application of Blockchain within the global financial system. For example, Santander introduced a pilot scheme to allow international payments through a bespoke app it developed and Allied Irish Bank announced an investment of €30m (£27m) in business-to-business international payments start-up TransferMate last month.

It is possible to create virtual currencies based on the protection Blockchain provides. The technology creates an efficient fraud proof log of financial transactions and has been lauded as a way of providing a secure, digital alternative to banking procedures that now seem very out dated, labour intensive and time consuming.

Curiosity is growing quickly, but the question still remains as to whether cryptocurrencies present a great investment opportunity or a very risky gamble.

If you have any queries, please contact Naomi Gaston, associate solicitor in the Banking team at Carson McDowell.

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