5 Reasons to Avoid Bitcoins

Bitcoins, the digital crypto-currency, is the latest financial craze hitting the streets, but I advise you to sit this one out. Completely digital transactions might be the way to spend money in the future, but don’t mistake it for a safe investment.

Bitcoins are never used as physical currency. They don’t have the backing of any government. In fact, its very existence is a legal gray area. To get this currency, you can go through an exchange or “mine” them with a powerful computer.

After the botched bailout of Cyprus, the price of bitcoins in dollars skyrocketed. Cypriot bank depositors got locked out of their accounts and some were forced to fork over some of their money. Bitcoins are very attractive to people who are losing faith in the safety of traditional currencies.

Folks are very curious about bitcoins, and some are scrambling to get some of this alternative currency for themselves. Unfortunately, some seem to be under the false impression that buying bitcoins would be considered a wise investment.

Bitcoins aren’t actually an investment, but a de-centralized alternative currency. They are transferred directly, person-to-person and anonymously, via the Internet. It’s simply an alternative to other currencies, such as dollars, pounds sterling or euros.

Personally and professionally, I tend to be pretty loyal to investments that I can expect to go up in value, yet all we can predict about bitcoins is that their value relative to the dollar is sure to be volatile.

Here are some other ways that buying bitcoins could go incredibly wrong.

Losing your keys. According to the Washington Post, the bitcoin network doesn’t even have a “password reset” mechanism. All of your bitcoins could be unrecoverable if you lose the unique character sequence, which is called the key.

Volatility. Investments work in our favor when the underlying asset creates value. The unfortunate thing about bitcoins is that people could just stop using them one day. When you use something as volatile as a digital currency, you risk losing 100% of your money. If you don’t think this can happen, just ask investors in some of the early online companies of the late 1990s or people who spent large sums on Beanie Babies. Nothing has value until there is a buyer. While the traditional greenback could theoretically meet the same fate, it’s more likely to happen with bitcoins.

The exchange rate. Bitcoins are primarily used and promoted by speculators, rather than participants in normal retail and commercial markets. Speculation leads to huge price volatility. While this is exciting, it means that holding bitcoins is just gambling.

Security problems. Bitcoins require a network of voluntary users to operate, and is subject to hackers who may gain control of the network and destroy the value of the community. Unlike the money in your checking account at the local credit union, there is no one backing up your bitcoin investment. When you hold dollars in the bank, the Federal Deposit Insurance Corp. stands behind the account to the tune of $250,000.

Legal challenges. Some prognosticators assert that the federal government might stop bitcoins from gaining traction in the currency marketplace. It does seem likely that the Federal Reserve could assert its power over U.S. monetary policy and block the growth of bitcoins if they become a major player. Money is a medium of exchange, and if it becomes illegal to exchange bitcoins, they are completely worthless.

I think that these reasons are sufficient for me to recommend standing on the bitcoin sidelines, at least for now. While it’s seductive to jump into what might be the next big thing, stick with PayPal for the time being.

Follow AdviceIQ on Twitter at @adviceiq.  

Hilary Martin, MBA, CFP, is a financial planner at The Family Wealth Consulting Group, a fee-only planning firm providing personalized advice, guidance and service to successful individuals and their families in Silicon Valley. She regularly writes about personal finance on the firm’s blog, Healthy Wealthy Families. You can find her on Twitter @WealthyFamilies.

AdviceIQ delivers quality personal finance articles by both financial advisors and AdviceIQ editors. It ranks advisors in your area by specialty. For instance, the rankings this week measure the number of clients whose income is between $250,000 and $500,000 with that advisor. AdviceIQ also vets ranked advisors so only those with pristine regulatory histories can participate. AdviceIQ was launched Jan. 9, 2012, by veteran Wall Street executives, editors and technologists. Right now, investors may see many advisor rankings, although in some areas only a few are ranked. Check back often as thousands of advisors are undergoing AdviceIQ screening. New advisors appear in rankings daily.