May 20 2024

A beginner’s guide to Bitcoin

In the world of finance, and financial-technology (fintech) in particular, Bitcoin is a bit of a buzzword, frequently appearing in headlines that alternately encourage and admonish would-be investors. In a relatively short period, it has ascended from a niche form of speculation to an almost mainstream investable asset. But what actually is Bitcoin?

Mysterious origins

Bitcoin is a digital currency, also known as a cryptocurrency, which operates independently of a central bank. It was created in 2009 by a still unknown person who goes by the name of Satoshi Nakamoto.

It’s not a physical coin – you can’t hold it or lose it behind the sofa cushions - but a computer file stored in a 'digital wallet' on a smartphone or computer. Bitcoin is the most well-known out of thousands of different cryptocurrencies that have sprung up in its wake and which are available for people to buy and use.


Mining…but not as we know it

Cryptocurrencies like Bitcoin are created through an extremely power-hungry process called mining, which involves using computers to solve complex mathematical problems. Once solved, the miner is rewarded with a certain amount of cryptocurrency. Alternatively, individuals can buy and sell existing cryptocurrencies through brokers and store them in digital wallets for future transactions.

People can send Bitcoins (or part of one) between digital wallets. Every single transaction is recorded in a public list (commonly referred to as a ledger) called the blockchain. This technology is deemed crucial by proponents of cryptocurrencies like Bitcoin because they say it helps ensure the integrity of the financial transactions, making it difficult to cheat the system.


What is it good for?

The many enthusiastic Bitcoin devotees consider it and its ilk the future of money, with the potential to facilitate real-time, secure, and borderless transactions, autonomously and anonymously. Since cryptocurrencies are operated by a decentralised network of computers rather than a country or single authority, they’re removed from central government control and interference.

Certainly, Bitcoin itself has become increasingly popular with some investors, including large global institutional fund managers like BlackRock and Fidelity. For a long time, the process of buying and holding cryptocurrencies was technically burdensome, which deterred a lot of people. However, since the beginning of this year everyday investors can gain exposure to Bitcoin through exchange-traded funds (ETFs) available on most trading platforms.


What is it less good for?

Extreme volatility: Bitcoin is perhaps most (in)famous for its eye-watering price swings. Until 2017, the price of a single Bitcoin was fairly stable below US$1,000. Then in late 2021 it soared to more than US$65,000, before plummeting to US$16,000 just over a year later. It reached an all-time high of more than US$70,000 in March this year, before falling back towards US$60,000 at the time of writing. This can lead to significant gains for some, but equally devastating losses for others.

Technological risks: The underlying technology of cryptocurrencies, blockchain, is often touted for its security and inability to be tampered with. However, it’s not flawless. The risk of technological failure, whether through coding errors or more systemic issues within the blockchain, could pose a threat to investors' holdings.

Security concerns: The cryptocurrency ecosystem has been beset by a number of high-profile security threats in its relatively short life. Exchanges and individual wallets have been subject to hacks and thefts, as well as larger-scale fraud, leading to losses for investors – some substantial. The decentralised structure of cryptocurrencies also means that there is no central authority to turn to when things go wrong.

Adoption and acceptance risks: The future of cryptocurrencies largely depends on their widespread adoption as a means of payment or store of value. Sceptics maintain that the current level of trust and acceptance isn’t enough to sustain long-term growth, so cryptocurrencies may struggle to maintain their value. That said, the arrival of ETFs backed by large conventional fund managers has helped nudge Bitcoin at least towards more mainstream acceptance.

Regulatory and legal risks: The legal and regulatory environment around Bitcoin and other cryptocurrencies remains uncertain and subject to change. Governments may choose to ban or heavily regulate cryptocurrencies, impacting their legality and potentially leading to a loss of value. Moreover, the lack of regulatory oversight can also increase the risk of fraud and market manipulation.

Environmental and ethical concerns: The environmental impact of energy-intensive cryptocurrency mining, particularly Bitcoin, has raised questions about the sustainability of digital assets and their alignment with global efforts to combat climate change. Meanwhile, the anonymous nature of cryptocurrency transactions boosts their appeal as a funding source for criminal networks.


Buyer beware

There’s no denying that Bitcoin and other similar cryptocurrencies have great potential and could, in time, become a widely accepted form of payment. However, the risks at this stage in its evolution are considerable. Gaining exposure to Bitcoin has become easier, but it remains a speculative investment at best – closer to a bet, you could say – and unlikely to be appropriate as part of a long-term investment or retirement savings plan, like KiwiSaver for instance.

Morningstar data director Greg Bunkall told Stuff: “The short-term volatile characteristics of cryptocurrencies flies in the face of the intent of KiwiSaver. It risks putting investors’ retirement savings at peril if not managed with extreme governance around limiting exposure and access to advice.”

It’s crucial that anyone considering investing in Bitcoin seek financial advice in the first instance. Thorough research and a healthy dose of scepticism would also be advisable!   


Written by: Vanessa Glennie

Vanessa is Head of Communications at Lifetime Retirement Income. She’s an experienced investment writer, having spent more than a decade writing about financial markets in the global fund management industry.