Is bitcoin the answer if traditional investments are letting you down …

Looking at the negligible returns offered on cash investments, Edward Cunningham started searching for alternatives. Instead of going to the stock market or buying up gold bars, however, the 45-year-old from Sherborne in Dorset turned to the internet, and last September invested in the digital currency bitcoin. Since then his stake has more than doubled.

Bitcoin is a paperless, bankless, stateless currency which exists on computers, and carries with it a whiff of peril for investors. Cunningham admits to being nervous when he first signed up to trade in the currency, especially when he had to make his first deposit via a bank in Estonia. “It all turned out well and I bought my first coins for $225 each, well below today’s price of around $575,” he says.

The price of bitcoin has fluctuated wildly since it was launched in 2009. Six years ago, two pizzas were bought for 10,000 bitcoin. By 2013, each bitcoin peaked in value at $1,000.

Coupled with these enormous peaks and troughs have been hacking controversies. Earlier this month almost 120,000 bitcoin, worth around $78m, were stolen from Hong Kong-based Bitfinex, one of the most popular cryptocurrency exchanges, causing a 20% drop in the value of the currency.

Investor Edward Cunningham is confident in his bitcoin  holdings
Investor Edward Cunningham is confident in his bitcoin holdings

Despite such drops Cunningham is ahead on his investment and feels positive about the currency, which is now being used for payment by companies such as Tesla and Microsoft, and is confident his investment will grow further. So, is it time for others to follow his cryptocurrency lead?

What exactly is bitcoin?

Started by a small group of hackers, bitcoin is unlike traditional currencies in that it has no central bank, nation state or regulatory authority backing it up.

The coins themselves are made by computers solving a set of complex maths problems, and people who use their computers to make coins and record transactions are called miners.

To spend it, users buy bitcoin and transact using exchanges such as San Francisco-based Coinbase. Rather than a central authority validating transactions, they are all recorded on a public ledger, called the blockchain.

Bitcoin has a finite supply of 21m of which more than 15m are in circulation, which supporters claim make it more stable than government-backed currencies that can be devalued by central banks printing money. They say this means its value will only rise over time, with some claiming the price could top $10,000 a coin. Bitcoin first came to the attention of many people after it was used on the online black market site Silk Road, known as a platform for selling illegal drugs.

“The coins are ‘manufactured’ using cryptography, which is spooky to most people. Bitcoin is also a reasonably anonymous way to carry out large cross-border money transfers, so has inevitably become linked to illegal goods and services,” says Dave Hrycyszyn, of digital agency Head, which advises companies on new technologies.

The lack of regulation appeals to some, but also means it has none of the stability mechanisms typically associated with a currency, which can make it volatile, he said.

How do I buy it?

Bitcoin is bought via online exchanges and platforms, with an increasing number of UK options. Fractions or “bits” can be bought instead of a whole bitcoin. Investment can start with as little as $10 on some sites. Bitcoin exchanges and brokers include Coinfloor, CoinCorner and QuickBitcoin. Transaction fees vary according to the exchange or broker, but typically range from 0.2%-1% of the currency bought, plus bank transaction charges. Fees of up to 1% can apply on sales.

Bitcoin are stored in a “digital wallet”, which can also manage transactions. It exists either in the cloud or on computers, and can be linked to bank accounts. If using an online wallet , investors must be sure they can trust the provider, because if hackers breach its server’s security measures the bitcoin could be stolen.

Typically, you can pay by bank transfer, mobile payments or with a Visa or Mastercard. There are also bitcoin ATMs, which allow for bitcoin to be exchanged for cash and vice versa, in London, Bristol, Brighton and Glasgow.

What can you buy with it?

A growing list of firms accept Bitcoin, including Tesla, Microsoft, CheapAir.com and Britain’s first bitcoin pub, The Pembury Tavern in Hackney, London, where a pint of Milton Pegasus costs £3.70 or 0.0084 bitcoin.

Obi Nwosu, managing director of Coinfloor, says you can spend it wherever you see the “bitcoin accepted here” sign, either online or at local stores, with no transaction charges. “You can pay using a bitcoin wallet app, and can even get bitcoin debit cards that you can use anywhere that accepts Mastercard or Visa.”

You can also cash in your coins at any time and get real currency in return, for a small broker fee, he adds.

Should I invest in it?

Bitcoin has grown strongly but with plenty of volatility along the way. Over the past 12 months its price has risen from $220 to $575, according to figures from Coindesk – a return of 161%. It has also shown resilience, with the price rallying after the Bitfinex hack. Yet it remains well below its all-time spike of $979.45, which it hit on 25 November 2013. In short, this is not a safe haven: despite excitable claims the price could hit $10,000, where it goes next is anybody’s guess, so investors should approach with caution.

Lex Deak, chief executive of alternative investment aggregator Off3r, says investing in Bitcoin isn’t for the fainthearted. “You should only invest a small proportion of your money and be prepared for massive swings in value.”

The early gold rush days are over, he adds, and buyers shouldn’t treat it as a get-rich-quick scheme. “You could double your money within a year, but you could easily lose it all,” he says.

Marc Warne, the founder of Bittylicious, a site where bitcoins can be bought, says novice investors should start modestly. “Just buy a small amount to begin with, say £30, to learn how it works, how to trade it, and how to handle it safely in a wallet,” he says. He advises against investing large sums unless you really understand crypto currencies and computer security.

As bitcoin has a finite supply, future price movement will depend on demand, Warne says. “Bitcoin will be used more in the future because it’s the first time that something not fully controlled by any entity like a government or bank has been used over the internet. It has been around for about seven years now without any fundamental issues.”

Is it safe?

Bitcoin cannot be hacked, manipulated or altered, but exchanges or digital wallets are vulnerable, just like online bank accounts, Warne says. “If you hold bitcoin in any form you instantly become a target,” he adds.

Since bitcoin doesn’t actually exist, what is stored in the wallet are the secure digital keys used to access specific details of the bitcoin. The private key is a secret code which allows the user to prove ownership of their bitcoin. Wallets can be installed on smartphones using an app or web-based wallets can be run by currency exchanges. Buyers need to make sure their computer’s security is up to scratch, and must also trust the exchange, which needs high-level security to prevent hacking.

James Hill, software developer at consultancy Scott Logic, says the core blockchain algorithm, which underpins all cryptocurrencies, remains secure. He says the real danger comes from losing the keys that prove buyers own their own coins.

If you are hacked, there is no way of claiming a refund from a bank or regulatory authority because none exists.

Word of warning

Hrycyszyn warns that, as with all technology, something better may one day come along. “When that happens, bitcoin’s value could collapse to near-zero, probably in a matter of hours or minutes, in a spectacular ball of flames. It has no support structure to prop it up, like a normal currency does. Do not treat this as a long-term store of value to fund your retirement.”

Damien Fahy, founder of website MoneytotheMasses, says it will remain a fringe investment until it is officially recognised and regulated. “Ordinary currency investing is risky enough, but bitcoin is even riskier.”

BUYING AND SELLING

Step 1 Set up a bitcoin wallet. You need somewhere to store the private keys that allow you to spend or exchange bitcoin. Security is vital, so check how your money is protected – otherwise you could lose all of it. Otherwise, this is similar to opening an ordinary bank account.

Step 2 Get your bitcoin address. Once you have signed up and accepted the user agreement you will get a bitcoin address, a unique identifier of 26-35 numbers and letters, beginning with the number 1 or 3, which is the destination for a bitcoin payment.

Step 3 Buy bitcoin. You can make your purchase through your wallet or a range of brokers and platforms. These are digital rather than physical coins. Input your bitcoin address, the amount of money you want to convert, how you plan to pay, and so on. You typically have to pay a fee of between 0.2% and 1%, depending on the site, plus a small bank transfer fee.

Step 4 Make a payment. Once you have bitcoin in your account you can start making payments. You will need the bitcoin address of the recipient.

Step 5 Sell bitcoin. If you want to cash in your bitcoin, or bank a profit, selling is pretty straightforward. You can register to sell direct on sites through an online exchange or platforms such as Coinbase, Coinfloor, BitBargain or Bittylicious. Again, there are transaction fees up to about 1% of your trade.

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