In recent years cryptocurrency and bitcoin, in particular, have taken the world by storm. So it’s no surprise that we have been flooded with questions about bitcoin - what it is, whether we invest in it, and if we think it can help people on their journey to FIRE.
So in this article, I’m going to answer all those bitcoin-related questions, so you can decide if it’s something you want to invest in yourself.
What Is Bitcoin?
Bitcoin is the largest cryptocurrency and digital currency by market cap, and is used to make online purchases. People also invest heavily in bitcoin, hence its popularity. These transactions are done through a digital wallet with a private and public key and verified and recorded digitally. Bitcoin is not backed by any banks or government, so keep in mind that it is not legal tender.
New bitcoin is created through a complex process called bitcoin mining, where an incredible amount of computer processing is used to solve computational puzzles that create new blocks in the blockchain. If that sounds complicated to you, you’re not alone.
How Do People Get Bitcoin?
1. Be a Bitcoin Miner
These are the people that solve bitcoin algorithms to create more bitcoin. As payment, they earn a small fraction of the bitcoin they create. Bitcoin ‘miners’ have that title because they own literal warehouses full of computers that are put to the task of solving these algorithms. As you’ve probably guessed, mining bitcoin on an individual level is incredibly difficult to do.
2. Receive it as Payment
People who own bitcoin can pay you in bitcoin. It’s that simple!!
3. Buying it on a Platform That Sells Bitcoin
Platforms like eToro, Binance, and Coinbase sell bitcoin and allow users to trade it. If you want to invest, these are the places to do it.
How Does Bitcoin Get Its Value?
It’s not legal tender, so why is it so volatile? Well, it’s all about supply and demand. There are a limited number of bitcoins that will be circulated (21 millions is supposed to be ceiling). Over time as supply goes up and demand is low, the price will drop, and vice versa. People also trust bitcoin and its continuing success, which encourages them to continue investing in the hopes that its value keeps rising.
Pros and Cons of Bitcoin
● Bitcoin often has large swings in value, which is great for people that want those short-term wins.
● It’s relatively easy to buy and sell. Now that it’s in the mainstream there are more platforms to access it.
● There is a finite supply. Once 21 million bitcoins are mined, that’s supposed to be it. That scarcity is supposed to means demand will far outstrip supply.
● The supply and demand dichotomy. Bitcoin is the cool new thing, but what happens if a new type of cryptocurrency comes along and steals the spotlight? At the end of the day, you buy bitcoin based on speculative demand, as opposed to the financials of a company you might buy stock in. The only thing holding up its value is popular opinion - once the demand for bitcoin goes, so does its value.
● Bitcoin is very volatile. It’s very hard to time the market when it comes to bitcoin because past swings in value have been huge. In my opinion, it’s impossible. You have to get it right when you buy and when you sell. Otherwise, you risk taking significant losses.
● There is no price history. When you invest in the stock market you can see its historic returns, which gives you a better gauge of where the stock market is going. Because bitcoin is so new, both literally and technologically, we don’t have much (if any) historical perspective of where it might be going price-wise.
● Security risks and online hacking. Crypto advocates will probably tell you how secure the technology is due to its technology. But that’s not the issue - it’s the digital wallets people store their bitcoin in that can be vulnerable. These wallets are shockingly susceptible to online hacking, and billions of dollars worth of bitcoin have been stolen from these wallets. And when your wallet is hacked, there are no regulations or government initiatives that can help you.
Investing in Bitcoin For FIRE
What I really want to talk about is how bitcoin investing relates to financial independence and retiring early. Over the eight years that Amon and I aggressively pursued financial independence, at no point did we ever invest in bitcoin or any other type of cryptocurrency. So when people ask us (as they often do), whether we would consider investing in bitcoin? Our answer is always ‘No.’
Sure, some people have reaped huge rewards from their bitcoin investments, and that’s great! But there is too much potential for risk and monumental losses for our liking. We base our investment portfolio on the 4% rule. This means that our portfolio has to generate at least 4% per year (adjusted for inflation), which is enough to maintain our early retirement year after year.
Going out on a limb for potential 300% returns means we risk losing all of our money, and it just isn’t worth it. The way we’ve invested over the years has allowed us to net far more than just a 4% return, so there’s no reason to give that up. Since retiring in 2019 our stock market index fund has returned an average of -10%. We’re satisfied with those returns, meaning we don’t have to risk significant losses to chase higher ones. That’s about the extent of both of our feelings toward bitcoin, despite its popularity, and we have no intention of investing now or in the future.
If you do plan to invest in bitcoin, make sure you have a plan. What percentage of your portfolio will be allocated to it? Will it be a short-term or long-term investment? What are you buying and selling at? How will you rebuild your portfolio in case of potential losses? And how will you integrate bitcoin into your FIRE journey?
These are all things you have to ask yourself and plan for if you’re investing in bitcoin. Only you can make your own plans, but it is important to know where you’re going and what you’ll do if you want to take the dive into bitcoin and other cryptocurrencies. Hopefully, this overview has given you a clearer image of this digital currency, and a better idea of your own path to financial independence in the future.