Every honest bitcoin proponent will tell potential investors that bitcoin is high risk and not to invest life changing amounts of money. But what are those risks?
Regulatory
The biggest risk is regulatory risk. Bitcoin makes value transfers more efficient. It makes transfers go directly between two people instead of involving a payment processor. For example when one swipes Visa to pay for gas or to buy an airline ticket, Visa facilitates the transaction. They take on the risk of fraud and also incur expenses to process the transaction, provide customer support, etc. Bitcoin transactions are similar to cash transactions in that the sender gives and the seller receives no third parties.
This means if bitcoin is successful there are many companies like Visa, Mastercard, Western Union, Moneygram, etc. who have a lot to lose if bitcoin is successful. The other big loser is regulators who today have many rules in place to prevent money laundering and to protect consumers. These rules are enforced through banks and payment processors. In pure bitcoin transactions there are no companies to regulate.
Related: Bitcoin Industry Growing Pains Create Risk For Investors
That means both regulators and big companies are potentially interested in having regulations that attempt to kill bitcoin or reduce it’s use. Napster was a person to person music sharing service released in 1999. It threatened record labels profits because people could now get songs more conveniently and at a lower cost. The record labels sued Napster and even individual file sharers. The labels were successful in bankrupting the investor-financed company, but they were unsuccessful in stopping the filesharing technology. Banks and regulators will discover the same thing. Digital cash cannot be regulated out of existence. It is too useful. It can only be pushed underground and prevented from benefiting law abiding citizens. However this creates massive risk for investors. Just like with Napster, if bitcoin is put under onerous regulations like those proposed in New York, bitcoin investors will take heavy losses.
Better Technology
In the technology space things move fast. There are already hundreds of bitcoin competitors. Bitcoin does have a huge lead right now and that lead is growing by the day. All the venture capital money, brand recognition, and entrepreneurs have given bitcoin what seems to be an insurmountable edge.
However think about AOL, Netscape, Blackberry, MySpace - all these companies dominated their space and then quickly ceded their dominance. The same risk exists for bitcoin. If a much better digital currency was created and bitcoin couldn’t compete there is the possibility that newcomer could overtake bitcoin’s lead.
Technical Risk
There also exists the possibility that for technical reasons bitcoin doesn’t work. Possibly a bug in the code that can’t be fixed or that bitcoin can’t work at Visa or Mastercard scale.
This risk seems the most unlikely bitcoin’s source code is available for anyone on the planet to examine. Researchers, hackers, and security experts have been searching for security flaws since 2009. The odds that all these people have missed a fatal flaw are small and are becoming smaller every day.
The challenge for bitcoin developers is to ensure bitcoin scales at global usage. They need to make sure the system stays secure while being able to process trillions of transactions per year.
Design Risk
The last risk is that bitcoin’s incentives need to be designed correctly. Currently the system works by having volunteers process transactions. These volunteers are called miners and they financial compensation for their effort. If the incentives for the miners aren’t designed correctly and for some reason in the future that can’t be changed then the bitcoin system could collapse.
Related: Why Bitcoin's Growth Should Explode
Bitcoin is just starting to become useful. Infrastructure like payment processors and exchanges needed to be built. With those in place, huge merchants are beginning to accept bitcoin, remittances are being tested, and bitcoin is starting to go mainstream. Bitcoin might be the best investment opportunity of our generation or if these risks are realized bitcoin may be just a memory a few years from now.
Disclosure: At the time of this writing, David Smith has a long bitcoin position and owns So What’s Bitcoin?
© 2024 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.
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