3 Things Investors Need to Know About Bitcoin

Markets Motley Fool

If you're reading this article, you probably already know that bitcoin has been on fire lately. The price of the world's largest and most popular cryptocurrency has skyrocketed 162% in 2017.

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Once a buzzword that was understood by few and used by even fewer, bitcoin has come to dominate this year's financial media headlines. In addition to attracting more of our collective attention, bitcoin is also beginning to create actual business value.

Several of the world's largest companies are already deploying bitcoin or other blockchains as a way to improve internal transparency and efficiency. But what are we to do as investors?

There are surprisingly few choices today for those eager to gain exposure to this fledgling technology that many believe could change the world. You can buy bitcoin directly on a variety of new exchanges, like Coinbase or Bitstamp, but many of these charge elevated transaction fees. You can buy into the publicly traded Bitcoin Investment Trust (NASDAQOTH: GBTC), but as my Foolish colleagues Matt Frankel and Jordan Wathen recently pointed out, this comes with its share of risks, as well.

However, the options available to investors are expanding quickly. As bitcoin and blockchains continue to steamroll forward in popularity and utility, here are two ideas and one warning that I believe Foolish investors should know about and prepare for before buying bitcoin. 

Idea No. 1: It's not just all about bitcoin

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The anonymous Satoshi Nakamoto introduced bitcoin in 2008 as the world's first digital-ledger technology. That digital ledger is now commonly referred to as a "blockchain," where all transactions are recorded and are transparently available for everyone else on the network to see. And because peers on the network were the ones verifying the transactions rather than centralized clearinghouses, blockchains could bypass the costs related to traditional middlemen required for bank withdrawals or credit card networks.

The novelty of bitcoin's design attracted a ton of imitators, who modified its original codebase to create new blockchains with slightly different properties. Without the middlemen administering the transactions, blockchains run off of consensus properties, which are the set of algorithmic rules that govern how the network will behave, and how transactions get fulfilled.

There are now more than 870 publicly available cryptocurrencies, which altogether are worth around $111 billion. Even though cryptocurrencies have been around for less than a decade, they already collectively command a greater market capitalization than Mastercard (NYSE: MA). The growth rate of the industry has been truly exponential.

At this point, Ethereum appears to be bitcoin's most formidable competitor. Ethereum enables the development of Smart Contracts, which automatically execute legally binding contracts between parties from anywhere on the globe. Though demand for Ethereum is surging, supply remains constrained -- which manifests in its significantly rising price. Ethereum's price is up 40-fold during just the past 150 days.

There are many cryptocurrencies now available. But it will be the creation of business utility that will ultimately decide which of them remain relevant and sustainable. 

Idea No. 2: Find companies actually using blockchains

Utility means different things to different people. But to make things more down-to-earth and understandable, here are a few real-world use cases of how blockchains are already being used.

  • In the global shipping industry, each shipment of goods involves transactions between an average of 30 unique organizations. There are a significant number of agreements, currency fluctuations, and regulations at play, which cause 20% of the goods shipped around the world today to suffer some form of delay. Maersk is using blockchains to optimize logistics planning -- replacing the signing of manual paperwork with Smart Contracts -- which they believe will save them millions of dollars of efficiency in their supply chain. 
  • In financial services, more than $11 trillion of credit derivatives are traded among 2,500 trade firms in 70 different countries (read that last sentence again, just to let those numbers sink in). DTCC is implementing blockchains for transparency into credit default swaps, which could help investors better understand what financial assets are worth and their risk profiles. Blockchains allow collaboration and streamlined automation between parties, eliminating the need for redundancies between proprietary ledgers.
  • In the energy industry, ConsenSys is building a consumer energy platform based upon blockchains. Customers can sell the power they generate from solar panels back to the grid and get paid in Ethereum, based on current rates. Fifty percent of electricity providers' costs are related to billing, administrative, and marketing expenses -- and a collaborative platform would eliminate many of these costs and more efficiently match supply and demand within communities.

There are $600 million of transactions done every day using bitcoin. Developers are frantically deploying and improving blockchain networks, which will save billions of dollars for enterprises with large supply chains, like Starbucks, or for companies that need a collaborative network to do business with multiple counterparties, like Bank of America

The warning: Beware speculation

Even with companies deploying blockchains to drive tangible enterprise value, there's still a significant amount of speculation built into the price of cryptocurrencies right now. There's a huge amount of uncertainty surrounding how blockchains can and/or will be used in the future, and what that will be worth for consumers and businesses.

These huge uncertainties lead to a wide range of outcomes in fundamental analysis, which is meant to define the intrinsic value of what cryptocurrencies are actually worth. Without that publicly agreed upon fundamental analysis -- similar to discounted cash flows for equity analysis -- the price of cryptocurrencies will boil down to market speculation.

As an example, a recent CoinDesk study showed that Ethereum's price was highly correlated simply to its Google search interest. Largely to see what the process was like from a user's perspective, I recently bought a single Ethereum. Before my funds had even cleared the bank, its price had risen 40%. Amazing.

Of course, the Dutch Tulipmania story teaches us that asset prices can't rise forever. Many experts believe the token economy is entering "bubble" territory, where many of the publicly traded cryptocurrencies will ultimately collapse and be worth absolutely nothing. It's already being compared to the 2000 dot-com correction, so investors should proceed with extreme caution. 

The Foolish Bottom Line 

Bitcoin appears to be at an impasse. Bulls argue that blockchains will unlock enormous future value for businesses and that their fixed supply will replace gold as an inflation-proof store of value. Bears argue that speculators have driven the pricing up to unsustainable levels and that a necessary correction is soon to come. While we can't offer personalized advice, we can certainly stress the importance of know thyself.

The safest way to invest in the rapidly changing payments space is in large enterprises that can save billions in efficiency and share those savings with shareholders. Think of large organizations that could benefit from reducing transaction, inventory, or processing costs.

For those comfortable with a bit more risk, I expect we will see a few natural winners emerge in the coming years. The world doesn't need 870 digital currencies, but it could certainly use four or five. Similar to how the flood of early worldwide web browsers eventually settled down to Netscape and AOL, we'll likely see a few public blockchains rise as the winners-take-all of digital ledger technology.

We also believe there are four companies that are extremely well positioned to benefit from the developing future of digital payments.

Motley Fool Explorer is taking a deep dive into "Bitcoin and the Future of Payments" this month. We're offering the following materials to our members who are interested in learning more about bitcoin:

  • Our complete notes from the Consensus 2017 Conference. Consensus is the world's foremost gathering of blockchain developers and business leaders. Its $2,800 registration fee may be a steep price tag for most, but we're sharing a recap and our key takeaways with our members for free! Our report describes -- in understandable terms -- how blockchains work, where they are disrupting industries, and the important upcoming role of regulations. 
  • Our interview with BanQu CEO Ashish Gadnis. Mr. Gadnis is an expert in the space and is personally deploying blockchains across the world. In our interview, he describes blockchains as "more innovative than anything I've seen in the last 30 years," and explains the impact they will have on the credit card networks of Mastercard and Visa (NYSE: V). (Sneak peek: Their existing competitive advantages aren't as strong as many investors think!)
  • Our in-depth research reports on the four companies we believe are best positioned to capitalize on innovation in the digital-payments industry. We have enlisted analysts and advisors from our Supernova real-money portfolios to write these thorough reports, and we'll be investing $20,000 of The Motley Fool's own money into the one company we believe is the best opportunity of the four for investors today.

You'll also gain access to each of our previous Explorations, where we cover even more of the world's most innovative developments -- such as self-driving cars, personalized healthcare, and the "Next Big Thing" out of Silicon Valley.

Click below to receive each of the above-mentioned reports and to start your free 30-day trial of Motley Fool Explorer!

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Simon Erickson owns shares of Mastercard. The Motley Fool owns shares of and recommends Mastercard and Visa. The Motley Fool has a disclosure policy.