Bitcoin: Virtual money or risky investment?

But that hasn't stopped some investors from jumping into bitcoins, hoping they'll be the next big thing, says Joel Redmond, a senior financial planner for KeyBank in Syracuse, N.Y.

"There's always going to be a group of people who want to speculate and that want to make money off of volatility, essentially," he says. "Anything that trades with the swings like the swings it's had, there's opportunity to make money there. But the problem is, you have to know what low is to be able to buy low."

Digital gold mined from Mt.Gox

Lack of any real fundamental value and relatively small market size make the price fluctuations of bitcoins extremely volatile and unpredictable, Redmond says.

"With those price movements, it's not difficult to get whipsawed," Redmond says.

For example, the closing price of bitcoins started the year at $13.28, rose as high as $230 in April and fell back down to around $136 in mid-September.

Some investors are attracted by the inherent supply limitations, looking to hold bitcoins as a store of value the same way they might use gold, Redmond says.

"They're only setting up a fixed supply of the coins, and that's a good thing," Redmond says. "I've seen people keeping it as a store and letting it appreciate -- almost like a collectible or like some kind of rare artifact or work of art -- rather than trying to trade it back and forth."

That strategy may make sense when you consider that liquidity can be an issue. Because bitcoins aren't traded on a centralized exchange, buyers and sellers must use private exchanges to buy and sell them via wire transfers, and those transfers usually take a while to transact. Bitcoin exchanges also have had a tendency to freeze up under heavy trading, as the world's largest bitcoin exchange, Mt.Gox, repeatedly has done.

"There's no centralized clearing floor. There's no centralized exchange, there's no central bank regulating it," Redmond says.

Investing in bitcoins may eventually get easier. Venture capitalists Cameron and Tyler Winklevoss, who famously contested Mark Zuckerburg's ownership of Facebook, this year filed papers with the Securities and Exchange Commission to start an exchange-traded fund for bitcoins. Should it be approved, the Winklevoss Bitcoin Trust would allow investors to buy and sell shares representing partial ownership of the trust's bitcoins in the same they would a stock.

Regulation of 'money transmitters'

New regulatory scrutiny is another potential wild card for bitcoin users and investors.

Earlier this year, the Financial Crime Enforcement Network, an agency of the U.S. Treasury, released guidance saying it considers any company that converts bitcoins into real currencies to be "money transmission services," meaning they're subject to stringent laws designed to prevent money laundering.

"Someone who uses a bitcoin for his own purposes, that person would not be regulated," says Kevin Levy, an attorney with the law firm Gunster. "But when you start to move money on behalf of a third party -- you take bitcoins and exchange them for some other currency -- now you become a money transmitter."

While the FinCen guidance is aimed at exchanges such as Coinbase and Mt.Gox rather than users, the availability and cost of those exchanges ultimately affects how easy and cost-effective it is to invest in bitcoins.

"The cost to operate a bitcoin platform or be an exchanger or administrator of bitcoin, that cost will go up and probably go up exponentially if you fall under this regulatory regime," says Andres A. Fernandez, a co-leader of the banking and financial services group at Gunster.

"When there's regulation put in place, people pause, and that usually has an effect," Levy says. "Any little issue causes huge fluctuations."


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