Bitcoin investors should be cautious, even if it is heading mainstream

OVER the past two decades, there have been attempts to create encrypted alternative currencies. None has captivated investors as much as Bitcoin, which was first "mined" in 2009.

In its early years, the idea of a digital currency not linked to fiat currency and independent of a government or central bank was intriguing, particularly on the heels of the 2008 financial crisis when confidence in banks tumbled precipitously. In the eight years since Bitcoin began its tentative debut, it has made some inroads as a medium of exchange. Debate about Bitcoin has typically swirled around the question of whether it is a currency or a commodity or both. This year, its astonishing price rise and the launch of Bitcoin futures contracts by Cboe Global Markets - the CME Group launches its version next week - would seem to make it more of a commodity. Bitcoin's price has exploded from less than US$1,000 in January to over US$16,700, based on Coindesk's Bitcoin price index. Its market capitalisation now exceeds US$280 billion. To be sure, other cryptocurrencies have seen even more dramatic spikes, sparking warnings of a bubble. Ethereum and Litecoin, the second and fifth largest cryptocurrencies respectively as at Wednesday, have both soared by some 6,000 per cent this year. Litecoin creator Charlie Lee has himself sounded caution. Buying Litecoin, he tweeted, was "extremely risky", and he expected a multi-year bear market. Paradoxically, digital currency investors are reportedly "diversifying" their Bitcoin holdings into other tokens such as Litecoin, a shift which hardly constitutes diversification.

Warnings aside, a number of developments are helping to usher cryptocurrencies closer to mainstream. The ability to trade Bitcoin futures, for instance, will enable more widespread participation; traders will be able to take long or short positions without actually owning the asset. Fund managers are also jumping into the fray. A number of cryptocurrency funds have been launched, and some are seeking approval to be exchange-traded. The US Securities and Exchange Commission has been understandably cautious. For funds that aim to hold Bitcoin directly, the unregulated nature of Bitcoin exchanges is a concern. But now that derivative instruments are available, it is likely a matter of time that a synthetic cryptocurrency exchange-traded fund is launched. This may well open the floodgates for yet more money, particularly from retail investors.