Bitcoin works like any other currency, but it is not controlled or backed by any government—it relies completely on the value its users place upon it. The currency is generated using computer processors and traded as electronic money for goods and services online.
While the price of Bitcoin seems astronomical and hard to access, bitcoins are often exchanged for transactions in fractions of a coin.
Bitcoins can also be exchanged for another currency. Many Bitcoin investors exchange their bitcoins for local currencies, creating interest in the bitcoin exchange rate. Trading bitcoins for local currency happens on websites called "exchanges," such as Bitstamp and Bitfinex.
The currency has been popular for several years with speculators and personal investors, but confusion remains as to how to invest in and use Bitcoin, as well as what it means for young investors.
While headlines were quickly made when Bitcoin hit over $10,000 on Tuesday, and $11,000 by Wednesday morning, the cryptocurrency also fell a low of $9,021.85 by Wednesday midday.
As of Thursday afternoon, the currency was trading for $9,627 on the Bitstamp exchange.
The value of Bitcoin can plummet just as easily as soar, making it a very difficult investment.
USC Marshall professor of finance and business economics Lawrence Harris noted that Bitcoin shares many characteristics with technology stocks.
"You look at the technology today, we're having something of a mini crash," Harris said. "People who are extraordinarily excited about new technologies are suddenly realizing they're vastly overvalued or potentially so."
Harris pointed out the legal challenges for Bitcoin. Specifically in the United States, Bitcoin could potentially run afoul of money laundering laws.
“The advent of Bitcoin allows people to circumvent those rules easily,” Harris said. “As these rules are designed to ensure tax compliance, and to make it difficult for people to profit from illegal activities, it seems highly unlikely that governments will continue to allow cryptocurrencies to be largely unregulated.”
Already in China, cryptocurrencies are under scrutiny. The People's Bank of China recently cracked down on initial coin offerings (ICOs), a chance to buy cryptocurrency units early, used by startup cryptocurrencies to draw initial investors. The bank claimed many of these ICOs conducted in China were fraudulent. In September, China told local Bitcoin exchange websites to halt trading.
But in the United States, as Bitcoin gains more notoriety, the likelihood that the government will soon set rules and regulations is rising. Already, the Security and Exchange Commission has begun to look into ICOs.
As a currency used internationally with no government backing, exchanging bitcoins for local currencies, such as U.S. dollars, requires local exchanges. But these local exchanges have no backing. In the U.S., deposits with banks are insured by the Federal Deposit Insurance Corporation; no such body exists for cryptocurrencies.
In 2014, a Japanese-based Bitcoin exchange, Mt. Gox, suspended withdrawals and trading for its 24,000 users. In the following months, the company had lost over 850,000 bitcoins.
While the lost bitcoins from Mt. Gox were recently discovered, customers remain unable to claim them. The exchange and its founder remain bound up in legal battles over bankruptcy and embezzlement charges. Japanese bankruptcy laws hold that any funds remaining with a bankrupt company are returned to shareholders—which could mean that customers may never get their coins back.
Ultimately, Bitcoin is being talked about this week as being an investment, a chance to earn money by buying low and selling high.
Individuals looking to buy bitcoins should ask themselves whether they're looking to use bitcoins as an investment or whether they're interested in using bitcoins to access goods and services that take the currency.
Holding $20 in bitcoin for personal use versus attempting to invest hundreds of dollars in the cryptocurrency in hopes the price rises are two very different prospects. Security issues, government regulations and volatility become much more pressing concerns if one is buying bitcoin for the latter.