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How to Invest in Bitcoin and Digital Currency

Matt Whittaker

In the years since the Great Recession, you've probably heard about the electronic payment system and so-called cryptocurrency called bitcoin.

But you're perhaps less likely to have heard of the underlying technology that powers it. It's called blockchain.

Blockchain technology is a digital ledger distributed across a network of computers that keeps track of transactions. But beyond payments, it can be used for a wide variety of applications such as contracts, documents and basic record keeping.

"Wall Street is going to eventually move into this in a big way," says Alan Friedland, founder of Compcoin, a blockchain-based public currency trading platform. "In the meantime, it's a great opportunity to get into early."

[See: 9 Under-the-Radar Ways to Buy Financial Stocks.]

Just like the internet democratized the dissemination of information, blockchain technology democratizes the securitization of information, says Chris Burniske, head of blockchain products with Ark Investment Management.

"It's probably the most impactful general purpose technology that's been invented in the 21st century," he says.

While bitcoin decentralizes payments, another major blockchain technology called Ethereum enables decentralized applications. Another, Storj, is involved in decentralized computer storage. Each issues its own value token or coin -- bitcoin issues bitcoins, Ethereum issues ether, and Storj issues Storjcoin X -- that can be bought and traded. There are now many different digital currencies.

Blockchain assets have a very low correlation to other assets, and so they can be used to diversify portolios, Burniske says. Some use them as a risk hedge similar to how they use gold, he says.

Stan Miroshnik, managing director with the Argon Group, an investment bank focusing on the blockchain sector, adds that bitcoin is uncorrelated to bonds, gold, real estate, commodities and emerging market currencies. It only has a very small correlation to U.S. equities, he says.

Blockchain is "an important enough technology that people should try to invest a little bit," Miroshnik says.

There are different schools of thought about the best way to invest in this nascent, but growing, industry.

On the one hand, you can stockpile tokens, such as bitcoin or another digital currency, and hope the demand for them will increase, their value will rise and you can sell them later at a profit. Or, you can invest in the companies that are creating different blockchain-based products.

Morningstar analyst Jim Sinegal falls into the latter camp, saying investors should focus on companies that stand to make money if they find useful applications for blockchain technology.

He suggests investors go after the companies because the coins don't generate any cash flow. So the only way you'll make money off it is if a token's price goes up and you can then sell it, Sinegal says.

However, because the industry is so new, it can be tough to invest in companies with exposure to blockchain technology, Sinegal says. He compares it to the early stages of internet stocks in the 1990s. A few were successful, but investors lost money on others.

"It's very tough to make a direct investment," he says.

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Still, Sinegal says companies such as Goldman Sachs Group (ticker: NYSE: GS) and CME Group ( CME) eventually stand to significantly benefit from the lower costs blockchain technology makes possible.

While more than 70 of the world's largest financial institutions have joined a blockchain-development consortium, and large technology firms like International Business Machines Corp. ( IBM) and Microsoft Corp. ( MSFT) have blockchain solutions, Miroshnik says it remains difficult to get true exposure to the technology through public companies.

The blockchain penny stock universe includes BTCS, Global Arena Holding, HashingSpace Corp. and First Bitcoin Capital Corp.

But penny stock companies are very young and may not be the best investment now as their business models are evolving, Miroshnik says.

Miroshnik says investing in coins is the way to go because blockchain assets appreciate for two reasons.

First, there is a real cost to producing each transactional ledger of the blockchain. It takes computer equipment and energy. These so-called miners compete to produce the next block in the chain and are rewarded with coins. This cost of production keeps going up over time, creating a fundamental driver of higher value, Miroshnik says.

Additionally, there is transactional value created as demand rises for a blockchain coin, Miroshnik says.

For investors wanting to buy into this emerging asset class, they can go to places such as Coinbase, Bitstamp or Kraken, Burniske says. It's similar to a foreign exchange trade, where investors exchange the value of one asset with another based on exchange rates, he says.

His company runs two exchange-traded funds -- the Web x.0 ETF ( ARKW) and Ark Innovation ETF ( ARKK) -- that each have exposure to bitcoin though Bitcoin Investment Trust ( GBTC), he says.

Uninitiated consumers should stick with bitcoin or ether to get comfortable with the language of this emerging capital market, Miroshnik says. For other coins, investing means doing research into what project they are supporting and what value the investor thinks it represents, he says.

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"That process is very similar to how you would think about investing in small-cap stocks," he says.

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