By Bradley Zappala
If you’ve been keeping up with the news over the past year or so, chances are you’ve heard of Bitcoin. Yet while most have heard of the virtual currency, many still do not understand exactly what it is, or how it works. Although many investors have viewed Bitcoin as a way to turn a quick profit, recent developments have reminded the public that Bitcoin remains a highly volatile and speculative product, which is inappropriate for investors without an extremely high tolerance for risk.
This notion was reinforced by FINRA in a recent investor alert entitled “Bitcoin: More than a Bit Risky.” Among other things, the alert highlighted recent events that have brought to light some of the very real dangers of investing in Bitcoin. The most prominent of these events was the recent crash of Mt. Gox, once the world’s largest Bitcoin exchange. Though details have been sparse, it is estimated that Mt. Gox lost approximately $460 million worth of its customer’s Bitcoins due to what its CEO described as “weaknesses” in its system.
Although what happened at Mt. Gox has garnered a tremendous amount of attention due to the eye-popping losses, it is hardly the first time something like this has happened in the world of Bitcoin. As FINRA points out, there have been several other instances of hacking and fraudulent manipulations of Bitcoin platforms. Unfortunately for investors affected by the Mt. Gox fiasco, the lack of regulation and oversight of virtual currencies likely means that they will have little recourse in seeking restitution. Worse still, unlike deposits held in a US bank, Bitcoin deposits are not insured.
Outside of the inherent risk of relying on still imperfect software in a fledgling, online industry, FINRA’s Investor Alert also points toward external factors such as deceitful Bitcoin “brokers” and companies with questionable business practices, several of which have rushed onto the virtual currency scene in an attempt to capitalize off of media hysteria and bamboozle unwary investors. One such example FINRA provided was recent SEC charges against a Texas man who allegedly defrauded investors out of $4.5 million in a Ponzi scheme involving Bitcoin. Unfortunately for the duped investors, the man was able to take advantage of the general lack of understanding and knowledge of Bitcoin to perpetuate his fraudulent scheme, using solicitations on Bitcoin-related websites to falsely assure potential investors that investing in Bitcoin carried little to no risk and would return massive gains. As a matter of practice, it is important that anyone thinking about investing in any financial product realize that guarantees of little risk and massive gains are usually indicative of fraud, and certainly do not apply to virtual currency, which in its current state is a highly volatile and speculative investment at best.
Ultimately, potential investors should be extremely cautious of virtual currencies—at least for the foreseeable future. For purposes of illustration, someone who invested in Bitcoin at its peak of almost $1,200 per coin in December 2013 would be looking at a loss of over fifty percent of his investment today, just three months later. This rapid decline in the value of Bitcoin occurred despite several online articles in December that claimed the price of Bitcoin would exceed $10,000—or even $100,000—per coin. As of this writing, however, the price of Bitcoin has steadily declined since its December peak, and many Bitcoin investors who didn’t lose everything on Mt. Gox have nevertheless suffered substantial losses.
Despite the risk posed to investors, it must also be acknowledged that the concept of Bitcoin—and virtual currency as a whole—is spectacularly innovative and could one day develop into a reliable method of payment, allowing for easier and more efficient transactions for both businesses and consumers. One of the chief advantages of Bitcoin is that it is not tied to any specific country, and allows for people without bank accounts or government issued identification—a large portion of the developing world—to transact online or face-to-face with anyone who accepts Bitcoin, simply through the use of smartphones.
At the current time, however, the relatively young technology remains vulnerable to hackers and fraudsters, and we have yet to see whether platforms for buying, selling, and holding Bitcoin can be made secure. Furthermore, without regulations like those that currently apply to the trading of securities, the world of virtual currency will continue to function like the wild west. Fortunately for Bitcoin proponents, it appears that security fixes—some, at least—are in the works, and that some form of governmental regulation and oversight may be on its way in the US. Until then, it is likely that Bitcoin and other virtual currencies will remain highly volatile gambles, which should be considered as investment prospects only by investors who are willing and able to lose.