BITCOIN: Your Opportunities, Risks and Dangers

Francisco A. Laguna & Wojciech Kornacki 

This second part of our series focuses on the risks and opportunities associated with BITCOIN, the new virtual currency.  As Bill Maher, pointed out, if you have virtual currency, it may virtually disappear.  On the other hand, it is also possible to virtually find it, and, indeed, in March 2014, Mt. Gox, a virtual currency exchange, lost 850,000 bitcoins and 200,000 bitcoins, previously thought stolen, were found in a virtual wallet that was thought to be empty.

BITCOIN Risks

Not insured – There is nothing backing the current value of the bitcoins in your virtual wallet.  Unlike most national currencies which are backed by National Banks, bitcoin is not backed by entity or institution.  In the United States, the Federal Deposit Insurance Corporation (“FDIC”) covers all bank deposits, including checking and saving accounts, money market deposit accounts and certificates of deposit up to a certain amount.  Thus, the FDIC insures almost everything except for investments.  The standard amount is $250,000 per depositor per insured bank per category.  The FDIC was created in 1933 in response to thousands of bank failures during the Great Depression where millions of Americans lost their savings.  The value of bitcoins can virtually disappear overnight, and there is no recourse, as in 1920s.  It is possible that at some point in the future, the FDIC may begin insuring virtual currency as well, but right now, this is a substantial risk.

While Bitcoin is virtual currency, it also exists on paper and in coins.  Here, we have an example of a bitcoin paper bill.  Its private key is hidden beneath tamper resistant paper.  It is possible that in the future many national currencies will look the same.  Courtesy of http://www.wikipedia.com

While Bitcoin is virtual currency, it also exists on paper and in coins. Here, we have an example of a bitcoin paper bill. Its private key is hidden beneath tamper resistant paper. It is possible that in the future many national currencies will look the same. Courtesy of http://www.wikipedia.com

Unpredictable Value – The first widely reported value of 1 bitcoin was $.075 in April 2011.  Only 2 months later, the value sky-rocketed to $30 per bitcoin, an increase on investment of about 40 times.  By November 2011, the value plunged to $2, only to climb back to $5 in early 2012.  In 2012, the value increased only to drop again.  In 2013, the value of bitcoin started at $13.50, went up to $266, and then again crashed to $50.  While the overall U.S. Dollar value of bitcoins seems to be increasing, it is very unpredictable at this point.  You may be a millionaire and an average person in the same month, depending on the value of bitcoins in your virtual wallet.  Thus, many financial advisors recommend investing in gold instead of bitcoins.

Virtual Currency attracts Crime –   Several months ago, someone stole almost half a billion US Dollars-worth of bitcoin virtual currency from the exchange managed by Mt. Gox.  Currently, no one knows who did it.  Mt. Gox blamed it on unknown hackers.  In addition, the Federal Bureau of Investigation has opened an investigation against some bitcoins users for alleged money laundering.  The FBI and IRS – Criminal Investigations seized 144,336 bitcoins, which amounts to approximately $28 million.  Until the technology improves and the bitcoin market becomes more transparent, these are some additional risk involving any virtual currency.

National Boundaries – Some countries recognize bitcoin as legal, and others consider it illegal.  Thus, it is possible that your virtual wallet may not be accepted everywhere around the world.  For example, the United States and many European nations (Germany, Poland, Finland) consider it legitimate, or at least not illegal.  The U.S. IRS has already developed tax guidance on it.  In contrast, the People’s Republic of China considers bitcoin illegal and has ordered third-party payment providers to stop using them.  Needless to say, the value of bitcoins dropped dramatically within days.  Similarly, Iceland has declared bitcoins illegal, primarily because of its currently restrictive financial regulations passed in response to the country’s financial meltdown several years ago.

Efficient bitcoin mining is critical to be profitable.  There are many bitcoin mining machines on the market.  Here, we have an example of Butterfly Labs ASIC-based mining machine.   Courtesy of http://www.wikipedia.com

Efficient bitcoin mining is critical to be profitable. There are many bitcoin mining machines on the market. Here, we have an example of Butterfly Labs ASIC-based mining machine. Courtesy of http://www.wikipedia.com

Excessive Regulation – Currently, governments around the world are developing policies and guidance regarding virtual currencies.  Last week, we discussed how the IRS and the Department of the Treasury are considering treating any income from trading bitcoins as taxable income.  Recently, the North American Securities Administrators Association warned to avoid virtual currency because it is not regulated.  Thus, once regulated, the use of bitcoin may be affected by the amount of regulation involved in its use.  Currently, however, there is a wide belief that virtual currencies are under regulated and not transparent.

BITCOIN Opportunities

Cheaper costs of sending money – Many international money transmitters charge 10% or more to send money from one country to another.  Thus, if you want to wire-transfer $500 to someone overseas, you are likely to pay a $50 fee.  With virtual currency, this is about to change.  In Kenya, for example, BitPesa only charges 3 % for same day overseas transfers, using bitcoin.  While bitcoin does not completely cut out the “middle-man”, in many transactions, it dramatically reduces the cost of sending money.  After all, the concept behind virtual currency is that it is a person-to-person transaction.

Virtual spending – Bitcoin allows users to shop with their phone without the need of real currency, plastic cards or checks.  It offers a convenient, quick way to conduct every-day transactions, and many businesses begin to accept bitcoin in addition to credit cards.

Source of Income – Bitcoin offers a source of steady income for its users, either through bitcoin mining or trading.  CNBC explains how Bitcoin mining is profitable.  Last week, we discussed that bitcoin relies on users to record public transactions.  Thus, the individuals engaging in bitcoin transaction recording earn bitcoins for their work. Bitcoin value is subject to tremendous fluctuation, which may be very profitable for some individuals.  Considering that the value of bitcoins may double, triple or quadruple in a matter of days, it may be worth it.  Apparently, Bloomberg agreed to list bitcoin prices with its financial data.

Next week, we will discuss future opportunities for bitcoin and how virtual currencies are expected to affect our everyday lives.

Call TransLegal to discuss bitcoin transactions.

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One thought on “BITCOIN: Your Opportunities, Risks and Dangers

  1. Pingback: BITCOIN: Future Developments Look Profitable | TransLegal

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