Revised: May 15, 2014
Originally Posted: March 11, 2014
As the Congress, and state and federal regulatory bodies, determine whether to or how best to oversee the virtual currency market, it would be wise for consumers to consider the risks of holding virtual currencies for investment or as a currency. Before buying, investing in or trading virtual currencies you should consider the following:
- Volatility. One of the major risks of holding virtual currencies is their volatility. Their value can rise or fall substantially over a short period of time. Bitcoin, the most well-known virtual currency in the market, traded for $13 in January 2013, $100 in July 2013, over $1,100 in December of 2013 and is now valued at $660 as of March 2013. Bitcoins, and others like it, are basically lines of computer code that are valued by the marketplace with no governmental support or oversight. Anyone holding virtual currencies should understand that they could lose a significant part of their investment as the market changes. Don’t invest more than you can afford to lose.
- No Deposit Guarantee. There are no deposit guarantees like FDIC insurance to protect customer funds held by virtual currency exchanges. Once the funds are gone, there is no way to retrieve them and no way to make the consumer whole.
- Lack of Protection for digital wallets. Some exchange companies that offer to store the consumer’s virtual currencies in virtual wallets have been unable to protect them. There are a number of instances where consumers have lost all their funds because their wallets have been hacked.
- Connection to criminal activity. Because virtual currencies provide some anonymity, criminal elements have found them useful for money laundering and other crimes. When exchanges are shut down as a result of either knowingly or unknowingly facilitating a crime, customers may have difficulty accessing their funds.
- Tax implications. On March 25, 2014, the Internal Revenue Service published Notice 2014-21. The notice provides that virtual currency is treated as property for U.S. federal tax purposes. General tax principles that apply to property transactions apply to transactions using virtual currency. Details, including a set of 16 questions and answers, can be accessed on the IRS website: www.irs.gov/uac/Newsroom/IRS-Virtual-Currency-Guidance
There are many institutional protections for the vast amount of financial services offered to consumers in the United States and many European countries. For the time being, the best advice when using virtual currencies is "Caveat Emptor" or Let the Buyer Beware.