By Benjamin Stubbs, Spring 2014 Student Intern
You may have heard of digital, virtual or cryptocurrencies before. If you haven’t, check out former Student Intern James Gallagher’s post on Bitcoin from last November. You may also remember that back in March, we told you that FINRA released an alert about the risks and potential scams involved with Bitcoin and other digital currencies.
Digital currencies have been in the news a lot lately, and not all of the news has been positive. Digital currency is eighth on NASAA’s list of most common investment frauds of 2013, and is listed as one of the newer threats that individual investors face.
What is digital currency?
In April, the Conference of State Bank Supervisors (CSBS) and NASAA issued some guidance on virtual currency. In CSBS’s and NASAA’s words, “Virtual currency is an electronic medium of exchange that does not have all the attributes of real currencies.” Digital currencies are not backed by a bank or government but can be exchanged with other virtual or real currencies. According to Forbes, some major retailers are beginning to accept them in place of real currencies.
What are the dangers of digital currency?
CSBS and NASAA list several things investors should consider before dealing with digital currencies. First, digital currencies “are highly volatile with the potential for complete loss of value.” You may buy a digital currency for $100 per unit, and their value may drop tomorrow to $50 per unit. Given this volatility, “securities offerings tied to these currencies [are] unsuitable for most investors.”
Second, because digital currencies are held in online wallets, there is potential that hackers can steal your virtual money. This is problematic because digital currencies are not insured and digital currency transactions cannot be reversed without the consent of the recipient.
Third, companies dealing in digital currencies might not be regulated. You may remember from my post on private offerings that there are additional dangers of dealing with unregulated investments. In the same way dealing with unregulated virtual currency transactions poses additional dangers as well.
One last thing that CSBS and NASAA mention that isn’t exactly a danger is that the IRS treats virtual currency as property, so buying and selling digital currency may create tax liability. See the IRS notice for more explanation.
What can you do to protect yourself?
As NASAA explains in its list, the highly technical and complicated way that digital currencies are “mined” and the lack of regulation “has provided fertile ground for scam artists to capitalize on the increasing popularity and acceptance of digital currencies.” There are ways to protect yourself.
First, be aware of the risks. Digital currencies are risky because of their volatility. If high risk isn’t right for you investment goals, digital currencies probably aren’t either.
Second, as we say often on our blog, ask and check. Ask the person who is trying to sell you a digital currency whether he or she is properly licensed and run a BrokerCheck on him or her. If the person is not licensed, don’t trade with that person.
Third, with digital currencies it is equally important to make sure that the platform or exchange through which you will purchase the currency is authorized and legitimate. To do this, CSBS and NASAA recommend visiting their site, and information on Georgia money transmitters can be found here.
Technology brings many wonderful and helpful things to our lives. Digital currencies may prove to be one, but for your investing safety, don’t rush in. Be aware of the risks involved from volatility to hackers and verify that the people with whom you are dealing are licensed and their companies run honestly. If you think you have already fallen prey to a digital currency scam, contact our Clinic. And remember to check back next week for a new tip to help you protect your future.