Blog : A Bit Late On Bitcoin

by Ed Zwirn on May 10th, 2014

All I can ask is 'what took them so long?'

The contents of this week's Securities and Exchange Commission Bitcoin investor alert break no new ground when it comes to warning of the risks involved with using and investing in the virtual currency. Bitcoin's history of volatility, lack of SPIC or FDIC protection and security and fraud vulnerabilities prompting the closure of exchanges and/or the theft from Bitcoin  "wallets" by hackers have all received their share of notice in the financial press. What is different this time around is that warnings about these dangers now have an official stamp.

The SEC alert follows closely on the heels of a recent alert by the Financial Industry Regulatory Authority (FINRA), an independent not-for-profit tasked by Congress with watchdogging the securities industry. Also, recent IRS guidance declares that Bitcoins and other virtual currencies are to be treated as property for tax purposes, exposing some windfall Bitcoin gains to taxation. This treatment puts Bitcoins at a tax disadvantage relative to actual currencies issued by governments, which are free to go up or down in value with no tax consequences.

But it is Wednesday's SEC alert, as timely as it wasn't, that virtually eliminated any hope that the Bitcoin would get support, or at least not outright rejection, from regulators in any major world economy. The Chinese last year dashed many Bitcoin hopes when they move decisively to discourage use of the currency for payment and/or investment, the result being a sharp nosedive for Bitcoin quotes.

As is the case with many schemes that go sour when a market reversal exposes their weaknesses, Bitcoin setups tended to unravel after that, such as when an exchange in Japan called Mt. Gox went under, blaming hackers for the disappearance of hundreds of millions of dollars worth of the so-called currency.

It's not the first time that the SEC has issued alerts after much of the damage has been done, but the agency's warnings about the risks of virtual currencies are pretty far reaching all the same:

Some of these warnings have already appeared in this space: As I pointed out in a December penny stock blog, the Bitcoin has been a volatile instrument throughout all of its existence. As the SEC points out, the Bitcoin exchange rate has dropped more than 50% in a single day, and Bitcoin-related investments are obviously affected by this volatility.

In addition, the agency warns, there are particular reasons to believe that both the Bitcoin and its investors may be especially vulnerable to fraud.

"The exchange rate of U.S. dollars to bitcoins has fluctuated dramatically since the first bitcoins were created," the agency states. "As the exchange rate of Bitcoin is significantly higher today, many early adopters of Bitcoin may have experienced an unexpected increase in wealth, making them attractive targets for fraudsters as well as high-risk investment opportunities."

Bitcoin users may also be vulnerable in part because of their belief in the Bitcoin. "Fraudsters target any group they think they can convince to trust the," the agency warns. "Scam artists may take advantage of Bitcoin users' vested interest in the success of Bitcoin to lure these users into Bitcoin-related investment schemes," in many case either being, or pretending to be, Bitcoin users themselves.

Other warnings contained in the alert sound like they could have come straight from the Peter Leeds website:

-- "If the investment sound too good to be true, it probably is. Remember that investments providing higher returns typically involve more risk." 

-- "Fraudsters may try to create a false sense of urgency to get in on the investment. Take your time researching an investment opportunity before handing over your money."

-- "An unsolicited sales pitch may be part of a fraudulent investment scheme. Exercise extreme caution if you receive an unsolicited communication - meaning you didn't ask for it and don't know the sender - about an investment opportunity."

The upshot for investors: In addition to truisms like these, the Bitcoin investor alert contains absolutely no information or risk warnings that should be news to any reasonably informed investor. Regulatory agencies in general, and the SEC in particular, are great at closing barn doors after proverbial flocks have fled.

The true significance of the document is that it constitutes proof that the cows have already left the barn, making it a postscript to an interesting idea whose time has come and gone. It was not-too-long ago that Bitcoin critics were worried that regulatory acceptance would in some sense undermine its crypto-status, or something like that. Whatever may have been meant by this, this is clearly not among the top worries these days among the Bitcoin's remaining proponents.

Coming next week: What's Better Than Bitcoin? Why mega-investor Mohamed El-Erian says it's time to look past the Bitcoin to other, more consequential, developments in democratic (and disruptive) technical innovation.