April 24, 2014
Virtual currency, electronic money, cryptocurrency: Whatever the name, it's in the news but not necessarily in a good way. When I start getting an increasing number of queries from industry participants and public customers about electronic currency, I realize that not only is the product beginning to gain wider acceptance but since folks only tend to contact a lawyer when there is trouble, I recognize that as with most new financial products, this one is not without its accompanying scams and frauds.
Although the courts have famously held that you may know pornography when you see, I'm not quite sure that you may ever truly know virtual currency - and it's doubtful that you will ever be able to even "see" it. It's there but not in touchy-feely fashion. One thing for certain, you can't bite down on it or hold it up to a light or rub your fingers on it. Another thing, and perhaps even more troubling, it's not legal tender issued by or backed by any sovereign, government, or recognized financial institution. Some may say that's the whole point - that's why we buy and sell with Bitcoin or the like. It's more private. More confidential. We don't need Big Brother sticking his nose into our business.
The early adapters of new financial products heard much of the same criticism before when they were among the first to accept credit card payment or PayPal or the like. It's not that virtual currency is intrinsically bad, these trailblazers will tell you, it's simply something new and different that you don't quite understand. Give it time. You'll see. Maybe . . . but that doesn't counter the fact that much of what drives the proliferation of virtual currency is a desire to skirt the law, to avoid paying taxes, to launder dirty money. On top of that, I keep hearing stories about failed transactions, stolen funds, and fraud. In fairness, the purportedly legitimate financial institutions have skirted the law, avoided paying taxes and laundered quite a bit of dirty money; and, moreover, brokerage firms and banks have had more than a brief history of account fraud.
Virtual currencies are volatile, in large part for many of the reasons that prompted their creation and promoted their use: the lack of backing by government or central banks. In and of itself, as attested to by the VIX, volatility isn't necessarily a bad thing and may be securitized or hedged; however, when you're contemplating a transaction that is to be paid in a predetermined rate of virtual currency units or you are buying a security that may be pegged in its offering price to a virtual currency, the issue of the volatility of the underlying virtual currency presents even greater challenges.
Then there are the mounting concerns about the security of the electronic "wallets" where virtual currency is stored or the very exchanges on which virtual currency is traded (see Mt. Gox for a current example). True, it may be comparing apples and oranges when we talks about bank and brokerage accounts as the repositories for funds versus the virtual wallets used to hold Bitcoins and the like. On the other hand, some of the distinctions are worth consider: most bank and brokerage accounts are covered by some form of depositor insurance and offer you a limited but still potential ability to stop a payment or reverse a transaction. Good luck with gaining the same considerations with an electronic wallet filled with virtual currency.
On April 23, 2013, North American Securities Administrators Association and the Emerging Payments Task Force of the Conference of State Bank Supervisors released the Model State Consumer and Investor Guidance on Virtual Currency. The Guidance offers consumers some due diligence considerations prior to undertaking an investment in so-called virtual currencies. The BrokeAndBroker Blog highly recommends that folks interested in transacting in virtual currencies read the document. If nothing else, it is a superb point of departure and a practical starting point for due diligence.