The Many Risks of Using Bitcoin

We’ve talked about Bitcoin as currency. We’ve talked about Bitcoin as an investment. We’ve talked about making money from Bitcoin, and about making Bitcoins.

So you’re probably all hopped up and ready to dive head-first into this Bitcoin thing. It’s all good, right?

Well, at the risk of sounding a bit like a broken record (does anybody remember what a broken record sounds like?), I must stress that Bitcoin isn’t all good. In fact, it’s risky. Very risky. Probably too risky for most normal folks to deal with.

Before you spend your life savings on a few dozen Bitcoin, then, let’s go over one more time the risks involved. These risks make Bitcoin something you really need to think about before you start buying and trading. I don’t want to come off as too negative here, but the risk might simply be too high for most people.

It’s Not Legal Tender

There are lots of risks associated with Bitcoin, but they all come down to the non-official nature of the thing. Bitcoin is a digital currency, as you know, but that doesn’t make it legal tender. There are no laws that require companies to accept Bitcoin as a form of payment. In fact, you can’t use Bitcoin to pay government-related debts, such as your income taxes. In most countries across the globe, Bitcoin has no legal standing whatsoever.

(One notable exception is Germany, which does recognize Bitcoin as legal tender.)

What does “legal tender” actually mean? The term has a very narrow legal definition, referring to coins or banknotes that must be accepted by a company or an individual if offered in payment of a debt. Bitcoin is none of that—but, for what it’s worth, personal checks and credit cards aren’t legal tenders, either.

That doesn’t mean you can’t buy things or pay debts with Bitcoin, just that no one is required to take Bitcoin as payment. (Just as no one is required to accept credit card payments.) It’s perfectly okay for Bitcoin to be used for private transactions. But it can’t be accepted by the government, which requires payment in legal tender, which Bitcoin isn’t.

Now, just because Bitcoin is not legal tender does not mean Bitcoin is illegal. It isn’t, at least not yet. I suppose it’s possible for the United States or another government to outlaw Bitcoin transactions, but that is not the case and it’s unlikely to occur. Bitcoin is not illegal, but it’s also not legal tender.

It’s Not Backed by Anything or Anybody

Bitcoin is not an official currency of any government. Therefore it is not backed by the currency of any government. It also is not backed by any physical commodity—there are no gold or platinum or diamond reserves backing up anyone’s horde of Bitcoins.

That means you can’t expect the government to take your Bitcoins and give you dollars in return. They won’t.

It also means that Bitcoin value is not tied to the price of the U.S. dollar or Chinese yuan or euro. Nor is it tied to the price of gold or silver or plutonium, or even the price of land.

In fact, Bitcoin value is not officially tied to anything or anybody. Nor is it backed by any entity. It exists in its own little world, its value defined by the marketplace, without official legal standing or anything.

That means that, unlike physical commodities and government-backed currencies, Bitcoin has no intrinsic value. If the market decides it doesn’t want to pay for it, Bitcoin becomes worthless. It could become something like a currency from a failed state or a conquered country after a war—without an existing entity propping it up, there is no value.

So any Bitcoin you hold maintains value only as long as the market says it does. If for whatever reason, there’s nobody out there willing to buy your Bitcoin, then it loses all its worth. You won’t be able to spend it or trade it or anything—just like the stock of one of those failed dot-com companies of the late 1990s.

It’s Not Regulated or Insured

Because Bitcoin isn’t backed by any government or entity, it also isn’t regulated by any government or entity. People can pretty much do with Bitcoin whatever they want to do—given the self-policing nature of the Bitcoin community, of course.

That also means that there’s no entity insuring your Bitcoin. Unlike with the traditional United States banking system, which is regulated by the Federal Reserve Board and insured by the Federal Deposit Insurance Corporation (FDIC), there’s nobody protecting you if your friendly Bitcoin exchange goes under with your personal Bitcoin in tow. There won’t be any government bailouts, and you’re not insured at all for any losses.

Let’s face it: You’re fairly well protected when you use U.S. dollars in this country. Your bank deposits are insured, your credit card company protects you against the use of stolen cards, you’re pretty safe overall.

This is not the case with Bitcoin. It’s the Wild Wild West out there in Bitcoinland—everybody for himself and nobody watching over you. If your Bitcoin gets stolen or otherwise goes missing, tough luck. If your Bitcoin exchange goes south, you’ll never see those Bitcoin again. If someone hacks into your Bitcoin wallet, there are no authorities to call. You’re on your own.

You Can’t Get Your Money Back

Because all Bitcoin transactions are essentially one-to-one transfers, with no middlemen involved, there is little recourse if a transaction somehow goes wrong. When you pay a merchant by credit card, you can have your credit card company reverse the transaction if the goods are bad or if the retailer won’t back up what he sells. That’s not the case with Bitcoin; Bitcoin transactions cannot be reversed. No chargebacks or reversals are possible.

This is particularly bad if you’re dealing with a company or an individual you’re unfamiliar with, and that company or individual turns out to be less than honest. That company or individual could take your Bitcoin and deliver nothing in return, and you’d have no recourse. None at all.

This also holds if you make a mistake when you’re conducting a Bitcoin transaction. Let’s say you accidentally put in the wrong Bitcoin address for the recipient, and the Bitcoin goes to somebody totally different than you intended. You can’t undo that mistake and reverse the transaction. In the world of Bitcoin, when a transaction is done, it’s done, period.

Refunding Payments

Just because Bitcoin payments are irreversible doesn’t mean that you’re automatically out that money if something goes wrong. Most legitimate businesses (and scrupulous individuals) will refund your payment if you make a mistake or are dissatisfied. This requires a separate Bitcoin transaction for the refund, but that’s easily done.

For this reason, you want to make sure that you are dealing with legitimate and respected businesses when you’re paying via Bitcoin. And make sure you know the company’s refund and return policies, and that there’s a real live person somewhere (ideally behind a toll-free phone number) to contact in case something goes wrong.

It’s Not Completely Secure

As you know, Bitcoin addresses and transactions are protected via the use of fairly robust encryption technology. It’s difficult if not impossible to crack the Bitcoin code or to falsify a Bitcoin transaction.

That said, there are lots of ways the bad guys can tap into your Bitcoins and transactions other than by cracking an encrypted address. Indeed, aside from the core encryption, Bitcoin is considerably less secure than other currency, or even credit cards. Whether you’re storing Bitcoin in your own digital wallet or using a Bitcoin exchange, there is the possibility that malicious individuals can hack into that wallet or online platform and make off with any Bitcoin you have stored.

It doesn’t matter whether your Bitcoin is stored online or on your own PC or smartphone. If the storage device is connected to the Internet (which it must be to conduct transactions, at least), it can be hacked by outside forces. The only way to keep your Bitcoin safe from outside hackers is to store your wallet on a PC that is never connected to the Internet—but then, how practical is that, especially when you want to spend or trade your Bitcoin?

In addition, the PC or another device on which you store your Bitcoin can itself be physically stolen, giving the thief access to whatever Bitcoin reside on the hard drive. Or you could just lose the PC, or have the hard disk go bad, or otherwise experience an event that prevents you from accessing the stored Bitcoin. If you can’t get ’em, you can’t spend ’em.

And then there’s the issue of deliberate fraud. A fraudster can pose as a legitimate Bitcoin exchange or trader and lure you into sending him Bitcoin or other money, which he then makes off with. This kind of fraud isn’t unique to the world of Bitcoin but can happen here as well.

None of this is idle speculation or scare talk. Every single one of these scenarios has happened, and multiple times. Bitcoin exchanges have been hacked and Bitcoin has stolen, Bitcoin wallets have been accessed without permission, and PCs storing Bitcoin have quit working and gone missing. In every instance, people have lost real money.

It’s Extremely Volatile

We’ve talked about this a lot throughout the book, but it’s worth repeating: In terms of price and value, Bitcoin is extremely volatile. The Bitcoin exchange rate fluctuates wildly from day to day, from month to month, and over the long term. A Bitcoin purchased for $600 could, just a few weeks later, be worth less than $500, or more than $700. There’s no logic to the price changes, no way of predicting whether the value goes up or down or how much in either direction.

This type of volatility is pretty much foreign in the world of established currencies. In this fashion, Bitcoin behaves more like a security or trading commodity, those financial instruments that investors bet on to go up or down over a set period. You don’t expect a dollar bill to suddenly be worth 20% less or 20% more than it was a few days prior; in the world of Bitcoin, however, this kind of price variability is the norm.

This volatility makes a lot of people nervous. Merchants are wary of accepting payment in a currency that changes its value so much and so often. Investors are wary of getting burned by huge price decreases—perhaps even more than they’re excited about registering big gains from corresponding price increases. And regular individuals are wary of getting involved with something with such a high unknown factor.

Frankly, it’s the price volatility that keeps me from personally recommending Bitcoin as either an alternative currency or an investment instrument. You don’t want to convert your life’s savings into Bitcoin only to find out that the price today is considerably less than it was just a month or so previous. For investors, that makes Bitcoin a high-risk asset. For consumers, it’s simply too unpredictable, price-wise, to use for buying stuff.

Some of the Players Are Less Than Upstanding

I don’t want to put too much of an emphasis on this, but it has to be said: Bitcoin is uniquely appealing to the criminal element. The fact that Bitcoin is anonymous and essentially untraceable makes it ideal for conducting under-the-radar financial transactions. If you want to buy a thing or a service that is not strictly legal in your particular jurisdiction, there is no better way to pay for it than with Bitcoin.

That doesn’t mean that all or even a large number of Bitcoin users are criminals. Far from it. But Bitcoin does attract the criminal element, whether that be for purchasing illegal drugs, running Ponzi scams, or just old-fashioned money laundering.

As an upstanding citizen, you probably don’t want to be associated with the kinds of people who participate in these kinds of activities. And just because you deal in Bitcoin doesn’t mean you’ll be dealing with those fellas. But, in some people’s eyes, Bitcoin is all about the under-the-table stuff, and it’s awfully convenient to paint with a broad brush. If your reputation is important, associating with Bitcoin might (unfairly) tarnish it somewhat.

In addition, it’s possible that law enforcement agencies, in their zeal to crack down on said criminal element, might also apply a broad brush. You don’t want to get caught up in any wide nets the good guys use to troll for the bad guys, Bitcoin-wise. It’s not unheard of for a given official agency to monitor or close questionable Bitcoin exchanges, and in the process keep legitimate customers (like you) from accessing any funds stored there.

When you use the same tools as the bad guys, you can get caught up in their activities, however unknowingly. That’s something to be concerned about.

It’s Not Widely Accepted

Forget the volatility. Forget the uncertainty. Forget the lack of regulations and support. Even if you get past all these other risk factors, you’re still faced with the reality that there are few merchants that accept Bitcoin for payment. Like Bitcoin all you want, but if there’s no place to spend your Bitcoin, it loses all value as a replacement currency.

I know and you know that this is changing, that more and more merchants are becoming friendly to Bitcoin, but that change is happening slowly. We’re nowhere near a critical mass in terms of merchant acceptance. And until that happens, the fact remains that Bitcoin is not widely accepted as a means of payment. Not online, and certainly not on the main street. And if you can’t spend it, why bother with it?

It’s Not Understood

Part of this lack of acceptance is a lack of understanding on the part of individuals, businesses, and the media. There are more scare stories involving Bitcoin than there are success stories, and that colors people’s perceptions. If all you do is read the daily news, you can quickly become convinced that Bitcoin is a danger to the clean people in our society, a tool used by criminals and terrorists, a surefire way for naive individuals to lose their life savings. Bitcoin is evil.

Now, you and I both know that none of this is true, but the guy down the street or behind the counter isn’t as well informed. (That guy hasn’t read this book, I’m sure.) And it’s not just individuals, it’s entire governments that are ignorant and scared of Bitcoin. This lack of knowledge is hindering the acceptance of Bitcoin on both a local and a global level.

Until more people (and more governments) understand what Bitcoin is really about, they’re going to make life difficult for our plucky little cryptocurrency. Government bodies will continue issuing warnings about the risks associated with Bitcoin, and continue discouraging their citizens from using the new currency. This might change over time (and is already starting to change in some quarters), but until then, be prepared to struggle a bit in the acceptance department.

Powerful People Don’t Like It

On that last point, know that some influential people really, really, really don’t like Bitcoin. Many of these people have a good reason to dislike the new currency: They have vested interests in our current currency and financial systems. It’s not surprising that rich Wall Street bankers and the guys who run the big credit processing firms are anti-Bitcoin; it’s in their personal interests to keep the current system chugging along without any undue interference. Because Bitcoin is all about interference, it’s a threat.

How are these guys responding to the threat? By bad-mouthing Bitcoin at every opportunity. By setting up as many roadblocks to Bitcoin’s success as possible. By actively campaigning against Bitcoin’s acceptance at all levels.

Now, just because these fat cats don’t like Bitcoin is no reason to abandon it. In fact, many readers will find Wall Street’s hatred of Bitcoin to be a damned good reason to support the fledgling currency. But know that these big players can put up a really big fight, and that might make it difficult for the Bitcoin community. It’s not a deal breaker, but it’s something you’ll have to deal with.

It’s an Experiment

A final risk to using Bitcoin is that the whole scheme—the currency, the encryption, the technology—is still in the experimental stage. Bitcoin itself is a big experiment, and Bitcoin traders all operate in what is essentially a huge petri dish.

Unlike the dollar or even the euro, Bitcoin is not an established currency; it is (and will for some time be) an experimental currency scheme that is in constant development. Much of what Bitcoin is doing has never been done before. The Bitcoin community is pretty much making up the rules as it goes along.

Remember, Bitcoin is only a half dozen or so years old. It’s still a baby compared to other world currencies. What this baby will look like when it grows up is anybody’s guess. In fact, we don’t even know if it will grow up. Heck, another virtual currency could come along and halt Bitcoin in its tracks. Or Bitcoin could morph into something totally unrecognizable today. We just don’t know. And there’s your risk.

Leave a Reply

Your email address will not be published. Required fields are marked *