Virtual currencies have taken the world by storm, with tens of billions worth of bitcoins already in circulation. But beware cash stored in a virtual wallet, warns the North American Securities Administrators Association. Significant protections you enjoy when dealing with real currency are lacking with virtual money.
Indeed, when Mt. Gox -- a major international Bitcoin exchange -- folded earlier this year, a reported million investors were out hundreds of millions of dollars, with no recourse. Here are a few things you need to know before buying virtual currency:
You don't know what it will be worth. One of the big draws of Bitcoin is that the coin that was worth $13 at the beginning of 2013 was worth $800 a year later. What a way to get rich quick, right? Except, a Bitcoin is now worth $441, which is a bummer for those who bought in at $800, thinking the value of the currency would go to a predicted $1,300. And there's really no guarantee that the coins won't decline further in value to, say, nothing. "The value of virtual currencies is highly volatile," says Ohio Securities Commissioner Andrea Seidt. "Investors should be aware that investments that incorporate virtual currency present very real risks."
It's not insured. If you put your money in a bank, the federal government stands behind $250,000 per depositor. If you put your investments in a brokerage account, the Securities Industry Protection Corp. makes sure you get back all your stocks, bonds and up to $100,000 in cash, in the unlikely event that the brokerage firm fails. State insurance regulators stand behind the value of life insurance policies (though the limits vary from state to state). But there's no backing whatsoever for Bitcoin and other virtual currency.
It's not legal tender. Sure, some merchants will take virtual currency, but don't think you're going to pick up a Starbucks latte with it -- or use it to buy goods at Wal-Mart, Target or Costco. The listing of merchants that take Bitcoin is long and, for the most part, obscure. Chances are good that the goods and services that you want to buy can't be bought with Bitcoin
It's unregulated and unsupported. You have a pretty good idea what your dollar is going to be capable of buying tomorrow because the U.S. Treasury stands behind the currency and regulates the value with the help of the Federal Reserve System. Currencies issued by other countries get the same support from their own governments. Bitcoin is a nationless currency. There's no government backing its value. There are no regulations or regulators out there attempting to ensure its worth. There are just a bunch of shadowy cyber-geeks promising to store your coins for you, until....whoops....Mt. Gox misplaces $400 million worth in coins and liquidates.
Cyber-hacks/attacks: How much do you know about cyber-security? Investors in virtual currency are highly reliant upon unregulated companies that may lack appropriate internal controls and may be more susceptible to fraud and theft than regulated financial institutions, says Seidt. Thus you will need to rely on the strength of your own computer security systems, as well as security systems provided by third parties, to protect your e-wallet from theft.