Mark T. Williams, a former commodities trading floor senior executive and Federal Reserve Bank examiner, teaches banking, finance and risk management at Boston University School of Management.
It is understandable why some in the venture capital sector are over the moon about Bitcoin and its endless possibilities. Marc Andreessen of Andreessen Horowitz, has about 50 million reasons why he wants Bitcoin to succeed. The only problem is that Bitcoin is a concept dreamed up in the virtual world and is not yet ready for the real world.
Bitcoin technology and its lower-cost payment system design may be elegant but that does not mean it should be blindly embraced and adopted. The payment system and Bitcoin as an e-currency can’t be divorced from each other. Before Bitcoin becomes a regular and reliable method for consumer transactions, several significant risks need to be assessed and addressed:
Reputational Risk
Is Bitcoin an innovative response to facilitate meaningful commerce or simply a designer currency for the criminally inclined? For Bitcoin to function as a currency, it has to be trusted as an honest means for transacting business. Its reputation needs to be rock solid.
Since its inception, Bitcoin has been a decentralized experiment with a morphing purpose. In 2009, in response to the Great Recession, Bitcoin was seen as a way to take back control from irresponsible central bankers, reallocating power of currency to the people through computer code and a decentralized payment system. However, creating an unregulated and untraceable currency also made it the currency of choice for those engaged in illicit activities.
The F.B.I.’s takedown of Silk Road in October 2013 significantly tarnished Bitcoin’s reputation by exposing a deep web of drugs, guns, prostitution, assassins for hire and a ready tool for tax evasion and money laundering.
Trojan Horse Risk
For the last five years, the pseudo name of Satoshi Nakamoto has been used to symbolize the innovative genius (or team) behind Bitcoin. Given that Bitcoin has mushroomed to $10 billion in value and prospects for commercialization abound, it is puzzling why this supposed e-currency messiah has not stepped forward. What if Satoshi Nakamoto is not real, and his likeness was manufactured by some cybercriminals to generate investor excitement?
At this embryonic stage it seems only logical that the true spokesman, not just someone from the venture capital industry, should step forward to part the waters, lead the followers and show the way. Or at least be the industry face before the growing number of e-currency regulatory hearings that will help shape industry economics and future prospects.
Could it be that this coding genius is instead enjoying computer-manufactured riches on some remote, tax-free island, or is he a cyber-terrorist who upon Bitcoin adoption will activate a Trojan-horse virus to bring world commerce back to the Stone Age?
Asset Bubble Risk
The speculative mania generated around Bitcoin has created a hyper asset bubble that is ready to pop. Since 2013, Bitcoin has risen from $13 to as high as $1,200 with price appreciation of more than 9,000 percent. There are 12.3 million coins outstanding, over 90 percent are hoarded, which helps to artificially inflate values.
Ownership is also extremely concentrated, increasing market manipulation risk. As prices have grown to the clouds, many Bitcoin millionaires have been minted along the way. But what supports these lofty prices?
Bitcoin is neither a legal entity, nor a start-up, and no stock is available for investors to purchase. It has no management team, board, balance sheet, business plan or even a coherent vision on how to commercialize technology that has been given away in the market for free. Even Mr. Andreessen, the venture capitalist, disclosed that he held only a de minimis amount of Bitcoin, making it clear that smart money is not betting on e-coins but directly on Bitcoin-related start-ups.
Increasingly, as Bitcoin investors gain greater awareness of what they actually bought (and more important not bought), values will fall further. In the last month, Bitcoin has dropped by about 30 percent. The bursting of the Bitcoin bubble will put in jeopardy the viability of the lauded payment system as it can’t be easily separated from the use of Bitcoin as its currency.
Consumer and Investor Protection Risk
Bitcoin is built around an unregulated, decentralized and untraceable coin. No legal protection is in place to assist consumers or investors.
If a consumer were to send a Bitcoin to the wrong e-wallet, if a hard drive storing coins were corrupted (intentionally or unintentionally), or an e-wallet picked, coin value is lost forever. The chance of counterfeiting increases as the profit potential has risen. Already, of the e-coins outstanding, an estimated 4 percent, or $400 million, have been permanently lost.
As Bitcoin’s value has skyrocketed, the amount of fraud related to stolen coins has increased. Recently, it was reported that $220 million in coins were stolen and not recovered. It is hard to track fraudulent activities and those who perpetrate these acts because e-coins are untraceable. For Bitcoin to work and protect consumers and investors, there needs to be clear legal protection. This will have to be implemented on a nation-by-nation basis with international cooperation. Without it, unacceptably high risk will persist and limit adoption.
Regulatory Risk
Bitcoin’s rapid price climb and growing visibility has also been its greatest weakness. In the last month, some of the world’s wealthiest nations have realized that there are the numerous risks and the economic instability Bitcoin could pose if not properly regulated.
There are a growing number of nations that have begun to debunk the idea it could serve as a real currency. China, the second-largest economy in the world, announced in December that it would not accept Bitcoin, and within 48 hours the price dropped as much as 50 percent. Other influential nations and authorities have also spoken out against Bitcoin, including Denmark, Finland, France, India, Norway, Sweden, Thailand and the European Banking Authority.
Next week, the New York State Department of Financial Services will hold an important hearing to further help clarify the role that Bitcoin should or should not play as it relates to our financial sector. Under this growing regulatory climate and concerns about not being able to prevent money laundering, American commercial banks are hesitant to open accounts with Bitcoin-related start-ups.
Increasingly, the fate of the commercial viability of e-currencies is moving into the hands of nations, their regulators and financial protectors and out of the control of Bitcoin enthusiasts.
