Bitcoin Is for (Savvy) Gamblers

By Ricardo Lesperance

At a dinner party a month ago, I met a medical student who wanted to know what I thought about Bitcoin as an investment option. As she is getting ready to graduate from medical school, and with a mountain of student loan debts towering over her head, this young woman was contemplating biting the bullet and investing a small inheritance in Bitcoin, hoping for high returns. I did my best to remain objective while outlining the opportunities and risks associated with investing in the world’s leading digital currency. However, after watching the Chairman of the Securities and Exchange Commission (SEC) and his counterpart at the Commodity Futures Trading Commission (CFTC) testify before the Senate Banking Committee a few days ago, I wish I could go back and tell that student to find a way to resist the temptation of getting on the Bitcoin bandwagon. Under the current fragmented regulatory regime, betting on Bitcoin (or any of the other cryptocurrencies for that matter), is not the ideal investment strategy for anyone who lacks the wherewithal and financial acumen to understand the intricacies of digital asset investment.

Over the last nine years, Bitcoin has grown from being an obscure technical curiosity to a global phenomenon that continues to attract investors of various financial background, knowledge and means. That rise in popularity and investment frenzy, combined with the virtual and highly speculative nature of the product, make Bitcoin an ideal vehicle for fraud and a formidable challenge to financial and market regulators. In 2014, Japan’s Mt. Gox exchange collapsed, wiping out $473 million worth of Bitcoin assets in the process. Since then, and especially in the last two years, there have been numerous reported Ponzi schemes, hacking and swindles that have cost helpless crypto investors billions of dollars. As recently as last month, hackers stole more than half a billion dollars in cryptocurrencies from Tokyo-based exchange Coincheck, far exceeding the $473 million stolen from Mt. Gox in 2014. As Professor Kevin Werbach from Wharton School of Business put it

“. . . the combination of credulous buyers and low barriers for scammers were bound to lead to a high level of fraud, if and when the money involved got large. The fact that the money got huge almost overnight, before there were good regulatory or even self-regulatory models in place, made the problem acute”.[1]

Many features make Bitcoin an attractive option for sophisticated investors who are looking to expand their portfolios. First, because of its speculative nature, and the fact that it requires a long-term hold in order to reap the returns, people who don’t need frequent access to their capital invest in Bitcoin, not for its inherent value, but for what they believe it will (might) be worth in the future. In the Bitcoin community, those investors are known by the cryptic term “HODL” or “Hold on for Dear Life”. Second, sophisticated investors can trade Bitcoin options on the LedgerX platform and Bitcoin futures at both the Chicago Board Options Exchange (Cboe) and the CME Group, albeit under stringent conditions.

For average investors, on the hand, there are many more reasons to steer clear of a high-risk instrument such as Bitcoin. Chief among them, is the likelihood of an unexpected event that would cause a total wipe out of an exchange. Such a catastrophic event would undoubtedly prove devastating to an investor who cannot afford to lose everything. Furthermore, while for many of Bitcoin’s fervent supporters one of the currency’s main attractions is the lack of a central authority, and the absence of regulation, this kind of freedom is not one average investors should strive for. Many of the companies that currently offer cryptocurrencies and conduct Initial Coin Offerings (ICOs) are start-ups that are still trying to get off the ground. Oftentimes, investors are not even able to reach the representatives of those companies by phone or email. That kind of risk may be tolerable for a Venture Capitalist who can fend for him/herself, but it is not the kind of precarious situation a student with loans to pay, want to find herself in. Finally, Bitcoin is not as liquid as other investment instruments. Settlements can take a long time, which means an investor who needs to sell off his crypto assets hastily for some emergency cash, may be unable to do so. In the midst of a crisis, no investor wants to be reduced to a hopeless bystander, as the value of his investment plummets right in front of his eyes, something many investors experienced during the most recent Bitcoin crash.

It is not often that government agencies own up to their shortcomings and admit their weaknesses and inabilities to efficiently carry out their mandates. Therefore, it was refreshing to hear the Chairmen of the SEC and CFTC admit that despite their best efforts, their agencies continue to struggle to rein in scams and fraudsters who are looking to take advantage of Bitcoin enthusiasts. The market for crypto products have substantially less oversight than the traditional securities market. Whereas broker-dealers who facilitate securities trading have capital and conduct requirements to adhere to; and whereas stock exchanges have specific rules to follow and surveillance exercises they must conduct to protect investors, promoters of cryptocurrencies and ICOs are not required to follow any of those standard operating procedures or comply with U.S. securities laws. In fact, many of those promoters go out of their way to disguise their sales and ICOs as a way to circumvent Securities Laws and Regulations. The awful truth is, for now, there is not much either the SEC or the CFTC can do, since those agencies do not have direct jurisdiction over many popular markets that trade crypto currencies.

That being said, both the SEC and CFTC have brought a fair amount of enforcement actions against US-based companies that perpetrated Bitcoin-related Ponzi schemes against American investors. The agencies have also launched numerous investor-education initiatives in recent months, in an effort to teach individuals who are determined to throw their money behind Bitcoin, what to look for and how to detect potential scams. Unfortunately, those measures are reactive and do very little to protect crypto investors who have already been caught in the web of lies and deceits particularly from fraudulent offshore companies.

At that February 6th hearing, the message from the SEC and CFTC could not have been clearer: Invest in Cryptocurrency at Your Own Peril!! The chances that the U.S. government can do anything practical to help defrauded investors get their money back, are virtually nil. Once Bitcoin is transferred, it can neither be recovered nor be traced. Chairman Giancarlo of CFTC put it even more bluntly when he said, “. . . If you are going to invest money in Bitcoins, you better be prepared to lose it”.[2]

Wall Street is quite enamored with blockchain - the digitized and decentralized, public ledger that supports Bitcoin and other cryptocurrency transactions – but it has yet to fully embrace cryptocurrencies as investment instruments. Jamie Dimon, the Chairman and CEO of J. P. Morgan Chase went as far as calling Bitcoin “a fraud”. The rule of thumb for average investors should always be, whenever Wall Street is apprehensive about a potential money-making scheme, Main Street should be twice as wary.

[1] Nathaniel Popper. “As Bitcoin Bubble Loses Air, Frauds and Flaws Rise to Surface.” The New York Times 5 Feb. 2018. Web 11 Feb. 2018.

[2] United States. Senate Committee on Banking, Housing, and Urban Affairs. Hearing on "Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission. Feb. 6, 2018. 115th Cong.