When Bitcoin investing goes wrong...
At one point last year it seemed as if the whole world was making its fortune trading in Bitcoin. Everyone, that is, except me.
But, as someone once said to me, lying on the beach can sometimes be the best investment strategy.
A glance at the charts below shows that, while Bitcoin went stratospheric in 2017, it has started 2018 on much shakier ground and it seems as though no one really has a clue where it's headed next.
Bitcoin's comet-like trajectory has not prevented it spawning a string of rivals including Ethereum, Litecoin and Ripple.
Each new currency has been accompanied by breathless claims that it is even more secure and enables even easier transactions than the last. Now, bricks & mortar companies are announcing plans to launch their own cryptocurrencies - prompting massive rises in their share prices. Perhaps the high point of cryptomania was Kodak announcing plans to create "KodakCoin", a cryptocurrency to be used to pay photographers for licensing rights. It should be remembered that Kodak, once synonymous with photography was brought down by its failure to keep pace with digital technology.
But even before Bitcoin's latest dramatic reversal, there has been plenty of heartache for investors amidst the hype. Anyone seeing the recent collapse as a buying opportunity should consider the cases where Bitcoin investing has not quite gone according to plan.
Launched in 2010, Mt. Gox was a Japanese Bitcoin exchange that by 2014 was handling over 70% of global Bitcoin transactions. "Handling" was perhaps stretching it a little as in February 2014 Mt. Gox reported that 744,408 Bitcoins, at the time worth in excess of $450 million, had been stolen from the exchange. Forced to file for bankruptcy, Mt. Gox subsequently received claims from over 24,750 customers for stolen Bitcoins. Since then, its former CEO, Mark Karpeles, has faced charges in a Japanese court of embezzlement and data manipulation.
More recently, in January 2018, Coincheck, another Japanese cryptocurrency exchange, had over $530 million worth of NEM coins stolen. Coincheck claims that it will repay customers 90% of the amount lost, though it remains unclear how.
While these are two of the most high profile cryptocurrency cyber attacks, they are by no means unique. The continuing vulnerability of cryptocurrencies means that very pertinent questions about the security of Bitcoin exchanges remain unanswered. They have been touted as much more secure than traditional currencies, yet the anonymity which has been a defining characteristic of cryptocurrencies also aids criminals who succeed in stealing them.
Perhaps even more alarming than cyber attacks, in January 2018, Danny Ashton, a cryptocurrency trader based in Oxfordshire, UK, had his home broken into and was forced at gunpoint to transfer an unspecified number of Bitcoins to a group of armed burglars. Admittedly, it is thought to be the first incident of its kind in the UK, but similar robberies have occurred elsewhere.
New wallet, same old problems
As the above examples show, the safe storage of Bitcoins is a problem for exchanges and investors alike. They are stored either in a "cold" digital wallet, or in a "hot" one. In essence, a hot wallet is connected to the internet whilst cold wallets are not. The obvious benefits of a hot wallet is that it allows immediate transactions; the drawback is that they are exposed to the risk of hacking.
But cold wallets aren't necessarily the answer either. It is possible to lose the hard drive where they are stored. This is exactly what happened to James Howells, a Welsh IT worker whose hard drive holding 7,500 Bitcoins was accidentally thrown out in 2013. Not surprisingly, he's gutted and now wants to dig up the landfill site where he thinks it is buried, but finding a needle in a haystack would probably be easier.
Still an uncommon currency
To be fair to Bitcoin, which has often been criticised in the past for being the favoured currency of criminals on the dark web, it seems to have cleaned up its act. This improved reputation is reflected in the fact that it is beginning to be accepted more and more for mainstream transactions. Indeed, there have been a few stories about houses being sold for Bitcoins, rappers being paid in Bitcoin and so on. Even so, many investors who have enjoyed incredible returns from cryptocurrencies have struggled to use the proceeds of their investments offline.
For now, cryptocurrencies remain far away from widespread adoption and it seems unlikely that they will replace euros, dollars, pounds and yen anytime soon. Indeed, in January the Financial Times reported that many mortgage lenders and bank in the UK were declining to offer mortgages to those trying to buy property with Bitcoin proceeds. Pressed by anti money-laundering regulations, banks have been forced to adopt a conservative approach amidst concerns over the difficulty of identifying the source of Bitcoin funds.
Even if banks do choose to accept the proceeds of cryptocurrency investments in the future, many apply an extra level of security checks when doing so. Until Bitcoin (or any other cryptocurrency) becomes regularly accepted legal tender, people will still be forced to transfer their cryptocurrencies into traditional currencies.
Aside from these drawbacks, one of the biggest problems of cryptocurrencies is what should be the simplest: buying and selling them. Investors often face large transaction charges, while the high volatility means that it is sometimes hard to nail down the value of what they are buying or selling before the deal goes through.
There's no escaping tax
Any naive hopes an investor might harbour that cryptocurrencies would avoid taxes that normal investments are subject to have been squashed by Her Majesty's Revenue and Customs. The tax men confirmed in 2014 that any money made from Bitcoin will face normal tax charges. Whilst the anonymity of Bitcoin might help act as a tax shield for now, the almost inevitable need to convert them back into traditional currencies means that they cannot escape the clutches of HMRC forever. HMRC's guidance suggested that Bitcoin can be taxed in one of two ways:
If the Bitcoin's have been "mined", then the proceeds of that "mining" are taxed as income tax.
If Bitcoins are purchased and then sold, the proceeds are liable to capital gains tax.
To wrap up...
Ten years ago there wasn't a single cryptocurrency in circulation. Today, there are over 1,500 with a total value rapidly approaching $500 billion. This fact alone suggests they are increasingly likely to stay. Even large financial institutions which once rubbished cryptocurrencies and denounced Bitcoin as a fraud are now reportedly beginning to start trading in the currency. However, one only needs to scratch the surface to see that there is still plenty to concern crypto investors. They suffer from many of the security problems that afflict traditional currencies, yet "virtual theft" can be more difficult to detect and protect against than the old-fashioned sort. Perhaps, increased adoption of cryptocurrencies by indvidiual and institutional investors will force governments to be more proactive in their regulation of the market. Certainly we think there will need to be a lot more confidence that the errors and mishaps that have characterised the short yet chequered history of cryptocurrencies are a thing of the past before they move into the mainstream.