A timely warning from the feds: Bitcoins are the ‘Wild West’

The Consumer Financial Protection Bureau, that whipping boy of big-business conservatives everywhere, demonstrated its value to the average consumer this week by explaining the pitfalls of bitcoins and other such “virtual currencies.”

The key takeaway, in the succinct words of CFPB Director Richard Cordray: “Virtual currencies are not backed by any government or central bank, and at this point consumers are stepping into the Wild West when they engage in the market.”

The agency underscores several risks in the use and trading of bitcoins that experienced participants generally know all about, but could trap the unwary--precisely the people the CFPB was created to look out for.

That’s important, because as we observed last November, bitcoins are widely misunderstood. As they become accepted by more merchants and traded in greater volume, the gap between reality and consumer understanding becomes more dangerous, for the consumer.

The CFPB release underscores the limitations of bitcoins as investment instruments, and the stark distinction between them and real currencies. It reminds users that bitcoin accounts aren’t backed by the FDIC, that they’re not legal tender anywhere, and that realized gains in bitcoin trading are taxable in the United States.

Among the specific risks the agency mentions are these:

• Exchange rates to hard currencies are highly volatile: on one day earlier this year, the CFPB observes, bitcoins fell by 80% in value against the U.S. dollar.

• Some trading companies charge transaction fees that may be obscure or just plain hidden; consumers need to be on the lookout for unexpected or poorly-disclosed markups or fees.

• Despite promoters’ assertions that bitcoins are secure, they are vulnerable to hacks, thefts of digital security keys, and scams. Bogus exchanges and traders lie in wait to shear innocent sheep.

Indeed, bitcoin losses are common enough to warrant their own online forum page: the roster of “major” losses has grown to 45 incidents, many of them involving more than $100,000. The largest appears to be a $4-million loss at a Czech underground marketplace, though that doesn’t include the government seizure of bitcoins valued as high as $27 million from the black market trading site Silk Road. The government is auctioning off its hoard.

--Customers may not have recourse: “Some virtual currency companies do not identify their owners, provide phone numbers and addresses, or even specify the country in which they are located.,” the CFPB says.

Perhaps the most important part of the CFPB announcement is the statement that it now stands ready to assist consumers with complaints against bitcoin service firms. The agency will refer the complaints to those firms, work with the firms to obtain a response, or refer the complaints to any other appropriate agency. It will also compile complaints to get a better picture of the bitcoin marketplace--that is, a better map of the Wild West.

To their credit, some bitcoin promoters accepted the CFPB statement as a positive development; anything that adds to the virtual currency’s legal validity can only expand its customer base. That’s true, for example, of proposed rules for bitcoin firms just released by New York banking regulators.

Bitcoin Foundation General Counsel Patrick Murck called the CFPB warnings “reasonable.” He told Politico, “I didn’t see anything objectionable in these warnings. Seems like common sense for handling digital currency.”

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