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Red Oak Blog

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Saturday, December 12 2015

Bitcoin, Virtual Currency, & What You Need to Know

Bitcoin and other digital/virtual currencies have been a growing topic in media reports and government hearings have been held with focus not only on virtual currency’s potential promise, but also on very real abuses and criminal activity associated with it.

Bitcoin was introduced in 2009, and is a peer-to-peer payment system that uses its own currency, called bitcoin, to transact business. Bitcoins are not issued by banks or governments and its platform was designed to offer an alternative to national currencies like the dollar, as well as commodity-based currencies such as gold or silver coins.

While Bitcoin users are anonymous, a public record or “block chain” is public and shared between Bitcoin system users. Bitcoins are created by a process called “mining,” and the process is labor intensive. Miners use software algorithms to add transaction records to Bitcoin’s public ledger of past transactions and verify legitimate bitcoin transactions.

Bitcoin miners get transaction fees. In addition, if the miner finds a new “block,” the miner is awarded new bitcoins. A finite number of bitcoins can be mined (21 million based on the mathematics underlying Bitcoin mining).

Bitcoins can also be bought and sold online or at physical locations. A growing number of physical establishments and exchanges allow customers to buy and sell bitcoins using cash, credit cards, money orders and other methods. Bitcoins reside in a digital “wallet,” where they can be used to purchase items from establishments that accept bitcoins.

Bitcoins can also be traded for traditional currency at exchange rates that fluctuate. Bitcoin prices have been extremely volatile, and subject to wide price swings. As a result, investors should be made aware that buying and using digital currency, such as Bitcoin, because of the highly speculative nature of trading in bitcoins, carries significant risks. There is also the risk of fraud related to companies claiming to offer Bitcoin payment platforms and other Bitcoin-related products and services.

The Securities and Exchange Commission (SEC) recently charged two Bitcoin mining companies—GAW Miners, and ZenMiner, with conducting a Ponzi scheme by purporting to offer shares of a digital Bitcoin mining operation. Last year, in February 2014, two additional companies, Mobile Technologies Corp, and the Tokyo-based Mt. Gox, one of the largest bitcoin exchanges, stopped its operations, following questions about the company’s business, revenue and assets. Mt. Gox subsequently filed for bankruptcy in Japan and then in the U.S. The Chinese central bank has officially banned banks from accepting bitcoins.

In 2013, the SEC charged a Texas man and his company with fraud, which also involved an alleged Bitcoin Ponzi scheme. The SEC simultaneously issued a warning about the potential for fraud. As with so many other “hot” or new trends, those seeking to defraud investors may see the latest digital currency trend as a fantastic opportunity.