Government regulators issued a consumer advisory Monday on the risks of bitcoin and other digital currencies, warning that the virtual funds expose users to volatile exchange rates, hacking, scams and theft.
Markups and transaction fees for digital funds such as bitcoin, XRP and Dogecoin can cost consumers more than using credit cards or regular cash, and the companies that issue digital currencies aren’t backed or insured by any government, according to the six-page alert from the Consumer Financial Protection Bureau, a federal watchdog agency.
The advisory also cautions consumers that digital currencies can experience huge price fluctuations due to speculation and the lack of regulation. Bitcoin’s price has fallen by as much as 80 percent in a single day.
Consumers who use or invest in virtual currencies “are stepping into the Wild West,” the bureau’s director, Richard Cordray, said in a statement.
“Virtual currencies may have potential benefits, but consumers need to be cautious and they need to be asking the right questions,” Cordray said.
In addition to issuing the advisory, the bureau announced Monday that it will start collecting consumers’ complaints about virtual currencies on its website, www.consumerfinance.gov.
An official with the trade group Bitcoin Foundation shrugged off the advisory as standard practice.
“There are consumer risks around new technologies, and even-keeled educational material from government agencies can help make consumers aware and savvy,” Jim Harper, Bitcoin Foundation’s global policy counsel, said in a statement.
In response to Cordray’s characterization of the digital currency market as “the Wild West,” Harper said new ideas – from credit cards to the Internet – always started as unknowns that became familiar over time as the market matured.
“Bitcoin is poised to modernize legacy financial services, one of the most regulated industries in the global economy. It’s not going to remain an unknown territory for very long,” he said.
Virtual currencies are a form of electronic money that enables people to send and receive payments online. Consumers store the funds in digital wallets in clouds or on computers and protect them with 64-digit codes known as keys.
Advocates hail the technology as an innovative, anti-establishment payment system that protects users’ anonymity and has the potential to transcend politics and national boundaries.
But the pitfalls of bitcoin and other virtual currencies became painfully clear to many users in February, when the Japanese bitcoin exchange Mt. Gox suddenly disappeared. The exchange had lost $460 million to hackers, and collapsed into bankruptcy. Customers have yet to recover any money.
“Some virtual currency exchanges do not identify their owners, their phone numbers and addresses, or even the countries where they are located,” Monday’s advisory warned. “Ask yourself: In any other business transaction, would you trust these people with your money?”
The advisory points out that traditional banks and credit card companies are required to help consumers recover stolen funds, but people who store digital currencies or keys on their computers or hard drives are on their own in the event of theft or loss.
One man lost $5 million in bitcoin last year when he accidentally threw away a computer hard drive that contained his keys for 7,500 bitcoins, according to the advisory.
The advisory also notes that paying taxes on digital currencies can be complicated. New guidelines that the Internal Revenue Service issued in March treat digital currency as property for U.S. tax purposes, meaning it’s subject to federal income-tax withholding and payroll taxes and that users must report their virtual gains and losses on their returns.
Consumer advocates welcomed the advisory as a step toward further regulation of virtual currencies.
Consumers need “a sheriff” such as the Consumer Financial Protection Bureau “to protect them from unscrupulous companies and unfair practices,” Jeffrey Chester, the executive director of the Center for Digital Democracy, said in an email.
“The agency needs to better police the growing use of digital and other virtual currencies to make sure they operate fairly and don’t place consumers at financial risk,” Chester said.
The bureau’s alert makes it clear that virtual currencies “are not ready for prime time,” said Ed Mierzwinski, the consumer program director for U.S. PIRG, a consumer advocacy group. “You’ll probably have problems; let (the bureau) know if you do.”
The digital currency industry isn’t opposed to government regulation as long as any new rules don’t smother innovation, said Pete Rizzo, U.S. editor at CoinDesk, a digital-currency industry news source.
Regulation might reduce volatility and make more consumers and businesses comfortable with the technology, Rizzo said.
“I think it’s something that most of the businesses in this space would want; they just want it to be done in a smart way,” he said.