On March 5, the Alberta-based Bitcoin exchange Flexcoin collapsed, following a cyber attack that stole $600,000 worth of digital currency. This was the second major exchange collapse, following in the heels of the theft of $450 million worth of Bitcoins from the Japanese-based Mt. Gox last month. With the legal status and the security of cryptocurrencies in doubt, investors in Canada and around the world are facing legitimate concerns regarding the safety of their investments.
Bitcoin and other cryptocurrencies operate largely like a commodity. Bitcoins are ‘mined’ by using computer processing power to solve digital problems. Once sufficient computing power has been used to chew through a problem, a block of Bitcoins may be released. Then the problem restarts at a higher level of difficulty, meaning that more processing power must be used to retrieve coins. This mining favours early adopters, and as the value of Bitcoins has risen from a few dozen dollars to a peak of $1000/coin last fall, several early users have made princely profits.
Cryptocurrencies have been used to ‘pay’ for items, several online stores and charities accept Bitcoin. A related cryptocurrency, Dogecoin (based off an internet meme of a shiba inu dog), partially funded the Jamaican bobsled team’s participation in the Olympics in Sochi. Cryptocurrencies, due to their anonymous and unregulated nature, have also been used for illegal online transactions and money laundering. However, cryptocurrency exchanges have become the nexus of legitimate profit. The coins are traded like a commodity or real currency.
The legal status of Bitcoins is still quite vague and there is a patchwork of rules that vary by country. Last year, the Canada Revenue Agency officially declared cryptocurrencies a commodity for tax purposes and that profits will be treated as capital gains. At the same time, a Texas court ruled that Bitcoins were currency. Justice Mazzant, in the case of SEC v. Shavers, 2013 BL 208180 (E.D. Tex. Aug. 6, 2013), ruled that:
“It is clear that Bitcoin can be used as money. It can be used to purchase goods or services, and as Shavers stated, used to pay for individual living expenses. The only limitation of Bitcoin is that it is limited to those places that accept it as currency. However, it can also be exchanged for conventional currencies, such as the U.S. dollar, Euro, Yen, and Yuan. Therefore, Bitcoin is a currency or form of money, and investors wishing to invest in BTCST provided an investment of money.”
The Japanese cabinet is currently deciding how Bitcoins will be treated and taxed, while China has banned financial institutions from trading in cryptocurrencies.
The main danger of cryptocurrencies is that due to their inherent value as an anonymous, unregulated commodity, a precise cyber attack can cause the loss of millions of dollars, but leaves victims with little recourse. A wildly fluctuating value and unclear legal status only compound the problem, making Bitcoin a risky investment.