When performing an analysis of a client’s unique personal risk profile, we often find that their assets relate to their special interests. Whether it is a passion for fine art, fine wine, or exotic cars, a hobby can often grow into a valuable asset. For those who have an interest in new technology, bitcoin could be a very exciting possibility.

 

While some may view bitcoins as an investment, it is more generally defined as virtual currency. As early adaptors dive in and experience this still relatively new concept of regulation-free spending, they are discovering the limitations and risks associated with owning currency that is completely digital. Understanding these risks before you join in on the experience can help you protect yourself from fraud and other threats.  

 

 

According to bitcoin.com, "the most simple and accurate way to define bitcoin is as a peer-to-peer electronic cash system.” You can also think of it as “digital cash” or “cryptocurrency.” It is intangible; it only exists on a virtual ledger within cyberspace.

 

Many different virtual currencies exist, but bitcoin has become the most popular, with Bitcoin Teller Machines, similar to an ATM, available in cities around the globe. An increasing number of businesses in major cities are now accepting bitcoin as payment for everything from your morning coffee to an evening cocktail.

 

The first thing you need to get started is a bitcoin “wallet,” which is free to create and own. Similar to a bank account, the wallet allows you to send or receive bitcoins, pay for goods, or accumulate savings. Unlike bank accounts, bitcoin wallets are not regulated by a central authority or insured by the FDIC.

 

Your bitcoin wallet can be stored digitally several ways. You can choose to store your wallet on a personal device (computer, hard drive, smart phone) where you have responsibility for keeping your bitcoins secure. There are also bitcoin banks and exchange services that will store your wallet for you, supported by an app and web portal to access your account.

 

Each individual wallet has a private digital key or password that should never be shared with anyone. This key allows the owner to approve transactions from their wallet. These transactions are then recorded on a public ledger called the “blockchain.” The blockchain keeps track of every transaction ever made in the network, timestamps them, and stores them to be verified by “miners.” While this information is public, it will only be marked with your wallet ID, an identifier which is unique to you and your wallet. Names of buyers and sellers are not included on the blockchain. 

 

Once you have created a wallet, you have many different choices on how to purchase bitcoins:
 

Once the bitcons are in your wallet and you have your private key, you are ready to start spending.

 

It is important to note that your local bank will not deal directly with bitcoins. If you need your bitcoins converted back to dollars, you will need to have the bitcoins exchanged for dollars through one of the above methods.

 

 

While this new technology can be intimidating to some, early adopters are enjoying its global functionality and freedom from authority.  

 

Bitcoin banks and exchanges have become high-value targets for hackers, who have stolen millions of dollars-worth in bitcoins. The largest bitcoin exchange, Mt. Gox, once held more than 70 percent of all bitcoin trade. It was hacked in 2014, and about 800,000 bitcoins worth more than $600 million were stolen. More recently, Bitfinex  fell victim to hackers who stole nearly 120,000 bitcoins worth about $72 million.

 

So, how do these losses affect individual bitcoin owners? The Mt. Gox hack, which remains the largest bitcoin heist ever, caused the exchange to file for bankruptcy. Individual investors will likely never see their funds returned. In the case of Bitfinex, the virtual bank applied a generalized loss percentage to assets of all its account holders, with no reimbursement planned.

 

Not only do these hacks impact the bitcoin banks, exchanges, and their account holders, such drastic losses often prompt an overall decrease in the value of bitcoins across the world. In general, bitcoin values fluctuate often, but hacks such as these can cause a more severe drop in price.

 

Without insurance protection from a government entity such as the Federal Deposit Insurance Corporation (FDIC) or the Securities Investor Protection Corporation (SIPC), many people have experienced significant financial losses. Personal insurance policies, such as a homeowner’s policy, generally offer only a small amount of coverage for theft of money or securities. These policies should not be relied on to provide adequate protection in the event of a virtual currency loss. There are some insurance products available in the high net worth personal insurance marketplace that may provide higher limits of coverage against fraud. However, these policies contain exclusions and coverage may not protect against losses related to virtual currency, including losses due to financial performance and loss in value.

 

It can take time for laws and insurance products to respond to the new realities of risk and virtual currency is no exception. Your insurance advisor will be able to assess any potential exposures to your actual or expected use of bitcoins.

 

 

 

However, bitcoins can be infinitely divided into smaller pieces or percentages. For example, a cup of coffee might cost 0.003 bitcoin.

 

 

 

If you decide that bitcoin makes sense for you, make sure to do your research. Deal only with reputable bitcoin banks and exchanges, know who you are buying from, find out what policies retailers have regarding refunds and returns, and make sure you are comfortable with the risks. The more you know, the better you can protect yourself.