Financial market regulators and central banks around the world regularly warn consumers about the risks related to virtual currencies such as Bitcoin.

The Autorité des marchés financiers (the “AMF”) has already raised awareness among investors about the fact that the anonymity of virtual currency transactions can make it easier for fraudsters to lure investors.

What are virtual currencies like Bitcoin?

Virtual currency, or cryptocurrency, is similar to money but is not legal tender. In Canada, the only currency that is legal tender is the Canadian dollar, although transactions may in some cases be settled in another currency (e.g., in U.S. dollars) following an agreement between the two parties involved.

Bitcoin is the most widespread and best known virtual currency. It is a peer to peer, “decentralized” payment system.

  • Contrary to money that is legal tender, Bitcoin is not issued by a central bank or government.
  • No financial institution is involved in the transaction.

Several other virtual currencies are also not legal tender, such as ORObit, Litecoin, Namecoin, Peercoin, Quark and Dogecoin. They all have similar features and carry the same risks as Bitcoin.

How do virtual currencies work?

Virtual currencies can be earned or purchased.

They are issued and managed according to unique and complex open source code algorithms. The algorithms are defined by individuals called “miners” using powerful and sophisticated computers. In exchange for their services, miners are awarded virtual currency units that can be exchanged. Someone who wishes to obtain virtual currency units without participating in these “mining” activities must purchase them.

A cryptocurrency has two keys:

  • The first one, called the “public key,” confirms the existence and unique identifier of the virtual currency unit.
  • The second one, called the “private key,” is the equivalent of a secret code which the owner stores in a digital wallet.

Once the digital wallet is set up using software or platforms intended for this type of trading, users can buy goods or services, and trade or transfer virtual currency. These types of transactions are done pseudo-anonymously due to the keys used.

When making a payment, owners of a virtual currency unit validate their currency unit with the private key. The transaction is then submitted to a network of miners who confirm the owner of the virtual currency unit, validating the transaction and the transfer to the new owner.

What risks are associated with virtual currency?

The following risks are related to the use of virtual currency:

Volatility risk

The value of a virtual currency is determined by the public’s interest in it and is based strictly on supply and demand. Media coverage of a virtual currency can have a major impact on its value over a short period of time without any official organization or mechanism controlling the volatility. For example, at the end of August 2017, Bitcoin was worth US$4,748, but decreased at US$3,320 on September 13, 2017 (source: blockchain.info).

Liquidity risk

It can be difficult to trade a virtual currency for money that is legal tender. The trading channels such as platforms are not overseen by official regulators or central banks. The bid-ask spread is often very wide due to speculative trading in virtual currencies.

Technological and operational risk

Virtual currency may be exposed to hacking and theft.

The security of digital wallets and virtual currency trading and transaction platforms is not guaranteed. Users may be exposed to theft and total loss of assets.

Legal risk

Virtual currencies are not regulated. There is also no legal framework to protect consumers who buy goods or services using virtual currency.

Risk of participating in criminal, terrorist or fraudulent activities or money laundering

Virtual currencies have been associated with fraud, money laundering and criminal or terrorist activities.

If you want to speculate on the price of a virtual currency or transact business using a virtual currency

Make sure you understand the characteristics of these currencies and the risks you will incur.

Warning

No protection

The AMF wishes to stress that transactions involving virtual currency are not covered by the financial services compensation fund or the deposit insurance fund.

You should therefore use caution when making virtual currency transactions as you could incur losses.

End of the warning