CFPB Warns Of Virtual Currency Dangers

Much debate on cryptocurrencies has gone on over the past few years, driven by the cult-like following of Bitcoin and the general transaction anonymity most of the so-called virtual currencies support that has led on occasional to illicit use. In fact, many countries, cities and even merchants have taken positions on the issue, either through legislation, agency mandate or acceptance policy.

Now the Consumer Financial Protection Bureau (CFPB) has stepped in, offering its views on digital currencies for the first time. The U.S. General Accountability Office earlier issued a report calling on the CFPB to take up the issue.

The bureau has concerns with how virtual currencies could affect consumers. In its consumer advisory, the CFPB warned consumers about the risks, cautioning them to be aware of such potential issues as unclear costs, volatile exchange rates, the threat of hacking and scams, and that companies may not offer help or refunds for lost or stolen funds.

“Virtual currencies may have potential benefits, but consumers need to be cautious and they need to be asking the right questions,” Richard Cordray, CFPB director, said in the bureau’s advisory announcement. “Virtual currencies are not backed by any government or central bank, and at this point consumers are stepping into the Wild West when they engage in the market.”

Virtual currencies instead are designed to be an alternative to current payment systems. Bitcoin, for example, launched in 2009 as a highly secure digital currency that relies on cryptography to prevent double spending as well as counterfeiting and theft?

The concept is highly sophisticated. In the case of Bitcoin, for example, each transaction is traceable back to the bitcoin’s original creation through a verifiable record of every transfer from one owner to the next, though encryption conceals the identity of the user. A computerized network of bitcoin users automatically verifies that a bitcoin file sent to someone for an online payment wasn’t also sent to someone else, which would flag a problem with the transaction. Once a legitimate exchange is complete, the transaction record is embedded in the file with all earlier ones for verification in the next exchange involving that bitcoin.

Virtual currencies such as Bitcoin enable users to track, store, and send payments online, and they potentially can make payment processing cheaper or faster. But, as the CFPB pointed out, they are not backed by any government or central bank. Moreover, the funds are not insured by the Federal Deposit Insurance Corp. or the National Credit Union Share Insurance Fund. So if a virtual-currency company fails – and many have – the government will not cover the loss, it noted in its advisory.

This issue has been a point of contention for some time, and it seemingly was only a matter of time before the bureau chimed in. Other agencies, including the IRS and the U.S. Treasury Department’s anti-laundering unit, the Financial Crimes Enforcement Network (FinCEN), earlier noted their concerns.

As the bureau pointed out, virtual currency companies are springing up globally to offer products and services to consumers. PYMNTS.com has even interviewed a top executive from one, Adam White, director of business development at Coinbase, who in the March podcast noted that some 26,000 merchants were using Coinbase’s payment tools. Many virtual currency exchanges are also digital wallet providers.

In its advisory, the bureau cautioned consumers of the highly volatile nature of virtual currency exchange rates, often the result of investor prospecting but also because of hacker attacks, fraud and other issues.

“Consumers who buy virtual currencies should be prepared to weather this kind of volatility,” the bureau noted. “Consumers should also consider whether there are markups or other fees when using an exchange or digital wallet provider. Companies may be charging consumers to buy, spend, or accept virtual currencies.”

In addition, sophisticated hackers and scammers pose serious security threats to virtual currencies, and individuals, digital-wallet providers and exchanges are all at risk, the bureau said.

“For example, if a hacker gains access to a consumer’s Bitcoin “private keys,” which are 64-character codes that unlock the consumer’s funds, the consumer can lose all their virtual currency,” the agency noted in its advisory. “Fraudsters are also taking advantage of the hype surrounding virtual currencies to pose as bitcoin exchanges, bitcoin intermediaries, and bitcoin traders in an effort to lure consumers to send money, which is then stolen.”

Once lost or stolen, the opportunity to regain bitcoins is no sure bet, the bureau stressed in its advisory. “Some virtual currency companies do not identify their owners, provide phone numbers and addresses, or even specify the country in which they are located,” the agency said. “If a consumer trusts a company to hold their virtual currencies and something goes wrong, the company may not offer the kind of help the consumer would expect from a bank, debit card, or credit card provider. In fact, some virtual currency companies disclaim responsibility for consumer losses if funds are lost or stolen.”

Consumers who encounter a problem with virtual currency products and services, including exchange services or online digital wallets, can now submit a complaint with the bureau, which will send it along to the appropriate company and work to get a response. The bureau will forward complaints outside its jurisdiction to the appropriate federal or state regulator.

The bureau’s other intention is to use all complaints it receives to better understand the virtual currency market and its effect on consumers. It will then to use them to help enforce federal consumer financial laws and, when appropriate, take consumer protection policy steps.

For more background on Bitcoin, read David Evans’ bitcoin series.