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The Bitcoin Bubble, and the Undoubted Debt that will Follow its Burst

September 20, 2018

We know that you likely engaged in many heated conversations over dinner about Bitcoin, and probably have developed some sort of position about it, while at the same time secretly not really understanding what Bitcoin actually is. Don’t worry; we've got you covered.

 

Let’s start with a cursory definition of Bitcoin.

  • Bitcoin is a cryptocurrency or a digital token, bearing no backing from any government or bank, that can be transferred, traded, and purchased electronically from users all around the world. Launched in 2009, Bitcoin was developed by a person under the alias Satoshi Nakamoto.

  • Bitcoins are stored in a “digital wallet” which exists either in the cloud or on a user’s computer. The wallet is a kind of virtual bank account that allows users to send or receive Bitcoins, pay for goods or save their money.

  • New Bitcoin are introduced into circulation by a sort of computational competition to process new transactions coming onto the network by solving mathematical puzzles, and recorded in an electronic ledger called “the blockchain.” This process is called mining. With each new transaction that is validated, miners are rewarded with Bitcoin. By design, there is a finite amount of potential Bitcoin to be mined. A decentralized and anonymous network of computers around the world runs the cryptocurrency system.

 

Why is Bitcoin such a source of contention?

  1. Criminals and anarchists prefer Bitcoin to traditional currency. They prefer Bitcoin because it’s a 'somewhat' secure system for storing and exchanging money anonymously and there is no governmental or banking affiliation. Although the stress here should be on ‘somewhat’ secure leading into our next major issue;

  2. Bitcoin holds the very real possibility of being hacked by said criminals. There have been few notable instances over the last couple of years. Hundreds of thousands of dollars have disappeared out of the peoples Bitcoin Wallets.

  3. On top of that a Bitcoin wallet is especially vulnerable due to the fact that it isn't insured. The CFTC and Securities and Exchange Commission have both warned of the need to combat and beware of fraud in the virtual currency wild west. Unlike bank accounts, the FDIC does not insure Bitcoin wallets. (Although there are some exchanges where cryptos trade that are insured by the FDIC, namely Coinbase, and the Winklevoss twins’ exchange, Gemini, among others.)

  4. Bitcoin is a bubble. Value investing guru Warren Buffet’s remarks describing Bitcoin as a bubble that will pop, also contributes to the public's apprehensive attitude, “I can say almost with certainty that they will come to a bad ending, when it happens or how or anything else, I don’t know.” Even Google, Facebook and Twitter have banned advertisements from cryptocurrency related ads in an attempt to protect from possible consumer harm that they feel is imminent on the cryptocurrency platform. 

To sum up the major contentions surrounding Bitcoin: (1) it is the ‘preferred’ currency of criminals (2) it’s hackable (3) it’s not backed or insured, and (4) many credible individuals and institutions view it as a bubble. 

 

Crypto Regulation

From a legal perspective, regulation of cryptocurrencies in the United States is still in its early stages. While in Japan, its biggest market, it is considered legal tender, in the U.S., its second biggest market, “virtual currency does not have legal tender status in any jurisdiction” (according to the bureau of the Treasury Department). To this day, Congress has not passed any laws directly addressing Bitcoin, or any other virtual currency, and U.S. regulators differ in their views of digital currency as a security, commodity, or property.

 

The Securities and Exchange Commission indicated it views digital currency as a security, like a stock or a bond. While, Federal U.S. district judge Jack Weinstein in Brooklyn, New York ruled that virtual currencies like Bitcoin can be regulated as commodities by the U.S. Commodity Futures Trading Commission. At the same time, the IRS views cryptocurrency as property and issued a guidance in 2014 on how it should be taxed. In summation, it is currently unclear under which federal regulators will win this debate.  

 

Why would a cryptocurrency bubble burst lead to debt and a possible financial crisis?

Optimists would say that it wouldn’t, because bitcoins worth is controlled by an elite class of outrageously wealthy Silicon Valley top guns and therefore wouldn't affect the economy at large. “Most of bitcoins value is held by a few thousand very, very wealthy people who would simply become a bit less wealthy. I would expect no meaningful general impact." speculates Ari Paul, an analyst for BlackTower Capital, a cryptocurrency investment firm.

However, this ignores the fact that according to Cointelegraph, 22% of bitcoin investors used borrowed money to purchase bitcoin. Individuals took out mortgages, used credit cards, and took out equity lines to buy cryptocurrency. “Buy Bitcoin with credit card” was even trending on Google at some point. This means there is a massive amount of people accumulating virtual currency on borrowed money, and when the crypto-craze bubble undoubtedly bursts this will have serious financial repercussions.

 

If enough people got into debt to invest in cryptocurrency, and cannot pay back the debt when the bubble bursts, this can spiral through the system and cause a financial crisis. Financial pundits are quick to compare this to the housing bubble that created the financial recession in 2008 or the dot com bubble burst in the ‘90s. This dreaded reality seems to be coming sooner than people think with June 24th, 2018 reflecting Bitcoins newest lows at $5,845.45 a unit, compared to its all-time heyday in December 2017 at nearly $20,000 a unit. Bitcoin has recovered slightly as of today August 13, 2018 at $6,225 and will surely continue with its rises and falls for some time. But its extreme volatility only reinforces general uneasiness in the future of the cryptocurrency and highlights the looming burst that is to come.

 

How will the Debt Collection industry respond?

How the debt collection industry will respond to the burst remains to be seen. One thing is for certain though, blockchain technology insures a certain level of anonymity to users, therefore this will likely cause great difficulty for creditors to track down who is beholden to the cryptocurrency debt. This will surely lead to a more vigorous and agressive skip-tracing industry. It will be interesting to see what level and types of proof a court will require to prove a transaction had indeed occurred. However, the technology is not truly anonymous. If a user trades Bitcoin for a national currency, or purchases something with bitcoin, their identity can be traced through that transaction. If you transact with Bitcoin, make sure to keep a trial of documentation.

 

Here at Witkes Law Firm we are curious and cautious about how cryptocurrency will affect the future of the debt collection industry. Based in Columbus, Ohio we pride ourselves in our modern and innovative approach to collections. We encourage our clients to think critically before jumping into the cryptocurrency wild-west, and strongly discourage any purchases on borrowed money. Our philosophy remains steadfast and grounded in our subject matter expertise, seamless collaboration of the collections process, and deep professional value system. Reach out to our team to find out how we can help you.



 

 

 

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