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The risk of bitcoin

bitcoinYou cannot pick up a newspaper these days without reading about bitcoin and the other digital currencies that are vying to be an alternative to traditional fiat money issued by nation states. The price of a bitcoin has skyrocketed this year. If only we had ditched the stock market and put all of our coin in bitcoin last January.

But, some business writers are starting to question the premise of digital currencies. The latest skeptic is Andrew Ross Sorkin writing in the New York Times. Sorkin hints at the problems, but I find that even he understates the risks, both of the currency itself and potential problems for organizations that choose to trade in and support digital currencies. 

Sorkin appropriately asks whether the purported limit on the total number of bitcoins to be issued (as proposed by bitcoin’s anonymous founder) is enforced by any central banker like Ben Bernanke. True that. But, Sorkin fails to close the loop. The anonymous source of bitcoin has every incentive to change his or her mind and to issue more bitcoins. Why should anyone in commerce trust an unnamed and unregulated printer of currency, particularly a printer who has every incentive to profit by increasing supply surreptitiously or otherwise? An unexpected increase in supply of bitcoins while demand stays constant will result in a sudden and painful crash.

Of course, the more clever feature of bitcoin is not its supposed scarcity but its supply chokehold that requires bitcoin holders to “earn” their coin by solving complex mathematical puzzles. Somehow this meritocratic task leads, I think, to an enhanced sense that bitcoin has an inherent complexity. And complexity means it is not just some simple scam, right? And now there are big brands like Virgin Galactic that will accept the coins (immediately turning them to real currency) in an act that gives bitcoin more legitimacy and gives free publicity to Virgin, as Sorkin notes. But, again, Sorkin fails to make the key distinction between nation state fiat currency and digital currencies. Currency of the United States, for example, is backed by all of the assets of the country – all the government-owned land, buildings, airplanes, and computers (well, maybe not much value on the healthcare.gov computers, but you get the idea). Bitcoin is backed by – nothing.

So, what’s all this have to do with insurance and risk, the subject of this blog? Plenty. Financiers who promote bitcoin and other digital currencies stand to get hit when this currency collapses for the failure to use professional judgment to advise clients to stay away from it, a professional liability risk. For retailers who accept the currency as payment, they may find themselves holding the bag with a useless currency. It is no different than having a masked gunman enter the store and steal your cash. Except, you can buy insurance for losses from the masked gunman, probably not for bitcoin losses. In short, if you choose to engage in the bitcoin craze, give your insurance broker a call. There are risks that we have not even begun to consider depending upon your usage. Better yet, stay away, unless all you want is some publicity. And remember that even publicity can turn into a Madoff type story later on down the line.


About the Author

Phil Edmundson is the Chairman and CEO of William Gallagher Associates, insurance brokers and consultants for businesses with over 30 years in the insurance industry. He manages strategy, talent acquisition and development, and management / acquisitions at WGA.

617.646.0229 | PEdmundson@wgains.com | Connect with Phil on LinkedIn |
Follow Phil @PhilEdmundson
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