Recently, the rise in the price of bitcoin has been much reported in the news. Bitcoin, the best known of the cryptocurrencies, was originally developed as a means of payment. Currently, however, it appears that bitcoin and other cryptocurrencies are primarily used as speculative investments and their use for payment is secondary.
Evidently, the pursuit of quick profits has motivated individual citizens, who are buying bitcoin and other cryptocurrencies. The risks associated with investing in cryptocurrencies are not fully recognised, however. For this reason, the Financial Supervisory Authority is warning consumers about the risks associated with cryptocurrencies.
Bitcoin and other cryptocurrencies are highly speculative investments. There is no solid foundation to their value formation. Moreover, no-one pays a real return, such as a dividend or interest, on bitcoin. The expected return is based solely on the expectation that someone will purchase the investment later at a higher price. This type of investment activity always involves significant risks. The market prices of bitcoin and other cryptocurrencies have been extremely volatile. In addition, some cryptocurrencies have been created for fraudulent purposes.
Those considering investing in ICOs should carefully weigh the risks
A phenomenon called ICO (Initial Coin Offering) is also associated with cryptocurrencies. It means offering a new cryptocurrency, a kind of “token”, in exchange for financing sought from other businesses or consumers. An investor participates in an ICO financing round by giving the seeker of finance either official currency or some cryptocurrency, and receiving in return a new issued cryptocurrency. The terms of an ICO and how it is structured depend on what the new cryptocurrency can be used for. Sometimes it can be used to pay for the issuer’s current or potential future services or products, and sometimes the intended use of the new cryptographic currency is unclear.
The European Securities and Markets Authority (ESMA) has expressed its concern about investors’ growing interest in participating in ICO financing rounds. In ESMA’s view, the following risks are associated with ICOs:
- An ICO might be unregulated. Regulations protecting investors may not necessarily apply to ICOs, and several ICOs have been identified as frauds.
- Risk of complete or partial loss of capital. There is a high risk of losing all of the invested capital.
- Extreme price volatility. In the absence of a secondary market, it may be impossible to find a buyer for the acquired cryptocurrency if the investor wishes to dispose of it.
- Inadequate information: the information made available to investors is often incomplete, unbalanced or even misleading.
- Technology risks: the technology may not function quickly and securely.
The Financial Supervisory Authority urges those planning to invest in cryptocurrencies to carefully weigh the above-mentioned risks and to find out from the organisers of ICOs the terms of investment before making a final investment decision.
In December 2013, the European Banking Authority (EBA) also warned consumers about bitcoin and other cryptocurrencies. In the warning, the EBA highlighted a number of risks, which are still valid, associated with buying, holding or trading bitcoin and other cryptocurrencies, such as:
- Consumers may lose their money on the exchange platform
- Money may be stolen from digital wallets
- Consumers are not protected when using cryptocurrencies as a means of payment. Legislation does not provide the same protection as for transfers from a conventional bank or other payment account.
- The value of a cryptocurrency can change quickly and could even drop to zero
Those planning to organise an ICO must be aware of the relevant regulatory requirements
ESMA has also issued guidelines for those planning to organise ICOs. Organisers must find out whether some regulatory requirement is applicable to the ICO. Regulatory requirements applicable to the ICO are determined according to the how the ICO is structured. The ICO may, for example, be subject to crowdfunding regulations, securities legislation, regulations on alternative investment fund managers or it may also be structured such that it falls outside the regulated space.
For further information, please contact:
Hanna Heiskanen, Senior Digitalisation Specialist (Wednesday 22 November, from 14.00). Requests for interviews are coordinated by FIN-FSA Communications, tel. +358 9 183 5030, weekdays 9.00–16.00.