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The user risks in this category exist because of the technology underlying VCs and their general features.
This risk arises when the conduct of employees of an exchange falls short of reasonable expectations by consumers; the exchange is not legally incorporated in a jurisdiction and cannot therefore be subjected to regulatory requirements; the corporate governance responsibilities of the exchange’s senior management are unclear; and/or its business activities are not subject to an independent audit. The priority of this risk is high.
The risk can arise because anyone can anonymously create (and subsequently change the functioning of) a VC scheme. Anyone can set up and call themselves an exchange, and exchanges may not necessarily be registered entities subject to licensing or authorisation requirements. The priority of this risk is high.
Several different drivers can create this risk, including that VC markets, and the price formation therein, are relatively opaque, and that the VC price formation on exchanges can easily be manipulated, including by a concerted effort of a small number of large VC holders. Denial of service attacks may prevent processing of transactions, which can further exacerbate the problem. Finally, in the case of decentralised VC, there is, by design, no central authority that could intervene to stabilise exchange rates. The priority of this risk is high.
The legal and regulatory treatment of VCs is unclear and inconsistent, as is their tax treatment. The taxable event and geographic location of the taxable event may also be unclear. This may potentially lead authorities to treat VCs as property, forcing users to track and pay capital gains. The priority of this risk is medium.
The inevitable lack of standards and definitions found in innovative products and services makes it difficult for users to gauge the features of a particular VC scheme. The units of the VC scheme bought may even transpire to be different from the expected scheme. The risk arises because anyone can anonymously create (and subsequently change the functioning of) a VC scheme, any computer file can be misrepresented as a VC and any scheme name can be given to that file, including the name of an existing, genuine VC. Once the user detects the misrepresentation, they will be unable to reverse their decision as VC transactions are not reversible, the counterparties are anonymous, no legal contracts exist, and no complaints procedures are in place. The risk is of medium priority.
The risk arises because anyone can anonymously create (and subsequently change the functioning of) a VC scheme. The software protocol that controls the VC scheme is not subject to any independent standards and can be changed once a majority of miners agree. These changes may accidently introduce errors, or miners may not necessarily act in good faith. The priority of the risk is high.
The decentralised and unregulated nature of VCs makes it difficult for users to access independent and objective information that would explain the risks arising from holding VCs. Some users may also have unfair information advantages, and the emergence of new VCs will affect the incumbents, and their prices, in unpredictable ways. The priority of the risk is low.
The regulatory and legal treatment of VCs is unclear and authorities may change their views unexpectedly, at short notice, and the view may not be communicated sufficiently. The priority of the risks is medium.
The risk arises because e-wallets are software that are stored on the user’s computer or mobile devices. Those devices might suffer from malfunction as might the software itself. Furthermore, their encryption can be hacked, and unlike a conventional FC, this is possible from anywhere in the world. In many VC schemes, the e-wallet is stored unencrypted, making it an even easier target for hacking or theft. Furthermore, the user has no refund right after fraud because there are no safeguards in place, such as a deposit protection scheme for conventional accounts, and because lost or stolen coins cannot be distinguished from unused coins. The priority of the risk is high.
An exchange may temporarily hold users’ VC units but can be hacked. A user may suffer losses because of insufficient security measures implemented by the exchange, because the VC units were held in a separate account, because no own funds are available that could be used to repay users, because the user has no refund rights and because the transaction cannot be reversed. The risk priority is high.
Until governmental and regulatory authorities have formed an opinion on VCs, legal uncertainty remains over any contractual relationships that market participants may have forged. Once authorities have formed a view, these legal contracts may be rendered illegal or unenforceable. The priority of the risk is medium.
The risk arises due to the anonymity of (some) counterparties, the decentralised set-up of VC schemes, the fact that counterparties have insufficient own funds, and that VC markets become temporarily illiquid. The priority of the risk is high.
The risk arises due to the anonymity of (some) counterparties, which can undermine the enforcement of any legal contracts that may exist, the lack of ‘payment vs. payment’ procedures, the lack of settlement finality, the decentralised set-up of VC schemes, the fact that counterparties have insufficient own funds, and that VC markets become temporarily illiquid. The priority of the risk is high.
The risk arises because the custodian is insolvent, behaves negligently or fraudulently, lacks adequate governance arrangements to oversee transactions, fails to keep adequate records, or has inadequate own funds to repay creditors. Also, transactions are not reversible. The priority of the risk is medium.
The anonymity of some market participants and the lack of technological accessibility for others facilitate information inequality and insider know-how that are benefit the former and are to the detriment of the latter. The priority of the risk is medium.
Individuals may use VCs not only as a means of payment for goods and services but also as an investment. The investment may take the form of holdings in VC units themselves or in investment products such as exchange traded funds (ETFs) or contracts for difference (CFD) that use VCs as an underlying asset. The risks arising from these activities are listed below.
The risk arises because of the low depth of VC markets; the ability of concerted action, by a small number of large VC holders, to undermine price formation; the general opaqueness of VC markets; and the absence of any central authority that could intervene to stabilise price formation. The priority of the risk is high.
The risk arises because the lack of regulation of the underlying amplifies any risk taken on by purchasing the regulated investment product, such as a collective investment scheme (CIS), derivative or structured products. In addition, the investment products are highly complex, the returns are uncertain, and the underlying is opaque. The priority of the risk is medium.
The risk arises because the trading, market activity, market making, settlement and clearing on exchanges across the world are not subject to independent standards that would usually ensure there are reliable and consistent exchange rates. Furthermore, price formation in VC markets is opaque and subject to manipulation, and the execution of buy and sell orders lacks transparency. The priority of the risk is medium.
The risk arises because the individuals involved in the underlying asset can conceal their identity and are therefore not subject to any probity requirements, nor are they required to disclose the risks to which the investor is exposed, etc. Furthermore, the nature of VCs leaves investors more vulnerable to abuse by a Ponzi scheme based on VCs than other, regulated forms of investments. Finally, the user may have no access to redress schemes. The risk is of medium priority.
The risk arises because the trading, market activity, market making, settlement and clearing on exchanges across the world are not subject to independent standards that would usually ensure there are reliable and consistent exchange rates. Instead, the price of a unit of a particular VC scheme depends on the extent to which it is adopted and accepted as mainstream, which is uncertain. Furthermore, the market depth (i.e. the size of an order needed to move the market price by a given amount) is low, price formation in VC markets is opaque and subject to manipulation, and the execution of buy and sell orders lacks transparency. The priority of the risk is medium.
The risk arises because VC exchanges tend to be cash poor. As a result, investors may find it difficult to sell the VCs when they want to, so as to prevent a loss or to make a profit. Furthermore, the low market depth gives rise to an increased execution risk, (i.e. that the order is not executed at the price expected by the user).
Following risks are inherent to Virtual currency savings accounts: