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Earlier we wrote an introduction into trading digital currency and Bitcoin (BTC). One of the most important parts of trading and investing, in general, is knowing the risks involved. When trading virtual currency, it is especially crucial to choose the right exchange, follow relevant world events and understanding where and how to appropriately store your digital money.

Trading Digital Currency and Government Regulation

As was mentioned before, virtual currencies are not recognized or regulated directly by governments. This had led to some recent clashes; the most notable with the US government.

Just last week a major digital currency exchange system, Liberty Reserve, was shut down. Its owners were charged with money laundering for failing to comply with the Know Your Customer (KYC) and other Anti-Money Laundering (AML) regulations regarding the nature of the transactions into their currency. Investigators claimed that they were able to create and utilize accounts with bogus names. Prosecutors claimed the service was mainly being used anonymously to conduct criminal activities.

Liberty Reserve was a different type of digital currency trading system than Bitcoin in that it’s ledgers were centralized. The trading between US dollars or Euros were performed by external exchanges and not by the reserve itself. These exchangers charged a high level fee to exchange in and out of the Liberty Reserve system. Being that these internal transactions could be sent completely anonymous, those looking to conceal and launder the proceeds of illegal activities would be willing to pay the excessive internal and external exchanger charges.

Bitcoin has recently suffered dissimilar setbacks in the regulation of its largest exchanges. In the past month, the largest Bitcoin exchange MtGox had its US accounts seized because the owner failed to declare that he was operating a Money Services Business (MSB). The exchange continues to operate, but it is difficult for Americans to retrieve their deposits in dollars instead of Bitcoin.

Bitcoin and newer cryptocurrencies don’t suffer from many of the same problems as Liberty Reserve because the currency itself is decentralized much like modern P2P (Peer to Peer) filesharing clients. It is also much easier to exchange between these coin and fiat currencies as the fees are much lower than bank wires or paypal. Finally, all transaction records are public and can be traced back, giving the so there is more of an argument to use Bitcoin for legitimate purchases.

Staying Secure While Trading Digital Currency

One of the consistent ongoing threats to using a digital currency is the threat of losing an investment to hackers. Bitcoin has proven itself very resilient to all hacking attempts on the currency. Since 2008 there has been no way to counterfeit Bitcoin and no one has managed to spend the same coin twice. This is a major reason the value has been so resilient to other negative news.

While the currency itself is secure, the exchanges have proven to be anything but secure. Nearly every major exchange has experienced theft of some amount of Bitcoin either through an internal security breach by a disgruntled ex-employee or through outright hacking attempts by various groups. As Bitcoin can’t be charged back, there is no way to “freeze” this money. The best attempts out there are to trace its public record of transactions and try to block stolen Bitcoin from trading on large exchanges, much like the US government can flag serial number ranges on paper money.

Another attack on the exchanges has been via a Distributed Denial of Service (DDOS) attack, where a hacker controls a large number of compromised computers and floods the exchange with various commands and requests. The exchange becomes bogged down and trades begin to lag significantly. This makes it difficult for the order book to fill up and the spreads increase. In the most recent significant price drop hackers were able to manipulate the perceived value of Bitcoin by stalling the major exchanges and causing a price drop, then ceasing the attacks and letting the value rise again.

For end-users of virtual currency it is advised to keep a “cold copy” of their digital wallet encrypted in a USB drive or burned to a CD. Virtual currency is most vulnerable when stored at a third-party or kept accessible by a internet connection. Loss of personal funds usually happens in one of two ways:

A local copy of a Bitcoin wallet gets destroyed by a failing computer or deleted by user error, the coins are not recoverable.

Coins are stolen through a trojan and/or phishing attack on the system. This usually happens on Windows but can happen on other OS by using outdated Java. Once the coins are stolen, again it may be possible to trace, but unlikely to ever recover.

There have indeed been cases in the past year where some users lost BTC wallets worth over $100,000 USD due to poor security practices. Phishing attacks can also rob users of funds stored in third-party wallets or exchanges by tricking them into entering their login details to a fake page.

Moving Forward

Despite the above risks, trading digital currency like Bitcoin can be an exciting way to diversify your investment portfolio especially if you already engage in forex trade. Many of the above risks can happen with traditional brokerage accounts if the investor has poor security practices and fails to keep an updated system. Contrary to the above setbacks, the market for virtual currency continues to grow and is expected to continue to do so.

Are digital currencies like Bitcoin too vulnerable to theft? Would you invest in Bitcoin or are the risks of being hacked too high?

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