In recent years, virtual currencies such as bitcoins – and the huge gains these digital tokens have achieved – have made headlines globally. They started as virtual currencies but some have evolved to involve investment schemes.

Before you rush in, you should heed the advice of financial experts and the authorities who are urging investors to understand the potential risks of these complex products.

On Thursday, the Commercial Affairs Department (CAD) and the Monetary Authority of Singapore (MAS) warned retail investors not to throw caution to the wind when dealing with such investment schemes. They noted the emergence of initial coin (or token) offerings (ICOs), and other investment schemes involving digital tokens here. Some recent ICOs were TenX in June and Cross Coin last month.

Since 2015, a little over 100 police reports have been filed here involving five such investment schemes. And since January last year, the Consumers Association of Singapore (Case) has received five complaints over digital currencies, such as bitcoin. The complaints focused on the lack of payouts after investing or unsatisfactory services.

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The consumer advisory follows a recent clarification from MAS on its regulatory stance on digital tokens. MAS had said that the current securities regulatory framework requires that any offering of shares, debt instruments, or units in a collective scheme will have to comply with prospectus requirements, or exemption requirements (if any are applicable).

The statement “was a strong reminder, to clarify to the market that transactions falling within one of the above categories would be regulated. This is to ensure that the market understands that just because there’s a cryptocurrency, digital token or blockchain element, it does not exempt it from regulations”, said TSMP Law Corporation joint managing partner Stefanie Yuen Thio.

Singapore University of Social Sciences (SUSS) Professor David Lee said he has invested in digital tokens not to get good returns, but to learn and be involved in the digital token community. He declined to disclose the sum he had invested.

“I enjoy the inclusive nature of the community and the potential of blockchain… The invested amount will not prevent me from sleeping. If returns come, then (it shows) you are good at identifying what technology will scale and which will benefit mankind and be very valuable,” he said.

Simply put, a blockchain is a way to maintain a database without a central authority.

According to financial research provider Autonomous Research, more than US$1.2 billion (S$1.6 billion) in cryptocurrency was raised through ICOs in the first half of this year around the world.

Besides hoping for high returns through appreciating token prices, advocates of digital tokens see the new technology as an enabler of the growth of community projects, particularly in areas where financial services infrastructure is lacking. Others like the transparency and liquidity opportunities.

Potential pitfalls

Like any investment product, it is prudent to understand it first. When sellers of digital tokens fail to highlight the risks, consumers should make the effort to find out more information about the underlying project, business or assets. Look out for these eight risks.

1. FOREIGN AND ONLINE OPERATORS

The CAD and MAS warned that you are exposed to heightened risk of fraud when investing in schemes that operate online or outside Singapore as it would be difficult to verify their authenticity.

Should the scheme collapse, it would be difficult to trace the scheme’s operators. The recovery of invested monies may also be subject to foreign laws or regulations, which may not be the same as Singapore’s.

Mr Low Kah Keong, a partner at WongPartnership, said: “It will be difficult to get an effective legal remedy if an issuer breaches its promises but has no substantive assets in Singapore to compensate an investor who obtained a court judgment.”

2. SELLERS WITHOUT A PROVEN TRACK RECORD

Sellers of digital tokens may not have a proven track record, making it hard for one to establish their credibility. As with all start-ups, the failure rate tends to be high.

3. INSUFFICIENT SECONDARY MARKET LIQUIDITY

Even if digital tokens are tradable in a secondary market, in practice, there may not be enough active buyers and sellers or the bid-ask spreads may be too wide. This means you may not be able to exit your token investments easily.

In the worst-case scenario where no secondary market develops, you may not be able to liquidate your token holdings at all. The exchanges or platforms that facilitate secondary trading of digital tokens may not be regulated by MAS.

4. HIGHLY SPECULATIVE INVESTMENTS, PRICE VOLATILITY

The valuation of digital tokens is usually not transparent, and is highly speculative. Transparency could be limited as there might be little publicly available information that could help you gauge the fair value of the virtual currency.

This could lead to speculative forces driving up unit prices resulting in volatile price swings.

Where digital tokens do not hold any ownership rights to the seller’s assets, the digital tokens would not be backed by any tangible asset. Such tokens would be merely speculative investments and their traded price can fluctuate greatly within a short period of time.

There is a high risk that you could lose a portion or your entire investment amount. In the worst-case scenario, the digital tokens could be rendered worthless.

5. INSUFFICIENT SECURITY PRECAUTIONS

The platforms or persons you deal with may not have taken enough security precautions and this could lead to theft through hacking.

For example, in the case of bitcoin exchange Mt Gox, 850,000 bitcoins were stolen in February 2014 (valued at more than US$450 million at the time), leading to its subsequent bankruptcy and closure.

6. FRAUD AND SCAMS

Fraud has also occurred in relation to companies that claim to offer virtual currency payment platforms and other virtual currency-related products and services.

For example, in December 2015, the United States Securities and Exchange Commission charged two bitcoin mining companies with conducting a Ponzi scheme.

7. INVESTMENTS PROMISING HIGH RETURNS

Be wary of investment schemes involving digital tokens that promise high returns. The higher the promised returns, the higher the risks.

High returns could come in the form of high referral commissions, that is, promising consumers benefits for referring additional participants. In fact, such commissions would increase operating costs, which could lower the chances of achieving the returns.

8. MONEY LAUNDERING AND TERRORIST FINANCING

Funds invested in investment schemes involving digital tokens are prone to being misused for illegal activities due to the anonymity of transactions, and the ease with which large sums of monies may be raised in a short period of time.

As such, you would be adversely affected if law enforcement agencies investigate any alleged illicit activities related to the token investment scheme you have invested in.

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