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Executive summary:

  • Bitcoin is a huge potential financial "iceberg," that has the majority of its risks hidden and yet to be discovered.
  • Had companies used Mt Gox as their Bitcoin "wallet" the results could have been catastrophic.
  • People considering investing in public companies that accept and hold Bitcoins should evaluate its balance sheet carefully for its "Bitcoin Risk."
  • From the 12/31/2013 balance sheet, it looks like Overstock may have dodged a bullet of epic proportions by not fully embracing Bitcoin.

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I wrote my first article about Bitcoin in April 2013 warning of the risks and likely fraud that was inherent in the Bitcoin ecosystem. Well, almost a year later that article couldn't have been more prophetic. When I wrote that first article, the Bitcoin was trading at $140, and the Bitcoin continued to go much higher, but I never waiver in my conviction that the Bitcoin was going to go down, and it was going to go down hard. I continued to write about the risks involved and flaws inherent in the Bitcoin system, and I got countless comments and messages about how wrong I was and how I "just didn't get it." Well, today the Bitcoin is trading at $131 US dollars on the Mt Gox exchange, below where it was when I first started to write about the Bitcoin about a year ago, and things look to be getting worse.

To be fair, the Bitcoin is still trading around $600 on other exchanges, but that is for now. Mt Gox has reminded the world what I've been warning about all along, there is no Federal Reserve in the world of Bitcoin, there is no lender of last resort, there is no SEC to prosecute crime. The Bitcoin was designed to shun all those safety nets we have built into our current system. Bitcoin is built upon the belief that the lawless wild wild West was the ideal place to set up an unprotected bank vault. The people that have accounts at Mt Gox have just discovered on an epic scale just how infinitely foolish that concept was, is and forever will be. Many of those Bitcoins being held hostage at Mt Gox, if they even still exist there, could have cost $1,000 or more, and now all they can hope to get out of them is $131.

While there are many articles out today warning that the stock markets look like 1929, the far better analogy would be the 1931 bank run on New York's Bank of the United States which kicked the Great Depression into high gear and Mt Gox today. While Mt Gox and Bitcoin aren't large or significant enough to pose a threat to our National or global economy, a Mt Gox bankruptcy could certainly trigger a catastrophic run on the Bitcoin and cause an ecosystem depression.

Welcome to the world of bitcoin, the Wild West of finance, a place where hackers and scandals and insane price fluctuations are just part of doing business. Mt. Gox, a digital currency pioneer that was once the world's largest bitcoin exchange, is imploding before our very eyes. Investors who have accounts with the exchange are selling their bitcoins, even though they may have trouble getting hold of the proceeds. That's because they suspect - not unreasonably - that if the company does go bankrupt, it will be easier to retrieve their stranded funds as U.S. dollars rather than as bitcoins.

There is no FDIC insurance to protect the Bitcoin account holders from loss, there is no Federal Reserve to "bail out" Mt Gox with emergency liquidity loans, there is absolutely nothing in the system to prevent the panic at Mt Gox from spreading to the other exchanges. Right now I'm watching CNBC and they are highlighting how Bitcoin is trading down $122, or 17%, on the other exchanges.

The real problem I see isn't that some Bitcoin account owners may lose their Bitcoins and some money, the real problem I see is who those account holders may be and most likely are. Many of those Bitcoins were likely used for transactions on the now defunct Silk Road buying drugs, sex, child pornography and paying for murders. You simply don't tell the Russian mob or Columbian drug lords that their Bitcoins have been stolen. A Mt Gox bankruptcy may protect the CEO and employees of Mt Gox from their creditors, it will do nothing to protect them from the criminals whose accounts were and remain frozen. Any retributions against the CEO or employees at Mt Gox would likely send a crippling message to the Bitcoin ecosystem. Dealing with Bitcoin isn't only financially risky, it means dealing with criminals who bring a whole new level of risk to the table.

I don't think most people and companies understand that concept now, but I doubt they will want anything to do with the Bitcoin once that message is clearly understood. Each Bitcoin "blockchain" is likely a ledger of mostly criminal transactions. Did Marc Andreessen really think through this concept before he threw his support behind the Bitcoin? Bitcoin "blockchains" are public ledgers of the Bitcoin's transactions. Do CEOs (i.e. deep pockets), like Overstock's Patrick Byrne or Virgin Galactic's Sir Richard Branson really want to risk being dragged into court cases where they have to defend themselves and their companies for accepting Bitcoins that were earned through illegal activities like prostitution, drugs and murder for hire? Unlike physical cash which has no ledger, the Bitcoin does. Who knows how a slick lawyer can use that public ledger to their advantage, I for one would never want to find out. Would Virgin Galactic really risk a public lawsuit defending itself for accepting and keeping money earned in the child pornography trade? I'm pretty sure they would settle out of court in favor of the slick lawyer.

Additionally, Overstock's CEO is reported to hold millions of dollars worth of Bitcoins. His holdings are worth a lot less today than they were just a few weeks ago. Imagine the blow to his company's earnings if the Bitcoins Overstock (NASDAQ:OSTK) accepts aren't immediately converted to cash. Imagine the blow to OSTK's earnings if instead of converting the Bitcoins immediately to cash OSTK instead had deposited them to an account on Mt Gox. Starting to get the picture? Bitcoin is a disaster to any company that accepts it, and does anything other than immediately converts it to cash, and even that transaction will be permanently recorded in a public ledger.

I wrote that above paragraph before checking my facts. I wrote that above paragraph assuming that no publicly traded company in their right mind would ever accept Bitcoin without immediately converting it to cash. I wrote the above paragraph as a hypothetical situation to demonstrate why no publicly traded company would ever accept Bitcoin unless they immediately converted them to cash. I wrote the above hypothetical to highlight the unacceptable risk Bitcoin represents to publicly traded companies.

Well, it turns out my assumptions were wrong, there are publicly traded companies that may actually transact in Bitcoins and not convert them immediately to cash. According to OSTK's most recent earnings conference call, OSTK may be accepting and holding Bitcoins on their balance sheet.

I would also like to mention I said publicly and this is true, this play is not at all a play on the valuation of Bitcoin. And I said publicly that we are not going to be holding any Bitcoin. I would like -- it is true at this point and it was true when I said it that we are not holding any Bitcoin but I would like to at this point retract that and say it is not out of the question that we will be holding small amounts of Bitcoin. And I personally just to be clear, I personally have gone out in the last days, in recent days, and bought several million dollars of Bitcoin. So I am no longer bound by that commitment not to trade in Bitcoin myself, and the Company is no longer bound. If we do keep any Bitcoin you will see it show up on our balance sheet but it is not out of the question anymore that you will see us holding a little. Anything else Jonathan?

I was unable to find any Bitcoins on OSTK's balance sheet published 1/30/2014 in its 8k filing for the Q4 2013 earnings. The quote above uses a lot of hedging words like "small amounts," "If" and "not out of the question," so I really don't have any clue as to the true meaning of the above quote. One thing is for certain, however, is that investors interested in OSKT should pay special attention to OSTK's balance sheet to understand the company's "Bitcoin Risk." Going into its Q4 conference call, if OSTK had an account at Mt Gox that was holding anything other than a "small amount" of Bitcoins, I'm sure the tone of that meeting wouldn't have been so "rah rah" about the Bitcoin, in fact I bet they would be asking for the CEO's resignation.

In conclusion, OSTK and other companies that are foolish enough to accept and hold Bitcoins have most likely dodged a bullet of epic proportions. The Mt Gox fiasco highlights how the Bitcoin is a giant financial iceberg, hiding the majority of its risk out of sight and just waiting to take down its first CEO or company foolish enough to sail into its waters. Had public OSTK or private Virgin Galactic earned a majority of their sales through Bitcoin and placed all their Bitcoins at Mt Gox, it is likely those companies would now be facing bankruptcy all because of the foolish idea of accepting and holding a Bitcoin. As time goes by, more and more of the risks inherent in Bitcoin are being discovered. Mt Gox is the first major ship to hit the BitBerg. Other companies, if they are wise, will use the Titanic mistake Mt Gox made, and OSTK almost made, as a warning to sail far away from the risk infested waters where the BitBerg lurks.

Disclaimer: This article is not an investment recommendation or solicitation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice. Past performance is no guarantee of future results. For my full disclaimer and disclosure, click here.

Source: Bitcoin Is A Financial Iceberg - Investors Must Watch Balance Sheets To Evaluate Bitcoin Risk