The Bitconnect Denouement

A Noob’s Dilemma

For the many noobs in the cryptosphere it’s tough and confusing, and haven’t we all lost money uselessly at some point? Hopefully only a tiny portion of it. Alas, the gold rush bug camped under my computer keyboard. Would it not be unnatural if I did not try to throw it some crumbs? In short, I was one of the (minor by far) investors in the platform. I only suffered 10% of the total invested, expressed in bitcoin, and it was not very much. Am considering myself lucky. A shout out to the Bitconnect promoters who kept me away after the initial splash.

However, what I am not buying are the gluttony of arguments “told you so,” and here’s why.

I went in, being one month into this “universe,” still at a stage of understanding the Euclid’s theorem, trap door arithmetics, why and how RSA works, why and when quantum computers may crack the private keys, and what are the chances of various accidental collisions. That research convinced me that the crypto space is extremely risky and uncertain in its core, and if I am to venture in, then only on a less serious note (I finally found my computer game), at least for now, until various fundamental issues are fixed. It’s a hedge of sorts: in case it all works out.

For anyone investing and diversifying holdings in crypto, Bitconnect’s value proposition does not necessarily seem so far fetched. Let’s compare this investment with any other coin, say an innovating solution being developed by a private company. In both cases there is a promise to deliver and there is a promise that someone is doing something but without any guarantee that anything is being actually done. There is an argument that a potential investor can follow progress of most projects on Github but there are plenty that do not use that service or do not allow others to peek in.

Further, the options of staking and mining are out of the question for me, at least, and surely many others, way beyond my technical capabilities or time capacity. A friend told me about the greenhouse farming with bitcoin miners in Alaska, which was amusing but not practical enough. There are some coins that again are offering a revenue share of sorts. Those are good opportunities, if the companies get audited on regular basis to make sure that all the payouts are made as promised and expected. I wonder how those will work out for them.

The Opportunists

Bitconnect claimed to take our bitcoins in exchange for investing them via a bot and sharing the gains in return. It did not occur to me to look for that “bot” simply because I thought that it was obvious how they could borrow money and make a ton of profit: through an arbitrage. Everyday, there is an easy 10%, sometimes up to 40%, dollar expressed differential in the prices of bitcoin on various markets throughout the world. Centralized exchanges in China, Korea, US, Europe, Southeast Asia, Localbitcoins, decentralized exchanges - it all fluctuates greatly. If a company (like Bitconnect) wants to borrow money to trade around the globe, why would it want to show the bot and explain how and when the trading happens? If it did, wouldn’t others have tried to follow in the footsteps? Follow its addresses on various exchanges? This does not make sense. In fact, being furtive about the “bot” is understandable. “Let others believe that we play the markets but in fact we’re doing a good ol’ arbitrage and give the public pennies on a dollar.” That’s how I understood the situation when investing into the platform. Even if they make 10% a day and give me 1%, fine, more than I personally could have ever made.

During almost my entire experience with the platform, it had one of the best running websites out of any other crypto related ones. Very professionally run, even when there were failures and maintenance issues, they always communicated well. Their exchange and the internet wallets worked seamlessly. They also had a huge community (isn’t this one of the main traits of a successful project?). They had their own coin which kept growing in price. With a market cap of a billion at some point. I thought that with such a leverage, even if they had tried to scam everyone in the beginning, they could have done lots of cool things and become an officially legit enterprise. There was a talk about a marketplace for goods and services that uses the coin. With an immense community and promotional networks already in place, they could have positioned themselves to rival any other similar site in the mainstream today. (There is Bitconnect Ex, but I’m letting them chug along on their own at this point.)

Let’s now compare this failed platform with some “coins” that did an “honest” ICO and ultimately faded away, stopped working, stopped developing after only a few months or even a year or so into it. I won’t call the names because some crypto gets picked up later to be rebranded, so let’s give them a chance. But no one announces: “Sorry guys, we the developers are abandoning such and such chain. Thanks for your support, see you later, it did not work out,” etc. Instead, they keep up some minor marketing buzz while quietly selling to the unsuspecting public. In other words, the chances of getting scammed in crypto are higher than not getting scammed. At such a backdrop, Bitconnect looked reasonably risky and reasonably rewarding.

The way they went out was to be expected: “we promised to return you Bitconnect coins and we did, here they are, at an average value in the last week,”- why not. It’s still a viable coin supported by wallets with an annual return, a very large number of users, reliable… why should it not have its own independent value, outside the lending platform? Why this coin is not as good as any other coin featuring a similar transactional tech, for example? Before platform closure, the value of Bitconnect coin was about $250, next day $35, and at the time of this post $10, so it’s still kicking.

The Tax Kicker

For all of us the US residents who lost money on the platform, we now must decide whether this is a capital or ordinary loss. If capital, then we might not be able to deduct it right away against our other income, unless we have capital gains this year. Even if we do have capital gains, if they are long term (taxed at lower rates), our deduction is not going to be as valuable against them. We want to find a way for this to be deductible as an ordinary loss, and there is a possibility.

If Bitconnect lending platform is ruled to be a “Ponzi” scheme, then those who were left out of pocket could deduct the loss as theft and claim an ordinary deduction in 2018. The party perpetrating the fraud would need to receive cash or property from investors, purporting to earn income for them, and reporting to the investors income amounts that are wholly or partially fictitious. In the class action suit filed a few days ago (https://cointelegraph.com/news/investors-file-class-action-lawsuit-against-bitconnect-following-its-shutdown), the investors do allege such Ponzi scheme, and if they are successful in proving that it was, then we all could claim the ordinary theft losses on our tax returns for 2018.

Curiously, such result is not available if there is a fraud is done by corporate offices and the value of the corporate stock goes down. Since this was called “lending,” I think that this quirk in the law should not prevent the theft loss treatment.

The Takeaway

The business as usual. (The crypto markets did not suffer because of this (the reverse is true: Bitconnect suffered because of the market downfall).

This is not a financial advice. Do not invest more than you can comfortably deduct on your tax return.

Hang loose and till the next time!