This week on NVTC’s blog, John Calanog of member company CohnReznick LLP offers an overview of Bitcoin in the first of two blog posts on the subject.
- Despite the fact that there are nearly 14 million Bitcoins in circulation, most people are not using this newest form of currency. In fact, the vast majority of the population has never even heard of Bitcoin. But that is changing – and changing quickly.
This article – the first of two on this subject – offers an overview of Bitcoin. The second article will analyze a number of U.S. tax implications related to the usage of Bitcoin.
Bitcoin: A Virtual Currency
Bitcoin is, quite simply, a virtual currency. It is a digital representation of money that can be used to purchase goods and services like cash. But Bitcoin differs from cash in that it is not backed by any bank or nation, is unregulated, and has no formal organizational structure behind it. Instead, Bitcoin is supported entirely by a peer-to-peer (“P2P”) network of individuals who manage balances and transactions on their own. Bitcoin functions as an online payment platform with reduced fees when compared to other online payment forms.
In the past few years, Bitcoin values have fluctuated $247 per Bitcoin to over $1,000. As of publication of this article, the 14 million Bitcoins in circulation are worth nearly $3.5 billion.
How Does Bitcoin Work?
To create a digital currency with no centralized organization backing the transactions, Bitcoin was designed so that its users verify and complete transactions. This is done through Bitcoin’s “blockchain,” which is essentially a chronological log of every confirmed transaction that occurs between Bitcoin addresses. Using cryptography, Bitcoin creates mathematical proofs and records to secure the blockchain and safeguard a user’s transaction. These proofs are verified by users who have software that processes (“mines”) the blocks that are part of the blockchain.
The Bitcoin system transmits transactions to the network almost immediately and verifies them within the hour. The mining process helps to create the ledger of payments with Bitcoins. This also helps to ensure that double spending, or a user’s attempt to send the same Bitcoins to two people simultaneously, is prevented. In this way, users contribute directly to Bitcoin, supporting the currency’s well-being.
Bitcoin in the Marketplace
Because Bitcoin technology is extremely complex, use of Bitcoin was originally limited to those with software expertise and a unique interest in alternative currencies. As the currency has become more widely accepted, an ecosystem of service providers has developed to facilitate transactions. Now, just about anyone can participate, even those without a technical understanding of the currency. The ecosystem is still evolving and now includes retailers, payment processors, banks, e-wallet companies, trading solutions, and currency exchanges.
Some very well-known companies are among those that support Bitcoins. They include Microsoft, Dell, Overstock.com, Virgin Galactic, Sacramento Kings of the NBA, Amazon.com, Reddit, Expedia.com, PayPal, eBay, Tesla, Etsy Vendors, and Time, Inc. Even some professional services firms, including law firms and accounting firms, now accept Bitcoin.
How Does a Business Do Business Using Bitcoins?
To accept Bitcoins as payment, a business sets up a merchant account with a Bitcoin exchange. From there, the business can issue invoices and receive payments in Bitcoins, convert them to dollars (or local currency), and then transfer them to its bank account.
If the business is not interested in converting Bitcoins to local currency, it can hold on to its Bitcoins and trade them. The business can register for a free online e-wallet, such as Blockchain.info. It can then give anyone its Bitcoin e-wallet address, and customers can remit Bitcoins as payment. The business has the ability to send its Bitcoins to any other e-wallets across the globe.
There are numerous Bitcoin exchanges on the web. They enable customers to convert physical currency into Bitcoins and vice versa. Increasingly, exchanges are offering a greater number of services including a range of both fiat (i.e., face value currency) and crypto-currencies, as well as various trading tools.
Bitcoin exchanges have fallen under scrutiny as one of the world’s first Bitcoin exchanges, Mt. Gox, mysteriously lost 850,000 Bitcoins. This left the exchange insolvent and many customers out-of-pocket. Many Bitcoin traders have since become wary of these exchanges, yet the exchanges continue to thrive. Four of today’s major Bitcoin exchanges include Coinbase, Bitstamp, BTC-e and Cryptsy. In January of this year, Coinbase launched the first regulated Bitcoin Exchange in the U.S in an effort to add stability to the Bitcoin ecosystem.
It appears that Bitcoin is a real and lasting game-changer. It has globalized currency with capabilities beyond our current monetary system. CohnReznick looks forward to monitoring the future impact of Bitcoin, and other virtual currencies, on businesses and the financial markets.
The content of this article is intended to provide a general commentary on the subject. Specialist advice should be sought about your specific circumstances.
John Calanog, CPA, is a Tax Manager with CohnReznick LLP and is a member of the Firm’s Technology Industry Practice. John’s experiences over the last fifteen years include U.S. tax compliance and consulting for C Corporations, S Corporations, Partnerships, and high net worth individuals who operate businesses in a wide variety of industries and taxing jurisdictions. Contact John at firstname.lastname@example.org. Follow CohnReznick’s Technology Practice on Twitter via @CR_TechInd