Understanding Bitcoin and digital currency

Have you heard about digital currencies such as Bitcoin? Often referred to as cryptocurrency or virtual currency, digital currency is a major technological development impacting commerce in the 21st century.

A $3,000 purchase of Bitcoin at the beginning of 2013 would be valued at over $1 million today.  Bitcoin hit an all-time high over $6,000 per coin in October, which represented an approximate 850% increase in value over the past 12 months.

The current cryptocurrency market is valued at $172 billion and Bitcoin is the dominant player with a market capitalization of $100 billion, or 58% of the total market. Other currencies (called alternative coins or altcoins) with large capitalizations include Ethereum and Ripple, with 16% and 5% of the market respectively. With over 1,100 cryptocurrencies circulating today, it is worthwhile to understand this new digital age phenomenon.

What is digital currency? It is electronic money serving as a unit of account and store of value.  U.S. dollars can be converted into cryptocurrency, which can be bought and sold through exchanges. Storage options include an online digital “wallet” and a portable “vault” syncing to a computer through a USB port. Consider conducting independent research and speaking to a professional financial planner to learn about cryptocurrency ownership and safekeeping options.

Can goods and services be purchased with digital currency? Yes, if the manufacturer or service provider accepts it. Electronic money also serves as a medium of exchange that can be used as a digital payment system to conduct commerce. In this respect, it is similar to “real” currency such as U.S. dollars. People can use digital currency to buy goods and services or convert a whole coin – or a fraction – back to “real” currency at the prevailing exchange rate.

However, a big difference is that digital currency is not controlled by a central government. The decentralized nature of it enables peers to exchange “e-cash” directly with each other without passing through an intermediary. This would be akin to sending an e-mail message rather than mailing a letter through the postal service.

Digital currency could reduce the cost of business in the same manner that email reduced the cost of communication. Merchants accepting cryptocurrency could potentially eliminate third party transaction charges (e.g. payment processing fees) in the same manner that email eliminated the cost of a stamp.

Where did digital currency come from? Bitcoin, the genesis currency, was invented nearly a decade ago by a person – or a group of people – under the name of Satoshi Nakamoto. Bitcoin operates on an open-source software platform with transactions verified and recorded through a blockchain, which is a digitized and decentralized algorithm-based public ledger facilitating transaction transparency and authenticity.

“Blockchain is the most amazing technology that exists at this time,” said Duncan Kabinu, co-founder of Gainesville Dev Academy, a local coding bootcamp that helps people build apps around blockchain technology. “Blockchain management and transactions are done through coding,” added Mr. Kabinu.

Since the launch of Bitcoin, innovative software coders around the world have developed new protocols birthing new cryptocurrencies. “Digital currency is not going anywhere as it is a new form of currency” and “in terms of currency, we are at the next paradigm shift,” added Mr. Kabinu.

Cryptocurrencies have disruptive potential and the U.S. Government has weighed-in. This past September, U.S. Rep. Jared Polis (D-CO) and Rep. David Schweikert (R-AZ), co-chairs of the Congressional Blockchain Caucus, introduced the Cryptocurrency Tax Fairness Act of 2017, which intends to remove disincentives for using virtual currency in commerce.

In 2014, the Internal Revenue Service issued guidance declaring that virtual currency is treated as property for federal tax purposes. Further, it noted that general tax principles applicable to property transactions are also applicable to virtual currency transactions. Check out www.irs.gov for more details.

Digital currencies and the blockchain technology powering them have the potential to fundamentally alter the way we conduct commerce. Whether cryptocurrencies will be accepted by most merchants and widely used remains to be seen.

By Kamal I. Latham

Kamal I. Latham is a freelance writer and not a professional financial planner. This article is educational in nature and none of its content should be construed as investment advice.


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