Headline: Is Bitcoin Only a Bit Player?
Date: 11/20/2020
Body: “IT’S ELECTRIC!!!” This used to be part of a chorus of a very popular song. Now, it can refer to:
- A Retro Dance style.
- A REALLY bright paint color
- Or, an intense compliment.
Now, it can also refer to currency. There was a great article on Bitcoin
https://www.cnn.com/2020/11/20/investing/bitcoin-prices-gold-blackrock/index.html
What is Bitcoin?
Bitcoin is a virtual currency that doesn’t depend upon the credit of an individual nation-state. (It was created by a shadowy individual or group called Satoshi Nakamoto in January of 2009. And, no, we still don’t know the identity of the individual or group.) In this system, people can make trades for goods or services in exchange for Bitcoin. Each transaction is noted to a blockchain that acts like accounting books, and each user in this market can see each trade being made. Since the information is known by so many people and computer systems, anybody trying to “spoof” the system is quickly found out. (With over 47,000 “nodes” spread around the globe, faking a transaction is nearly impossible.) Each “node” is overseen by a “miner” who watches the transactions and protects their portion of the blockchain. At the same time, these nodes are used in concert, to solve very demanding computational problems. They are compensated for their services by occasional release of more Bitcoin. This activity is referred to as “mining.”
Interestingly, in the current market, gold and Bitcoin have both benefitted from a lower dollar, and are rising in value. This appears to be because people see both as alternative ways to protect the value of their portfolios, amidst turbulent conditions.
What does the U.S. Government think about Bitcoin?
I have found numerous instances where either the SEC, the CFPB or FINRA has commenced legal action against bad actors within the Bitcoin environment. The U.S. Financial Crimes Enforcement Network (Fin-CEN) established the exchanges as “Money Service Businesses” that required them to comply with some legal requirements. In 2014, the IRS concluded that Bitcoin would be seen as property, and thus would yield capital gains or losses when held as investments, but if held as inventory, the gains and losses would be treated as ordinary in nature. Thus, the use of Bitcoin could be taxed, as any other medium of exchange. (As a side note, I work for the Federal Government, and all the time, there are virtual “brown bags” and other types of presentations regarding cryptocurrencies.)
What are the Pros of Investing in Bitcoin?
The chief value of investing in Bitcoin is that there is a tremendous potential for profit. With the value being figured out on a daily basis, transaction by transaction, the potential of reward is epic. Of course, with potential of reward goes commensurate risk. Bitcoin is no exception.
What are the Potential Cons of Investing in Bitcoin?
- It would appear that several different states are trying to regulate the use of Bitcoin within their borders. This could make the use of Bitcoin very complex.
- Bitcoin exchanges (which are entirely digital) are occasionally broken into by hackers. When this happens, all coin in your wallet stored at that exchange can disappear. And no, at this time, there is no FDIC insurance on Bitcoin exchanges.
- There have been instances of Bitcoin fraud.
- Market volatility is also epic. On one day, Bitcoin lost 61% of its value. Further, the merchants who do accept Bitcoin could easily decide not to accept it.
- Within the system itself, there are arguments. When this happens, there is a “fork.” If the argument is fundamental enough (hard fork) a whole new type of Bitcoin could result, and exchange with others becomes even more murky. If the argument is highly technical and rather unimportant (soft fork) the size of the block is expanded to compensate for the difference in opinion.
- The Private Key, used to access your Bitcoin Wallet can easily be lost or mis-transcribed. If this happens, there is no way to retrieve the value held in your Bitcoin.
Who should consider investing in Bitcoin?
Please note that these are usually very short-term investments. In one study by Forbes, 281,000 bitcoins that were used were held by the owners for less than 30 days. So, it seems reasonable to say that the savvy investor has to understand this to be a short-term trade. But, if you are OK with making the short-term trades, and conversant with the system, the potential for reward is enormous.
REFERENCES
What Is Bitcoin, and How Does It Work? – The New York Times (nytimes.com)
Bitcoin: What Is It? (thebalance.com)
CFPB Warns Consumers About Bitcoin | Consumer Financial Protection Bureau (consumerfinance.gov)
What is blockchain? – Journal of Accountancy
Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice. Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.