With the advent of digital currencies and initial coin offering (ICOs), there’s a rush of traditional money going into these forms of investments. As of December 2017, there was about $370 billion in digital currencies, worth more than the total value of the largest U.S. bank, JPMorgan. Among these digital currencies, Bitcoin is the largest.
What Is Bitcoin?
Bitcoin was the world’s first decentralized digital currency, or cryptocurrency. It was created in 2009 by an unknown person or group of people who refer to themselves as Satoshi Nakamoto. Bitcoin allows anyone to anonymously buy and sell goods online and in physical locations that accept the electronic payment. The way the cryptocurrency works, based on its encryption and proof-of-work scheme, means that no third parties need to be involved in a transaction.
This has the potential to disrupt many industries, most notably finance and banking. Because of this disruption, and the rapid upward momentum in bitcoin price, some investors are likening bitcoin to a new gold rush.
How Is Bitcoin Made?
Bitcoins are not actually made or printed. At the initial launch, 21 million bitcoins were created in a ledger. Instead, bitcoins are earned through a process called mining. Anyone can mine for bitcoin by using lots of computing power to solve complex equations needed to keep the bitcoin ecosystem running. This entails solving a specific cryptography equation to ensure all pieces of a transaction are what they claim to be.
Without getting technical, the encryption behind bitcoin requires brute force to solve the equation for each transaction. By finding answers to the equations over time, you can earn bitcoin for free. But you still need to pay your own electricity bill, so the efforts might not be worth it for you in the long term. Mining gets more difficult over time, and of the 21 million total bitcoin that can ever exist, about 80% of them have been mined already.
How Is Bitcoin Bought and Sold?
To buy and sell bitcoin, you need a digital wallet. These are created online using one of the many digital wallet and cryptocurrency services. You sign up for one of these services, such as Coinbase, download the app, and walk through the process of setting up your wallet. Through the app, you can then use traditional currency to buy bitcoin or sell bitcoin to get traditional currency.
What Is Blockchain Technology?
Blockchain technology is the reason bitcoin and other cryptocurrencies work. It’s a distributed online ledger that uses encryption to ensure all transactions are valid, can’t be duplicated, and can’t be deleted. It requires no outside authority to function and is more accurate and secure than any human-run ledger. It’s more of a computer architecture than a single technology, and it’s expected to improve over time.
How Is Bitcoin Taxed?
Different jurisdictions around the world tax bitcoin differently. The Canada Revenue Agency treats bitcoin as "specified foreign property" under Section 233.3 of the Income Tax Act. Depending on the nature of the specific bitcoin transaction in question, the transaction can be taxed as income or capital gains.
Bitcoin is an exciting new investment and method for normal transactions. It’s also becoming increasingly popular. As an accountant, you need to beware of how your clients are using the digital currency so you can properly advise them on how each transaction is taxed.