Technology: What's All the Fuss About Digital Currency?

Bitcoin, a decentralized virtual currency (which means no coins or notes exist in the “real” world) has been around since 2009 and exists only as strings of digital code. Formerly, this digital money was of interest only to a small segment of the public, but following the financial debacle in Cyprus and a meteoric rise in value, Bitcoins are now center stage. Do Bitcoins represent the future, or is the Bitcoin boom a bubble waiting to pop? You be the judge.

How Does it Work?

Bitcoins are a store of value whose purchasing power is protected by a hard limit on the number of coins that can exist (21 million by 2014). At the start of this year, a bitcoin was worth about $20. Since that time, its worth has shot up by as much as 1,000 percent; it has gyrated from the low $100s to the high $200s since reaching that peak. Unlike traditional currencies that are protected by a central bank such as the Federal Reserve in the U.S. or the Bank of England in the U.K., it has no central regulating body. Each coin can be split into smaller parts to be used in small transactions, and a unique digital signature protects them from forgery – a big advantage at a time when forgers of bank notes have become very sophisticated.

To pay someone in bitcoins, you would go through the following steps:

1. Visit bitcoin.org and download a “wallet” on either your computer or smart phone. Once you buy some bitcoins and locate them in the wallet (see below), you are part of a bitcoin peer-to-peer network. Using this network and authorized digital signatures, bitcoins are supplied to servers known as “bitcoin miners” in blocks of 25. Transactions require a 64-digit number involving a complicated algorithm. It might help to see it as the cash-transfer equivalent of peer-to-peer markets like eBay and the worldwide accommodation site Airbnb.
2. You would buy bitcoins via online exchanges like Mt. Gox or find your own seller online.

What Are the Advantages of Bitcoins?

Because bitcoin transactions don’t involve banks and clearing houses, there are no foreign exchange fees, exchange rate issues or bank charges to address. Using bitcoins to buy foreign goods online is as simple and straightforward as using cash at home.

What Are the Disadvantages?

Critics point out that the ease and simplicity of the transactions also make them untraceable – a red flag for enforcement agencies involved in tracking down drug smugglers, counterfeit goods and tax dodgers. If bitcoins gather a much wider audience, we can expect the financial sector to start pressing for some type of regulation.

Stability is another big issue. As noted earlier, the bitcoin has demonstrated some massive fluctuations in price. Time will tell if bitcoin can become a truly self-stabilizing currency.

What Can I Buy With Bitcoins?

Currently, not a lot in the regular mainstream market place. No well-known retailers accept them, though shoppers have reported that some specialized websites selling electronic products will take bitcoins.

Some observers believe that the time is right for a digital currency – whether bitcoin as the trailblazer will reap the rewards or not. Other economists think that bitcoin mania is a bubble ready to burst.

These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.

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