Bitcoin: Boon or Bane? Cryptocurrency Basics

If you never heard of Bitcoin until late in 2017, you’re in the majority. Bitcoin, a “virtual currency” invented in 2009 by a person or persons using the pseudonym Satoshi Nakamoto, rose from a value equal to about $1,000 per Bitcoin at the beginning of 2017 to a value just under $20,000 by mid-December. And then, on December 22, Bitcoin, along with just about every other virtual currency (usually referred to as “cryptocurrency”) crashed hard, losing about 30 percent of its value (worth just under $12,000 at its lowest point).

What makes Bitcoin unique is that it relies entirely on digital technology for its creation, use, and value. It is not associated with any government, central bank, or financial institution. It exists only as data on a decentralized, worldwide network of computers. It is–and this is probably the most important point for the present discussion–completely unregulated.

Computers “mine”–or create–Bitcoin by solving the complex algorithms that govern the cryptocurrency’s transactional validity, which prevents any Bitcoin from being spent more than once. It is estimated that the shadowy Nakamoto–whoever he, she, or they are/is–owns about 980,000 Bitcoins–worth about $13.7 billion at current value–placing him/her/them among the world’s fifty richest persons. Not bad for the inventor of an intangible that was originally valued at five cents each.

Since its humble beginnings, Bitcoin has attracted the attention of more and more individuals and businesses, and it is beginning to see actual use as a currency for online transactions and, as suggested above, a basis for wild financial speculation. You can use Bitcoin to pay for a trip on Expedia, to buy a cold beer at a pub in Sydney, Australia, to purchase a Dell computer, or to shop for furniture, jewelry, or home decor on Overstock.com. Some custodians will even let you put Bitcoin in your IRA.

You can buy Bitcoin (after first downloading a virtual “wallet” compatible with your iOS or Android device) on any of several online Bitcoin exchanges, using a credit card, debit card, or ACH transfer from your bank. Bitcoin is available in any amount, from a tiny fraction of a Bitcoin (units referred to as “satoshis,” worth a hundred-millionth of a Bitcoin) to the multiple thousands of dollars you’ll need to buy a full Bitcoin.

And that’s not all. Since the success of Bitcoin, other cryptocurrencies have been invented, including Litecoin, Omni, Ripple, Dash, Monero, Ethereum, and many others.

So, why doesn’t everyone own Bitcoin or some other cryptocurrency? Well, there are several good reasons. Perhaps most important is the one already mentioned: there is presently no overarching regulation of cryptocurrency transactions or trading. Most world governments and central banks are studying the issue (see, for example US Treasury Secretary Steve Mnuchin’s recent comments regarding “concern” about Bitcoin’s use for “illicit transfers of funds”). The IRS has issued guidance on how various types of Bitcoin transactions should be treated for tax purposes. But the current scarcity of regulation means that cryptocurrency markets are subject to manipulation—such as the insider trading alleged in a recent controversy at one of the more popular cryptocurrency exchanges–that would be unlawful in regulated markets like the major stock and commodities exchanges. For cryptocurrency markets, it’s still pretty much the Wild West out there, as evidenced by the astronomic swings in value seen in recent days.

Second, because of its decentralized and completely digital nature (one of its principal advantages, by the way, according to its creators), cryptocurrency can be vulnerable to sophisticated hackers and other types of online criminals, as demonstrated by cyberattacks on a South Korean currency exchange that forced it to close its doors.

Finally (and there are probably other risks associated with cryptocurrency that we don’t even fully understand yet), everyone should recognize that this is still an emerging technology. As with anything this new, there are a multitude of different directions the cryptocurrency ecosystem could take, any of which would have very different effects on the value of current products. Think Betamax vs. VHS. The cryptocurrency market is no place for anyone with more than an ounce or two of risk aversion.

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