Created by Satoshi Nakamoto in 2009, bitcoins are a digital currency some are using instead of traditional money for various transactions. The good side is that bitcoins are typically not taxable, immune to inflation, unregulated and not tied to any central bank, nation or government.
Unfortunately, that is where the benefits end.
As bitcoins are not backed by anything tangible (such as gold or a country), they are actually only worth whatever someone else is willing to pay you for them. Games of hot potato are fun, as long as you aren’t the last one holding on.
The actual intrinsic or book value of a bitcoin is zero. A single bitcoin is simply one digit in a very complicated open-source computer algorithm, and typically the owner doesn’t get to actually hold the coin in their hand, let alone see it beyond the digit on their computer screen.
As you could expect, the untraceable nature of bitcoins has led to rampant use in and for illicit activities, from hiring hitmen to laundering drug money. The clandestine and unregulated nature of the alternative currency also exposes owners to losses due to theft – it is not clear what authority you would go to if your bitcoins were to be digitally stolen. This was the case for more than 30 individuals recently, each of whom claims to have lost more than US$1 million in value. Meanwhile, the highest profile theft involved 96,000 bitcoins, at the time valued at more than US$100 million.
One of the greatest advantages of using bitcoins is their lack of regulation. Unfortunately for the alternative currency, this will change. The U.S. Senate’s Department of Homeland Security recently had a meeting to discuss if bitcoins should be regulated and to what degree. China has blocked their banks from using the currency at all. Other countries will likely follow suit and haven’t already only because bitcoins are so new.
The regulatory concerns are numerous, and include taxation, legal enforcement, traceability and the potential for fraud and use in other illegal activities. Organizations such as the Securities and Exchange Commission in America and other similar bodies worldwide are still determining their responsibilities and capabilities. Should they enforce rules and regulations, and to what degree? Can they even effectively do so? As bitcoins are a relatively new concern, much of the regulation has not been created or solidified as of yet.
When a currency is not beholden to any specific nation, it becomes incredibly complicated to apply taxation when wares are bought or sold. Besides the confusion involved with making Bitcoin transactions taxable, it also leaves the door wide open for legal arguments against any such efforts.
The issues of legal enforcement and traceability are almost one in the same. The difficulty in knowing where the transaction took place makes finding the merchant and customer almost impossible, which also creates the question of who is responsible (if anyone) for enforcing law and order.
Digital currencies are also a hotbed for fraud, scams and other illegal activities (such as child pornography, drugs, weapons sales or money laundering for criminals and terrorists). Any time there is anonymity, you will see unsavory characters come out of the woodwork.
There is a limit to the total supply of bitcoins. The advanced computer algorithm that controls the supply is hard-wired to only allow a total of 21 million units. With the limit to the total supply, any increase in demand can send the price higher.
In fact, we’ve seen exactly this play out during the currency’s meteoric rise from $13.50 one year ago to its high of $1,130. The value of a bitcoin currently sits at $693 as of the time of writing, but it can be extremely volatile and may be tens of percentages higher or lower a matter of hours from now.
In fact, the currency lost 50 percent in one day (dropping from $1,130 to $552) when the government of China issued a warning against the speculative nature of bitcoins. Currently two-thirds of all activity in the digital currency takes place in China.
Some may consider it ironic that there are dozens of alternatives to this alternative currency. For example, Namecoin, Peercoin and Litecoin are among the numerous “competitors” of Bitcoin. Even if the usage and acceptance for all of them were combined, the concept of digital money still would not come close to common acceptance. A critical mass of vendors who accept the various versions of the coins would need to be reached before they could become a lasting phenomena, and that critical mass would probably be upward of 20 percent of all vendors. Currently, less than 0.1 percent of worldwide vendors accept payments in bitcoins.
Similar to all previous fads, from the tulip bulb mania in Holland to the Occupy Wall Street protests, to binary options, to a stock picking robot, bitcoins will fade away. The excitement of the digital currency is just now passing, and all that remains is for the entire idea to disappear from view, which will happen in a matter of months, rather than years.