In Bitcoin We Trust?

Posted by Naveed on April 29th, 2021

You've probably heard of bitcoin before, but can you define it?

Most often, it is described as a non-government digital currency. Bitcoin is also sometimes referred to as a cyber currency or, in a nod to its crypto origins, a cryptocurrency. These descriptions are fairly accurate, but they miss the point. It's like describing the U.S. dollar as a green piece of paper with pictures on it.

I have my own way of describing bitcoin. I see it as store credit without the store. A prepaid phone without the phone. A precious metal without the metal. A legal tender for no debt, public or private, unless the party to whom it is offered wishes to accept it. An instrument backed by the sole faith and credit of its anonymous creators, whom I therefore trust and give no credit to, except that of ingenuity.

I wouldn't touch a bitcoin with a ten-foot USB cable. But a lot of people have already done it, and more will soon.

That's partly because entrepreneurs Cameron and Tyler Winklevoss, best known for their role in creating Facebook, are now looking to use their technological know-how, and money, to bring bitcoin to the mainstream.

The Winklevosses hope to launch an exchange-traded fund for bitcoin. An ETF would make bitcoin more widely available to investors who lack the technological know-how to buy the digital currency directly. As of April, Winklevosses reportedly held about 1 percent of all existing bitcoins.

Created in 2009 by an anonymous cryptographer, bitcoin is based on the premise that anything that exists, even bits of intangible code, can have value as long as enough people decide to treat it as such. Bitcoins exist only as digital representations and are not tied to any traditional currency.

According to the Bitcoin website, "Bitcoin is designed around the idea of a new form of currency that uses cryptography to control its creation and transactions, rather than relying on central authorities." (1) New bitcoins are "mined" by users solving computer algorithms to discover virtual coins. The purported creators of bitcoins have stated that the final supply of bitcoins will be capped at 21 million.

While bitcoin touts itself as "a very secure and inexpensive way to process payments," (2) in reality, few businesses have taken the step to accept bitcoins. Of those that have, a considerable number operate on the black market.

Bitcoins are traded anonymously on the Internet, with no involvement from established financial institutions. In 2012, the sale of drugs and other black market products accounted for about 20 percent of U.S. dollar bitcoin trading on the main bitcoin exchange, called Mt. Gox. The Drug Enforcement Agency recently made its first-ever bitcoin seizure after linking a transaction on the anonymous bitcoin-only marketplace Silk Road to the sale of prescription drugs and illicit drugs.

Some Bitcoin users have also suggested that the currency can be used as a way to avoid taxes. This may be true, but only in the sense that Bitcoin aids in illegal tax evasion, not in the sense that it plays a role in true tax planning. Under federal tax law, cash does not have to change hands for a taxable transaction to occur. Barter and other non-cash exchanges are always fully taxable. There is no reason why transactions involving bitcoin should be treated any differently.

Aside from the criminal element, the main proponents of bitcoin are speculators, who have no intention of using bitcoins to buy anything. These investors are convinced that the limited supply of bitcoins will force their value to follow a continuous upward trajectory.

Bitcoin has indeed seen some significant spikes in value. But it has also experienced major losses, including an 80 percent decline over 24 hours in April. At the start of this month, bitcoins were down to around , from a high of 6 before the April crash. They were trading near earlier this week,

The Winklevosses would make Bitcoin investing easier by allowing smaller-scale investors to profit, or lose, as the case may be, without the hassle of actually buying and storing the electronic coins. Despite claims of security, Bitcoin storage has proved problematic. In 2011, an attack on the Mt. Gox exchange forced it to temporarily shut down and caused the price of bitcoins to briefly fall to nearly zero. Since Bitcoin transactions are all anonymous, there is little chance of tracking down the culprits if you suddenly find your electronic wallet empty. If the Winklevosses get regulatory approval, their ETF would help shield investors from the threat of individual theft. The ETF, however, would do nothing to address the problem of volatility caused by large-scale thefts elsewhere in the Bitcoin market.

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