In the modern age, bitcoin and other cryptocurrencies have become a major sensation, with millions of users trading in bitcoin. Finances, like the rest of human society, are continuously evolving. Other cryptocurrencies like Etherium have also begun to grow, though recently they suffered a massive downfall.
What is Cryptocurrency and Bitcoin?
Cryptocurrency is actually a digital or virtual (having no physical existence) currency that manages its transactions and creations by a technique called cryptography and is completely decentralized (independent of a central bank) with peer to peer transactions.
Bitcoin was the first ever cryptocurrency to be introduced and currently holds the title of 5th most expensive cryptocurrency. Such a currency cannot be confiscated by any government.
The Birth of A New Currency
The first cryptocurrency, bitcoin was created in 2009 by a pseudonymous Satoshi Nakamoto. Soon it rose to fame, with the rise starting in the mid-2010s. The domain name, bitcoin.org was first registered on 18 August 2008. On 3 January 2009, the bitcoin network was created, starting with the mining of 50 bitcoins by Satoshi Nakamoto. Hal Finney became the first person to have a bitcoin transaction on 12 January 2009. The first use of bitcoin was the use of 10,000 BTC to buy two pizzas at US$ 25. Improper verification of transactions was the first bug in the bitcoin network resulting in a scam of 184 billion bitcoins, which found at two addresses and deleted. It has been the only problem with this currency so far. Satoshi Nakamoto has been a mystery and a source of interest ever since. Though there are a few suspects, no one knows who made the revolutionary currency.
The Growth of Bitcoin
On February 6, 2010, an actual Bitcoin Market was created with Bitcoin as it’s basic currency. By July 12, 2018, the price of Bitcoin increased from 0.008 to 0,08 US$. Mt. Gox, the first Bitcoin currency exchange market was established. Soon, in 2011, a drug site was established based on Bitcoin. Bitcoin’s value increased to US$ 1 on 9th February. On 14th February, the first vehicle was sold for 3000 BTC.
On 8th June, 2011, Bitcoin makes a major leap as the prices rise to US$ 31.91. By 2012, FBI and other agencies grew concerned over the use of Bitcoin for illegal ammunition and narcotics. In April 2013, Bitcoin exceeded US$ 100 per Bitcoin. It hit a landmark figure of US$ 503 on 17 November and surged to US$ 1242 after Senate hearings. This increase marked the rise of Bitcoin to fame. Universities, major and developing companies began to use Bitcoin as it saved a lot of taxes and transfer charges. Banks began to regulate Bitcoin and many governments expressed concern over it being almost tax-less due to anonymous transactions. By 2017, Bitcoin prices surged to thousand of US$s with an all-time high of US$ 15,000. However, 2018 marked the fall of the currency as hacking and theft grew out of control. The price of Bitcoin dropped by 50% (Below US$ 7000) while many other crypto-currencies fell by 90%.
Taxation of Bitcoin
Although Bitcoin is a digital currency, the governments consider them as property, thus being subjected to capital gains through buying, selling or trading for other currencies. many governments have tried for tax implications. Now, they are used as property instead of currency and taxes are applied as such. The general rules are:
- Trading cryptocurrencies produces capital gains or losses, with the latter being able to offset gains and reduce tax.
- Exchanging one token for another — for example, using Ethereum to purchase an altcoin — creates a taxable event. The token is treated as being sold, thus generating capital gains or losses.
- Receiving payments in crypto in exchange for products or services or as salary is treated as ordinary income at the fair market value of the coin at the time of receipt.
- Spending crypto is a tax event and may generate capital gains or losses, which can be short-term or long-term. For example, say you bought one coin for $100. If that coin was then worth $200 and you bought a $200 gift card, there is a $100 taxable gain. Depending on the holding period, it could be a short- or long-term capital gain subject to different rates.
- Converting a cryptocurrency to U.S. dollars or another currency at a gain is a taxable event, as it is treated as being sold, thus generating capital gains.
- Air drops are considered ordinary income on the day of the air drop. That value will become the basis of the coin. When it’s sold, exchanged, etc., there will be a capital gain.
- Mining coins is considered ordinary income equal to the fair market value of the coin the day it was successfully mined.
- Initial coin offerings do not fall under the tax-free treatment for raising capital. Thus, they produce ordinary income to individuals and businesses alike.
Bitcoin mining is a peer-to-peer computer process used to secure and verify bitcoin transactions—payments from one user to another on a decentralized network. Mining involves adding bitcoin transaction data to Bitcoin’s global public ledger of past transactions. Each group of transactions is called a block. Blocks are secured by Bitcoin miners and build on top of each other forming a chain. This ledger of past transactions is called the blockchain. The blockchain serves to confirm transactions to the rest of the network as having taken place. Bitcoin nodes use the blockchain to distinguish legitimate Bitcoin transactions from attempts to re-spend coins that have already been spent elsewhere.
The primary purpose of mining is to allow Bitcoin nodes to reach a secure, tamper-resistant consensus. Mining is also the mechanism used to introduce bitcoins into the system. Miners are paid transaction fees as well as a subsidy of newly created coins, called block rewards. This both serves the purpose of disseminating new coins in a decentralized manner as well as motivating people to provide security for the system through mining.
The Bitcoin Controversy
Since it’s creation, Bitcoin has been a center-point for many major controversies. Some of them include:
Silk Road and dark web
Following its creation as an anonymous cryptocurrency, bitcoin caught the imagination of an unlikely community — drug dealers and drug users. Bitcoin became the preferred mode of payment on murky deep Web sites and online marketplaces dealing in drugs, thanks to the anonymity it afforded to those dealing in drugs.
Until 2013, Bitcoin was used more by drug dealers and other shady elements than the law-abiding mainstream. A study commissioned in the fall of 2013 suggested that bitcoin had outgrown its association with the drug trade and was being mainly used to pay for legal goods and services. From then until now, adoption of Bitcoin by people has only grown exponentially and today, Bitcoin is well past its historical association with drugs and crime.
Mt Gox outages and hacks
Mt Gox was the leading Bitcoin exchange until it was forced to close in early 2014 following a string of hacks and loss of Bitcoins from its hot wallet. In June 2011, a hack leads to manipulation of the asking price for Bitcoin resulting in the sale of bitcoin at prices as low as one cent. In 2013, Mt Gox went offline after the site witnessed unprecedented traffic following positive media coverage. In the latter part of 2013, Trade Hill, the second most popular exchange after Mt Gox, downed its shutters dragging investor confidence down.
It was almost the death knell for bitcoin when in February 2014, Mt Gox was hacked into and 850 thousand Bitcoins were stolen. Though Mt Gox managed to retrieve 200 thousand Bitcoins, investor confidence slumped as Mt Gox filed for bankruptcy and initiated liquidation proceedings. Many predicted the end for bitcoin but three and a half years later, if anything, Bitcoin has only become more popular and mainstream. People now know that bitcoin is a robust viable alternative currency and that the exchange hacks had nothing to do with security flaws in the cryptocurrency itself.
Opposition to decentralization
Governments worldwide manipulate the economy with their monetary and fiscal policies. A central bank decides how much money to print and how much to put out in circulation. The value of money depends on the size of the economy and the amount in circulation. Thus, an external agency determines the value of the money you hold and mismanagement can lead to grave crises as a recession. Bitcoin is an answer to centralization and takes away the power to regulate money from a centralized authority. Thus, it’s a pure market currency. This is disliked by governments as they stand to lose control over currency if people adopt Bitcoin.
Bitcoin is not yet viewed as a significant threat to fiat money at the moment, but governments are noticing bitcoin’s rapidly rising acclaim and some are trying to clamp down on the currency’s use. Recently, China banned all Bitcoin exchanges and speculation is afloat that China may soon debar its citizens from dealing with Bitcoins in any way whatsoever. But thanks to bitcoin’s nature as an anonymous, peer to peer currency, any transaction with bitcoins won’t risk incurring the wrath of the government as the encryption effectively subverts government surveillance efforts. Further, some other countries like India plan to release their own closed cryptocurrency, albeit one that is centralized and not anonymous.
Contentious legal status
This is a vexatious question that governments have had to contend with. Is Bitcoin a commodity or virtual currency or a digital collectible asset? Should Bitcoin be taxed as a commodity or be treated as a means of transacting (virtual currency)? While some like Russia, United Kingdom, and the European Union recognize bitcoin as a virtual currency out of the ambit of capital gain taxes, the United States of America treats Bitcoin as a commodity for taxation purposes. India and China still haven’t recognized Bitcoin as a currency/commodity and its legal status are unclear in these jurisdictions though governments of both countries have declared that citizens are free to deal with bitcoins as they deem fit. Japan has passed a bill recognizing bitcoin as legal tender.
There are doubts with regard to the the enforcing of these tax laws. To resolve this, Bitcoin holding disclosures can be made mandatory and identity of tax evaders can be unmasked with identifying personal details filed with bitcoin exchanges and other sites whenever transactions with bitcoins are made on the portal.
Fork and new blockchain
A fork is a branching out of Bitcoin into two different crypto-currencies. Essentially, the blockchain branches off into two. This may be planned beforehand, as in tweaking the source code to improve bitcoin or could occur inadvertently. In 2013, due to differences in two versions of Bitcoin mining software, a fork came into existence which was resolved after users were told to downgrade to the earlier software version. In August of 2017, Bitcoin Cash, a version that allows faster transactions than Bitcoin, forked out from classical Bitcoin. But the value of Bitcoin has remained unaffected even after the fork.
Though Bitcoin has faced many a challenge, it has always come through with shining colors. As a decentralized currency fighting against the odds, Bitcoin has established itself because of its underlying robust and secure mechanisms.
The Future of Bitcoin
Many tech developers like Tim Draper, John McAfee and Bill Gates supported the concept of Bitcoin. It is expected that Bitcoin will, sooner or later, take the place of flat currency due to its huge advantages. Tim Draper said,
In five years, if you try to use flat currency, they will laugh at you. Bitcoin and other cryptocurrencies will be so relevant… There will be no reason to have flat currencies.