By now, you have likely heard of Bitcoin because, despite it still being a relatively young technology, it’s gained considerable media and market attention. Yet, like the worldwide web in 1995, its youth means that its potential, purposes and applications are yet to be defined and truly realised. Is it just electronic money? A foundation for smart contracts and electronic shares? Is it underground and subversive, challenging the power of governments, or will it integrate into mainstream finance and go unnoticed?
Challenging the status quo
Bitcoin paints a future that is drastically different from the fiat-based world of today. This is either exciting or unsettling for the vast majority of people. The Bitcoin universe is changing fast and often. Since 2009, the Bitcoin network has only been growing stronger, as more people learn about its fundamental technology and potential. Understanding Bitcoin’s potential is an essential first step to understand the impact it will have on how we store value, exchange value and transact with each other.
If we look back into history, money is the oldest technology humans have invented. Money forms as a natural result of human social interaction, as a way to transact and exchange value between participants. Bitcoin is the latest upgrade in the technology of money. With Bitcoin we are now at money version 5.0. Let’s put this into historical perspective:
- Money 1.0 was the use of commodity tokens such as nuts, seashells and other items that hold primary value. They can be used for their primary purpose such as being eaten, but they can also be used as money
- Money 2.0 saw precious metals pressed into standardised coinage. The face value of the coin can differ from its underlying commodity value. We see that value is based partly on belief and partly on primary value
- Money 3.0 introduced paper money and with it the removal of any notion of a primary value. The value of the money is only backed by the belief that the participants have in the system
- Money 4.0 created digital and plastic money. Money is now only a number on a computer and the widespread adoption of the internet removes friction from the system and opens the gateway to online payments and online banking. Plastic credit cards remove the need for paper money and coins
- Money 5.0 is where we are headed with Bitcoin and other Bitcoin-like solutions. Money is now decentralised and backed by no trusted third-party; no bank, no government and no individual or company. Money is secured only by financial market-based incentives, where you only need to trust yourself.
With every technological revolution in money we asked ourselves, how can this be considered money? Is this really money? Bitcoin has value in the same way that fiat money has value, it can be used to pay for your coffee, catch a flight and even buy a house. Its value comes from the economic activity it creates through its use as a medium of value exchange and in the social bonds that it forms as it is transacted. It is valuable because people use it, and believe in the real illusion that it has value.
But is Bitcoin a good solution?
To answer this question, we should consider what Bitcoin does differently to every previous version of Money. The key feature of Bitcoin is decentralised security through computation (proof-of-work). No one in the system is trusted and importantly no one needs to be trusted. The Bitcoin system is secure when every business and individual acts in their own best interest. Security is achieved through pure financial self-interest. This revolutionises the concept of trust in our current financial system.
Bitcoin’s point of difference
Managing transactions and the issuing of bitcoins is carried out collectively by the network. Bitcoin is open-source; its design is public, nobody owns or controls Bitcoin and everyone can take part. Through many of its unique properties, Bitcoin allows exciting uses that could not be covered by any previous payment system. All payments are peer-to-peer (P2P) and are settled in about 10 minutes – unlike credit card payments or transfers to overseas that can take weeks before they are finally settled.
All Bitcoin transactions are recorded permanently on a distributed ledger called the ‘blockchain’ – this ledger is shared between all full Bitcoin ‘miners’ and ‘nodes’ around the world, and is publicly-viewable. These miners and nodes verify transactions and keep the network secure. For the electricity they use to do this, miners are rewarded with new bitcoins.
The Bitcoin protocol is also hard-limited to 21 million bitcoins, meaning that no more than that can ever be created. This means that no central bank, individual or government can come along and simply ‘print’ more bitcoins when it suits them. In this sense Bitcoin is a deflationary currency.
What lies ahead
Bitcoin has the promise to level the playing field for the billions of unbanked individuals that currently do not participate in the global economy. It promises to remove our dependence on ‘trusted’ third parties such as banks and government for securing our currency and stores of value. It has the opportunity to unlock new opportunities in how we interact as a society and how we operate as an economy.
At BDO, we are taking on this new opportunity, alongside the new wave of individuals, entrepreneurs and businesses who are innovating and succeeding in this space. We are helping our clients operating in cryptocurrency markets to consider the tax implications of dealing in such a new and ever changing environment and working with them to proactively manage their tax position. Guided by our in-house cryptocurrency expert, BDO’s team is innovating alongside its clients, and together we are looking forward to what Money 5.0 has in store.
If you would like to learn more about Bitcoin or other cryptocurrencies, or have questions about managing your tax position as a result of trading in these markets, get in touch with your local BDO adviser.