Insights

You might have been asking yourself recently, what is Bitcoin? In a lot of respects, it is still not clear, but hopefully this article can provide some idea of what it might be, what it might not be, and why it could be more than a passing fancy.

Although the Bitcoin network came into existence in 2009, only very recently has this so-called virtual or digital currency garnered much attention. Bitcoin’s value has skyrocketed since the beginning of 2013 when one Bitcoin was trading at $15. On April 10th it peaked at $266 and then dropped to $105 before returning to $160 within six hours. Needless to say, its value is quite volatile.

So what actually is a Bitcoin? Some mystery still surrounds Bitcoin’s origins. Its supposed inventor, Satoshi Nakamoto, apparently disappeared from the Internet at some point in 2010. Unlike other digital currencies, such as Facebook Credits, which are used to purchase things on Facebook like virtual birthday gifts or virtual goods on Facebook-supported games, Bitcoin is not controlled or administered by a central authority. Yet similar to fiat money, which derives its value from government regulation or law, Bitcoin has no intrinsic value. It is only worth as much as someone else is willing to pay for it, although that appears to be a significant amount at this time.

Instead of a central bank, the typical administrator of a fiat currency, Bitcoin is controlled by algorithms. To acquire a new Bitcoin it must be “mined.” Mining is accomplished by running Bitcoin’s free software to solve complex mathematical problems. Once solved and verified by the Bitcoin network, the miner is awarded a Bitcoin, which is actually just a string of numbers like a computer code. It is because of this process that some have mocked Bitcoin as “gold for Internet geeks.”

Like cash, Bitcoins have the advantage of providing anonymity and allegedly have been used as payment for online drug trades and gambling transactions. However, the virtual currency is gaining traction as an acceptable form of payment for goods and services at more legitimate places like Reddit (a social media website) and WordPress (a website hosting service).

Bitcoin’s rise has forced regulators to pay heed. FinCEN, the department of the U.S. Treasury charged with overseeing money laundering and other financial fraud matters, issued guidance last month that would effectively treat entities that generate virtual currency as money transmitters if they sell the generated currency for national currency.[1] This could effectively make certain Bitcoin “miners” money transmitters. Such Bitcoin exchanges would thus have to adhere to FinCEN’s disclosure and fraud prevention requirements.

For various reasons Bitcoin is an interesting topic, but why should people not daring enough to invest in the latest craze care about Bitcoin? Bitcoin may never achieve wide-spread global acceptance as a virtual currency, but the reality remains that such a currency could serve a necessary and valuable role in a global, Internet-driven economy. In that sense, Bitcoin might best be viewed as the latest experiment in new methods for paying for goods and services (like PayPal or Square).

While imperfect, Bitcoin could be a step in the direction towards a universally accepted form of digital currency. Perhaps Bitcoin will be for virtual currencies what MySpace was for social media websites before Facebook. There already are a number of other virtual currencies in existence, like Facebook Credits. Imagine how easy online transactions across international borders could be if the need for currency conversion and interfacing with multiple different banks was eliminated. The possible reduction in transaction costs and the facilitation of commerce makes considering the theoretical importance of a Bitcoin-like currency more than just thought experiment.

Peter L. Cockrell is an associate of Hudson Cook, LLP, in the firm’s Hanover, Maryland office. Peter can be reached at 410-865-5418 or by email at pcockrell@hudco.com.
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[1] FinCEN Guidance, “Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies”, Mar. 18, 2013, available at http://fincen.gov/statutes_regs/guidance/pdf/FIN-2013-G001.pdf.