With the exponential rise in the value of Bitcoin over the last year, interest in cryptocurrencies is higher than ever. Investors, CPAs, and the IRS are all trying to figure out what it means and where we’re headed. The truth is, no one is entirely sure. But, what is certain is that cryptocurrencies aren’t going anywhere and will prove to be a disruptive technology in coming years. As blockchain technology expands into more traditional financial sectors, widespread adoption—rather than a reversal of the trend—seems to be the future.
A blockchain is an open-source protocol designed to store authenticated transaction information on a decentralized, secure, anonymous, public network ledger. Blockchains use peer-to-peer transactions to transfer assets on the Internet without the need for a centralized third party such as a bank or government agency. Cryptocurrencies, such as Bitcoin, are acquired and sold on public exchanges similar to traditional investments. But unlike the NYSE or NASDAQ, cryptocurrency exchanges are largely unregulated, run around the clock, and operate worldwide.
Although the transactions are anonymous (the parties engaged in the transaction and their personal information are encrypted), anyone can view the action in real time. Every transaction that has ever existed on the blockchain is independently verified by thousands of nodes in the system and is available for review and inspection by all users.
Businesses can choose to apply blockchain technologies in a number of ways. For example, when applied to accounting systems, blockchain could ensure that every transaction is authentic, verifiable, permanent, and authorized. Because of this, fraud could generally be more easily discoverable. If someone does perpetrate a fraud, the event can simply be traced to a specific transaction in the public blockchain.For forensic accountants, this provides a major tool for discovering the manipulation of financial data. Additionally, blockchain technology could be used to improve a number of traditionally complicated business tasks such as proving digital identities, issuing insurance, tracking title on property, voting, and more.
How Bitcoin fits in
By far the most well-known cryptocurrency to non-enthusiasts is Bitcoin. Bitcoin and its blockchain were created in 2008 and released to the public in 2009. Its creator (or possibly creators) used the pseudonym Satoshi Nakamoto, and to date, the true identity of who came up with the original concept is unknown. While its valuation has been prone to large, erratic swings in value, it has rebounded each time to reach new highs. Bitcoin has consistently delivered at least 100% return on investment year after year.
Early investors and miners (we’ll discuss how cryptocurrency is “mined” in our next post) were often technologists and people within a community concerned about the role of traditional banking systems, government overreach, and internet privacy. However, as public interest in Bitcoin has grown, and value has skyrocketed (Bitcoin was worth $173 on January 14, 2015; it topped $1,000 on January 1, 2017 for the first time; as of this writing in January 2018, it is worth $11,211.35), more traditional investors have begun to take notice and purchase it. A $1,000 dollar investment made in early 2013 would be worth over $500,000 at today’s valuation.
While Bitcoin is garnering all the attention (in part simply because it was the first), it is now just one of many cryptocurrencies operating on a myriad of blockchains. Ethereum, Ripple, Iota, and Litecoin, are just a few of the hundreds of different cryptocurrencies vying for attention and being publicly traded. Each of these currencies has their own specific use case and can be applied in a number of ways. Some are simply a digital store of value like Bitcoin while others provide entire computational platforms. While all are prone to the same type of fluctuations as Bitcoin, the market in general is expanding and growing.
In next week's post, we’ll discuss how cryptocurrencies are acquired by miners and what the IRS is saying regarding the taxation of digital currencies.
Stephen M. Yoss, Jr., CPA, MSIST, is a certified public accountant, the senior technology strategist and principal of Yossio, a continuing education instructor for financial professionals, and a licensed pyrotechnician. While his interests and skills are varied, they all share a common thread—his love for and skill in finding technology-based solutions.