Bitcoin

= = Bitcoin is the most famous and best-known example of digital currencies. Established in 2009, it has since grown rapidly both in use and worth, with its exchange rate exceeding 1,000$ at the end of November 2013.

Bitcoin is a typical virtual currency, in that its worth is not linked to any existing currency. Aleksandra Bal (2013) defines Bitcoin as a type of universal virtual currency, as opposed to community-related virtual currencies, while it is acceptable everywhere in the world, although still at limited venues.

How it works
Bitcoin operates as a peer- to- peer network, without the help of governments or financial institutions like banks. The system is run by the users and their network. The user chooses their own wallet which they manage with their own set keys to verify themselves when completing transactions. Bitcoin uses digital signatures for the users but doesn’t require other information than a valid email address.

The user can gather Bitcoin value through purchasing them, selling, donations or “mining”, where the users’ computers solve specific algorithms simultaneously creating new Bitcoins. The transactions from one user’s wallet to another wallet are recorded in the so-called block chain that is open to all users in the network. The block chain is also used to verify the transactions and it works as a guarantee that users cannot use more bitcoins than they have. The transactions are verified through mining, which also guarantees the network’s security. The block chain is proofed through using cryptography which helps protect the users’ funds and their identities.

**// Shadyness and increasing crime //**
On the side of working as a payment method for many legal actions, the anonymity of Bitcoin opens many possibilities to criminal action. The FBI issued a report in 2012 stating that, specially in the case of increasing usage, Bitcoin would present, among other things, possibilities to transfer funds to illicit groups and money laundering. Due to its decentralized nature, the currency was considered to pose challenges to law enforcement. The Economist also stated in an article that the network’s relative anonymity and its role as payment in suspicious online markets, such as the now closed Silk Road, as one reason for the currency’s success.

// Should Bitcoin earnings be taxable or not? //
Bal (2013) states that although Bitcoins and other virtual currencies functions as a medium of exchange and an unit for measuring value, it cannot considered as money while it cannot be stored and retrieved in the future. Despite of this she writes that Bitcoins might be considered income in some cases, such as creating virtual money (“mining”), receiving virtual currency as a gift or rewarding someone with virtual currency in exchange for goods or real currency.

Bal also states that practices will possibly vary from country to country. At the moment the taxation of the currency is being debated in for example Sweden and Norway, whereas for example Germany has recognized Bitcoins as “private money” making thus profit from for example mining taxable.

In the United States, the Financial Crimes Enforcement Network(FinCen) released guidance concerning virtual currency, while the Government Accountability Office(GAO) also decided that in some cases Bitcoin, as an example of an open-flow system, actions may produce taxable income and urged the Internal Revenue Service (IRS) to take measures. Currently the IRS is working on releasing guidance to Bitcoin users, as was confirmed on November 18th 2013.

// Bitcoin as a tax haven? //
As Bitcoin’s popularity grows, the question has risen whether Bitcoin could be used as a way to avoid paying taxes. Omri Y Marian (2013) writes that the threat that Bitcoin and other virtual currencies pose to paying tax is due to two developments: the increasing popularity of virtual currencies, specially Bitcoin, and the battle against tax evasion and tax havens, such as the Foreign Account Tax compliance Act(FATCA) in the USA.

According to Marian, Bitcoin possesses same qualities as tax havens: earnings are not subject to taxation because they are not located in any area of jurisdiction and the users remain anonymous. In addition to that Bitcoins are not issued by any bank or government. Due to its peer- to- peer nature they can escape the struggle against tax havens and tax evasion. This, according to Marian, gives Bitcoin the possibility to become a “super tax haven” and he finds it probable that using Bitcoin for tax evasion will increase together with the use of cryptocurrencies.

Although there has been doubt whether Bitcoin users would purposely try to avoid paying taxes, there have also been signs that Bitcoin users might try to avoid paying tax for mining earnings and even use Bitcoin as a means to avoid taxes. The biggest risks are that possible tax dodging could be done only with the press of a button and that it would become impossible to gather information about these people and companies. Seems like Bitcoin, virtual currencies and tax will be a very current topic in the next years.