Bitcoin 101: Could Cryptocurrencies Eventually Replace the Dollar?
So, Bitcoin. Yes, Bitcoin. It started as this pesty idea that hit us like a fly on a hot summer day. As the last few years have gone by, the fly keeps buzzing louder and louder and just won’t go away. Billionaires had been dismissing it since inception; however, in the last few months, many are coming to accept that it will be around in the future. Even companies like PayPal, Tesla and Square are starting to accept Bitcoin. So, what is it? What are the pros and cons of it? Will it ever replace the dollar as the world’s currency?
What Is Bitcoin?
Bitcoin was created by a mysterious person named Satoshi Nakamoto in 2008. This is an alias, and nobody knows for sure who he is. Bitcoin is a cryptocurrency or digital asset, meaning you cannot tangibly hold it. It exists through the internet using a technology called blockchain, which uses computers to keep a growing list of transactions. There is no central computer or server that monitors this, meaning it is decentralized. For many pro-Bitcoin people, this concept is one of the central reasons they like cryptocurrencies. There are only 21 million Bitcoins with close to 18.5 million in circulation and two million that are left to be “mined” (we won’t go into that here).
One of the arguments for Bitcoin is that there is only a finite amount of them, meaning you cannot scale during times of financial crises and governments cannot manipulate them. That is one of the main reasons that the anti-cryptocurrency crowd is so down on its mainstream use. However, there are other cryptocurrencies that have the functionality to create more coins. So why should Bitcoin be “the chosen cryptocurrency?” Because it was first?
Taxation of Bitcoin
As of today, Bitcoin is almost fully used as a speculative investment and not as a currency. Very few companies allow Bitcoin to be used as a currency in exchange for goods. The IRS has deemed Bitcoin as property, meaning that you are supposed to pay taxes when you sell your Bitcoin or exchange it. An example would be if Tesla started to accept Bitcoin as payment. Let’s say you’re buying a Tesla for $80,000, and you are going to use $30,000 in cash and a Bitcoin valued today at $50,000 to purchase it. If you had bought that Bitcoin at $10,000, you now owe taxes on that $40,000 gain! This makes Bitcoin very unfriendly to use as a currency and one of a list of reasons it will not replace the dollar in the short term.
A Regulation Nightmare
Without a centralized way to protect cryptocurrencies from being stolen or hacked, consumers will not have the confidence in exchanging their U.S. dollars for Bitcoin. There is no FDIC insurance for Bitcoin and nothing that guarantees your Bitcoin against theft. So far, over three million out of the 18.5 million Bitcoins in circulation cannot be accounted for. Without the ability to see all transactions and where they are coming from, it creates tremendous risk of money laundering as well. This would allow for terrorist funding and drug trafficking. The block ledger uses “codes” to name buyers and sellers of cryptocurrencies. Many believe a tremendous amount of Bitcoin transactions to date come from illegal money movement and the government’s inability to track money flows. The IRS has a hard time collecting taxes on these gains as most of the cryptocurrency exchanges do not report cost basis.
Conversely, the whole mantra of the cryptocurrency world is that there is no central government distorting the money supply, as well no central computer system to monitor Bitcoin or other cryptocurrencies. Pro-cryptocurrency people believe that regulation will stifle innovation, manipulate the cryptocurrencies and will create black markets making Bitcoin even harder to stabilize. So, support from the likes of the exchanges has not been ideal for the government or regulators. Will the United States ever support a currency that it cannot track?
Where Do We Go Next?
Over the past month, a new type of “online ownership”—known as NFTs, or non-fungible tokens, which use the same blockchain technology as Bitcoin—has become the latest hot topic Works of “digital art” are selling for millions and millions of dollars. Keep in mind when buying NFTs with cryptocurrency, you are required to pay the taxes on the gain of the cryptocurrency—another regulation nightmare and a way for criminals to try to launder gains. Will there be a world currency at some point in time that uses a blockchain? Possibly, just not sure it would be Bitcoin.
The other thing to consider is the amount of carbon emissions used in Bitcoin mining is dramatic (again, we won’t go in depth here on why). So, there are a lot of hurdles in the way of this concept going mainstream, especially with a big push to stop carbon emissions. Where we go from here is anyone’s guess. Will this be the next Tulip mania or will this be the new gold of the 21st century? Only time will tell.
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Bitcoin issuers are not registered with the SEC, and the bitcoin marketplace is currently unregulated. Bitcoin and other cryptocurrencies are a very speculative investment and involves a high degree of risk. Securities that have been classified as Bitcoin-related cannot be purchased or deposited in Raymond James client accounts.