Bitcoin Basics: What is Cryptocurrency?

July 3, 2017 Business planning, Law, Tax Planning Comments Off on Bitcoin Basics: What is Cryptocurrency?


Questions about Bitcoin have increased dramatically as investors have seen the price of Bitcoin rise from 30 cents per Bitcoin in 2011 to $2,550 per Bitcoin in July 2017. This article answers basic questions about Bitcoin and we’ll have two follow-up articles addressing IRA ownership of Bitcoin and about accepting Bitcoin in your business. Needless to say, there’s a “bit” of uncertainty when it comes to whether or not one should invest in Bitcoin (sorry –bad pun) but here’s a breakdown of the basics.

What Is Bitcoin And How Does it Work?

Bitcoin is one type of digital currency also known as crypto currency. Users of Bitcoin pay each other directly without traditional intermediaries such as banks or even governments using what is known as blockchain technology to effectuate transactions. First, you would install a Bitcoin wallet on your device and it will generate a Bitcoin address. When you provide your Bitcoin address, the person paying you can transfer funds to your address and into your Bitcoin wallet. This transaction and all transactions on the Bitcoin network are done using this blockchain technology, which is a ledger that tracks balances. Cryptography i.e. mathematical proofs that provide high levels of security are used to strengthen the security of the Bitcoin network. By the way, cryptography is not some untested technology – it is through cryptography that online banking is currently done. As a Bitcoin user, you would authorize a transaction using a secret piece of data called a private key. A transaction isn’t finalized until it has been mined, which is a confirmation process to ensure the integrity of the transaction. You can learn more at www.bitcoin.org. I will write another article regarding whether a small business owner should consider accepting Bitcoin as a form of payment.

Where Did It Come From And Is It Risky?

Bitcoin was created in 2008 by an anonymous creator. Many executives in the financial sector are cautious or even skeptical, but others are optimistic and confident that it is not going anywhere. Fidelity CEO Abigail Johnson believes in the future of digital currency and has been a proponent of Bitcoin.. One of the biggest complaints against digital currency is the lack of security/protection from hackers. JP Morgan Chase CEO Jamie Dimon has been a notable critic citing its use by criminals looking to transact outside of the traditional financial system. In 2015, a notorious online drug sales scheme was orchestrated using Bitcoin. There was an incident in Japan in 2013 in which digital hackers stole about $450M worth of Bitcoin. A similar incident happened in Slovenia in 2013. Other controversies surrounding Bitcoin include the disappearance of notable Bitcoin start-up companies Neo and Bee in 2014. In 2015 there were arrests when it was learned that Bitcoin company MyCoin was running a Ponzi scheme in Hong Kong. There have been quite a few money laundering cases here in the U.S. involving Bitcoin.

Should I Invest In It And How Do I Invest In It?

Most people investing in Bitcoin are using a relatively small portion of their investment portfolio i.e. I don’t know anyone who is investing most or all their “eggs” in the digital currency. A lot of people are excited about it, but like any investment, if you don’t time it right and/or you don’t know what you’re doing you can and probably will lose money. The concept, however, in simplistic terms is that you buy the digital currency at a certain price and sell it for more than you paid for it. There is the famous story of Kristoffer Koch who paid $27 in 2009 for 5,000 Bitcoins which has now been valued at almost $1M. Currently, 1 Bitcoin equals approx. $2,550 U.S. Dollars, so it would cost you over $10,000 to buy 4 Bitcoins right now. Over the last three or four years, the value of Bitcoin has continued to increase and it is the dramatic increase in value that has caused the recent stir and attention around digital currency investing. Others are attracted to Bitcoin as a protection against government currency. These investors fear a failure in the financial markets, which will dilute and may cause value declines in the dollar or other government currencies. These investors prefer to hold their Bitcoin directly, rather than through a fund.

Assuming you’ve done your research and are comfortable with the process, in terms of actually investing, one option is to invest in the Bitcoin Investment Trust (GBTC). GBTC is a publicly traded security that solely invests in Bitcoin. This allows an investor to use a traditional investment vehicle to realize gains (or losses) as the price of Bitcoin fluctuates without actually possessing and storing bitcoins. However, investing in bitcoin through the GBTC provides only a fractional value of the actual price of bitcoin and so in terms of ease and convenience, the GBTC is a good option, but at least for now, it’s not the best option to capitalize on the full value of Bitcoin. Coinbase, Inc. is another option – it is essentially a digital exchange where you can invest in Bitcoin as well as other cryptocurrencies (see below). Another option is to invest in actual Bitcoin through a self-directed IRA, which I will write about in another article.

What Are Other Types of CryptoCurrency?

Bitcoin is not the only form of digital currency – others include Litecoin, Peercoin, Primecoin, Namecoin, Ripple, Quark, Mastercoin, and Ether(Ethereum).

In sum, like any investment, it requires due diligence and a correct timing of the market(s). As you can tell, there have been some crazy tales of Ponzi schemes and fraud but also stories of incredible returns. In any case, I don’t think digital currency is going away anytime soon – I guess you could say that the stories in this article have been “tales from the crypt”-o currency (it was a stretch but I decided to go for it).

About the author

Kevin is an associate attorney at the Phoenix, Arizona office of Kyler Kohler Ostermiller, and Sorensen, LLP (“KKOS Lawyers”). Kevin’s practice areas include real estate, securities and raising capital, self directed IRA law, business entity formation, and estate planning. His experience prior to joining KKOS lawyers allowed him to focus on representing the small business owner in many facets of the law, including business transactions and litigation, real estate matters, bankruptcy, and estate planning. Kevin is a zealous advocate for his clients and has a passion for finding solutions to their problems.