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Expat Briefing Editorial Team, 06 December, 2013
One of the biggest expat gripes is the exorbitant fees that banks charge to transfer money from one part of the world to another, while exchange rates can often dictate an expat’s lifestyle for many years, consigning them to a life of luxury or penury in their adopted country. So just imagine that a monetary system was invented that wasn’t linked to any of the traditional currencies and enabled you to bypass the banks altogether, allowing payments to be sent internationally with the touch of a button from your favourite bar stool, and at no cost. Impossible, surely? Well, actually, no. Miracles do happen. And in this case it’s called Bitcoin. However, on closer inspection, perhaps this virtual currency isn’t the monetary utopia its supporters claim it to be.
What Are Bitcoins and How Do They Work?
Developed by the mysterious and elusive Satoshi Nakamoto (believed to be a pseudonym) and introduced in 2008, Bitcoins are traded over peer-to-peer computer networks. No banks or middlemen are involved with bitcoin transactions, and the currency is not controlled by any central bank or other jurisdictional or multilateral authority. Put simply, Bitcoins are a form of internet cash.
Bitcoins can be acquired in a number of ways. The most common way of obtaining Bitcoins are: buying them from a friend or another individual; accepting payment for the sale of goods and services in Bitcoins; and buying them from a Bitcoin exchange by converting money in your bank account into Bitcoins. Popular exchanges include Blockchain, Bitbargain and Quickbitcoin, and Bitcoins can of course be converted back into “real” money in the currency of your choice.
Another way of obtaining Bitcoins is to earn them by becoming a “miner”. By this we don’t mean donning an illuminated helmet and descending into the bowels of the earth. “Mining” is actually fundamental to the Bitcoin economy and is how Bitcoins are created. By donating a portion of your computer’s processing power to solving Bitcoin transactions and securing the network, known as the blockchain, Bitcoins can be earned. The software for Bitcoin mining can be downloaded for free. However, most miners have invested in specialist equipment with very high processing speeds, so unless you have a very powerful PC, you are unlikely to earn very much! Moreover, the Bitcoin mining industry is becoming increasingly competitive; the rate of new Bitcoins created each year is automatically reduced, and will continue to fall until 21 million Bitcoins are in circulation. It is expected that this point will be reached by 2040.
In order to send and receive Bitcoins, you need to set up a Bitcoin “wallet” which can be stored on a computer or a mobile device like a smartphone, and is secured by a password. Bitcoin transactions are anonymous and safe: each user has an “address” which is really just a string of code, and the Bitcoin development community says that payments are encrypted using military-grade technology. Still, it is recommended that users take additional steps to secure their Bitcoin wallets, for example by using an additional layer of encryption, or by storing Bitcoins offline. Cases of Bitcoin theft are rare, but eminently possible if the user has an easily-hackable password or makes the whereabouts of his wallet obvious. Think about it - in the “real” world, we wouldn’t intentionally leave our wallets lying around unguarded for very long!
As far as expats are concerned then, the most attractive features of this payment system are that Bitcoins can be transferred between one Bitcoin wallet and another almost instantaneously and usually with no or very low transaction fees (small transactions are the ones that tend to attract fees). Bitcoin is therefore particularly useful for expats situated in countries where the banking infrastructure is not as well developed as elsewhere. The anonymity of bitcoinage is also a bonus in a world where individual privacy is seemingly being eroded on an almost daily basis. Although the unregulated nature of Bitcoin could also be one of its vulnerabilities, as we describe below.
What’s a Bitcoin Worth?
It’s the 64,000 bitcoin question. How does something that doesn’t actually exist, except as a line of code in the ethersphere, derive its value? In a sense, the same thing could be said about “real” money. The printed piece of paper that is a ten dollar bill is worth a tiny fraction of the note’s face value, and we have long ceased to consider paper money as being backed by anything physical like gold. Indeed, much of the money we possess and spend is “virtual” anyway. Thanks to the rise of internet banking and electronic payments systems, money is often seen as merely numbers on a screen, there one second and gone the next. In the virtual world, as in the real world, the validity of the Bitcoin systems rests on trust and confidence, and the rising number of people using Bitcoin suggests that it is becoming increasingly viable.
But how is the price of a Bitcoin set? Just like any commodity traded in a market place, the laws of supply and demand rule. There is only a limited number of Bitcoins in circulation and new Bitcoins are created at a predictable and decreasing rate, which means that demand must follow this level of inflation to keep the price stable. However, because Bitcoin is still a relatively small market compared to what it could be, it doesn't take significant amounts of money to move the market price up or down, and thus the price of a bitcoin is still very volatile.
Recent trends illustrate the unpredictability of Bitcoin prices. From May 1, 2012 to the end of February 2013, prices for one Bitcoin ranged between USD5 and USD20. Then from April 1, 2013, to May 1, 2013, prices for one bitcoin ranged between USD79 and over USD237. In the same time period, the number of bitcoin transactions per day ranged from approximately 8,000 to 70,000. In early December 2013, the price of one Bitcoin had reached a stratospheric USD1,200, although by its very nature, there is no way of knowing for sure whether the currency is now significantly overvalued or not.
It is hoped that these fluctuations will be ironed out once more Bitcoins are released into the system and more people trade them. However, having no intrinsic value, critics warn that Bitcoin is a classic case of a bubble, on a par with Dutch tulips, or the sort of irrational exuberance that Alan Greenspan warned everybody about during the dot com bubble. And all bubbles tend to end badly.
Who Accepts Bitcoins?
It is perhaps reassuring to note that lots of businesses, as well as individuals, have put their faith in Bitcoin. A growing number of merchants now use them, selling everything from pizza to Alpaca socks. Popular online services such as Namecheap, WordPress, Reddit and Flattr also use Bitcoins. One university in Cyprus even accepts Bitcoins as payment for its degree courses.
By the end of August 2013, the value of all Bitcoins in circulation exceeded USD1.5bn with millions of dollars’ worth of Bitcoins exchanged daily.
What is Governments’ Attitude to Bitcoin?
The short answer is that nobody is entirely sure. Bitcoin is unregulated, and while it is not illegal, it is not expressly legal either. Still, by not acting, governments across the world seem to have given their tacit acceptance to the virtual currency. Except Thailand that is, which has banned its use. The Thai authorities do not consider Bitcoin to be a real currency, and have made it illegal to both buy and sell Bitcoins and trade in goods and services using Bitcoins.
The big question is: will Thailand turn out to be an isolated case, or the tip of a potentially growing iceberg? At the moment that is hard to answer without a crystal ball. But there have been some encouraging signs from the United States for the Bitcoin world. For example, in August 2013, a US federal judge in Texas ruled that Bitcoins were a legal currency, and in November 2013 the New York State Department of Financial Services announced a public hearing to consider whether Bitcoin traders should be licensed. It is also thought that a recent surge in the value of Bitcoin was linked to testimony by senior law enforcement officials at a United States Senate hearing in which it was suggested that virtual currencies were not a magnet for criminals and should be allowed to grow.
Then again it is difficult to imagine a world where governments continue to turn an effective blind eye to Bitcoin, and it is easy to see how the system could turn out to be a money-launderer’s paradise. Its developers claim that the system is designed to prevent a large range of financial crimes, although the Bitcoin community argues that money has always been used for illegal as well as legal purposes, regardless of its form. These days though, it is not easy to cross national frontiers with large amounts of cash without arousing suspicion. Conversely, an individual could potentially walk through border control with millions of dollars’ worth of Bitcoins on a portable hard drive without attracting a second glance. This is a situation that authorities around the world are unlikely to tolerate for much longer.
Indeed, law enforcement authorities in the US have already landed a significant catch of laundered Bitcoins in connection with the clandestine Silk Road website, which was allegedly used to traffic drugs, arms and other contraband. In all, over 173,000 Bitcoins, worth USD33.6m at the time, were seized as part of the operation. According to IRS Special-Agent-in-Charge Toni Weirauch, this seizure “sends a clear notice to those who think they can commit crimes and conceal the fruits of their criminal activities in digital anonymity.”
The ideal that Bitcoin is a currency by the people, for the people, with all participants in the system holding equal status, and with no political or regulatory interference from governments, is one of its major selling points. But it remains to be seen how long it is before governments do start interfering, and perhaps then it will lose much of its value.
Given that most tax authorities are struggling as it is to come to terms with the growth of the internet and e-commerce, it is not surprising to learn that the taxation of income derived from Bitcoins is a very grey area. However, the taxman is slowly but surely cottoning on to the world of Bitcoin.
In August 2013 for instance, Germany's Ministry of Finance said that it was recognising Bitcoins as a "unit of account", meaning that the sale of goods and services for a consideration of Bitcoins would be liable for value-added tax.
Similarly, in November 2013, the Canada Revenue Agency clarified that its tax rules for barter transactions apply when digital currency is used to pay for goods or services. Although how these rules applies to bitcoin transactions is not entirely clear.
Indeed, there is a lack of guidance on the tax implications of using virtual currencies generally. This was pointed out by the United States Government Accountability Office (GAO) in a report to the Senate in June 2013. The GAO urged the IRS to rectify this situation, observing in its report that: “If taxpayers using virtual currencies turn to the Internet for tax help, they may find misinformation in the absence of clear guidance from IRS. For example, when we performed a simple Internet search for information on taxation of Bitcoin transactions, we found a number of websites, wikis, and blogs that provided differing opinions on the tax treatment of Bitcoins, including some that could lead taxpayers to believe that transacting in virtual currencies relieves them of their responsibilities to report and pay taxes.”
The GAO report suggests that if somebody receives income in the form of Bitcoins, it is taxable in just the same way as income received in a fiat currency.
So far, the IRS has maintained its silence on the matter, although some sort of guidance is said to be on the way.
So is it Suitable for Expats?
It’s not the intention of this brief primer to give a straight yes or no answer to this question, as it is still very early days in the evolution of Bitcoin, and the new digital currency does have a somewhat uncertain future.
As a medium for transferring money, Bitcoin looks to be as secure and trusted as any other payment system. However, as alluded to above, Bitcoin has attracted more and more speculators hoping to profit from wild swings in its value against paper currencies. And with exchange rate risk already a huge issue for millions of people drawing income in one country but receiving it in another, the volatility of Bitcoin is the last thing expats need when finances are tight. Having said that, if Bitcoin does catch on in a big way – it is a big “if”, even though many observers seem to think that virtual currencies are an inevitability – then the market may eventually stabilise as liquidity increases. Against the “real” currency markets however, where around USD2 trillion is regularly traded on a daily basis, the Bitcoin world is a drop in the ocean.
In the here and now, expats must decide whether the benefits of using Bitcoin, which include convenience, extremely low transaction costs and anonymity, outweigh the risks, which would seem to be tax uncertainty, regulatory uncertainty and speculation.
It’s all very well trusting in a virtual currency, but worth remembering that its value could fall to virtually nothing overnight.