Bitcoin

Definitions
Bitcoin is

"a virtual currency scheme based on a peer-to-peer network. It does not have a central authority in charge of money supply, nor a central clearing house, nor are financial institutions involved in the Virtual Currencies: Key Definitions and Potential AML/CFT Risksusers perform all these tasks themselves. Bitcoins can be spent on both virtual and real goods and services. Its exchange rate with respect to other currencies is determined by supply and demand and several exchange platforms exist. The scheme has been surrounded by some controversy, not least because of its potential to become an alternative currency for drug dealing and money laundering as a result of its high degree of anonymity."

Bitcoin "(capitalised) refers to both the open source software used to create the virtual currency and the peer-to-peer (P2P) network formed as a result; 'bitcoin' (lowercase) refers to the individual units of the virtual currency." }}

Overview
Developed in 2009 by an anonymous programmer or programmers, bitcoin is a privately-issued digital currency that exists only as a long string of numbers and letters in a user's computer file. Bitcoins use cryptography to secure and safeguard against counterfeiting. Unlike U.S. dollars and other currencies, a bitcoin is not government issued and does not have a physical coin or bill associated with its circulation, such as a Federal Reserve note. Bitcoin has grown in popularity since its introduction and is the most widely circulated virtual currency available.

Bitcoins act as a real world currency in that users pay for real goods and services, such as coffee or website development services, with bitcoins as opposed to U.S. dollars or other government-issued currencies. Third-party exchanges allow bitcoin users to exchange their bitcoins back to government-issued currencies, such as U.S. dollars, euro, or yen.

How it works
Bitcoins are created and entered into circulation through a process, called mining, that members of the bitcoin network perform. To perform the work of mining, bitcoin miners download free bitcoin software that they use to solve complex equations. These equations serve to verify the validity of bitcoin transactions by grouping several transactions into a block and mathematically proving that the transactions occurred and do not represent double spending of a bitcoin. When a miner's computer solves an equation, the bitcoin network accepts the block of transactions as valid and creates 25 new bitcoins and awards them to the successful miner.

By the bitcoin program's design, there will be a maximum of 21 million bitcoins in circulation once all bitcoins have been mined, which the program's design projects to be in the year 2140. In addition to mining new bitcoins, users can also acquire bitcoins already in circulation by purchasing them on third-party exchanges or accepting bitcoins as gifts or payments for goods or services. Figure 2 shows an example of how bitcoins enter circulation and how an individual can use bitcoins to pay for real goods or services.

Bitcoin transactions can be anonymous, since all that is needed to complete a transaction is a bitcoin address, which does not contain any personal identifying information. Only the private key holder knows the identity of the bitcoin address owner.

Legality and regulation
Different jurisdictions are taking vastly different approaches to Bitcoin and crypto-currencies. The landscape continues to evolve. The current regulatory framework, applicable to each national jurisdiction, can be found here.

The United States has taken the most pro-active measures, showing a willingness to actively engage industry groups and companies. This commenced in November 2013 with the first senate hearings into the cryptocurrency space. Tom Carper of Delaware presided over the hearings, which were led by the Foundation Bitcoin Foundation. The meetings functioned as a fact finding and introduction session for the Senate, who were largely uninformed up to that point.

The newly appointed Director of FinCEN: Jennifer Shasky was the most notable of presenters, because of her position. Her approach to Bitcoin and cryptocurrency was very mature. This lent what many saw as much needed legitimacy to the industry. Her positive remarks were of influence to the Senators.

Again in the United States, top financial regulators in New York have confirmed that proposed rules and guidelines will likely come in 2014. These will provide regulatory certainty for Bitcoin businesses operating within the state. This follows two days of hearings on digital currencies earlier in the year.

New York Department of Financial Services superintendent, Ben Lawsky, noted that this would see New York as the first U.S. state to create such a regulatory framework specific to Bitcoin and crypto-currencies. Given the state’s standing in global financial markets, this would prove key.

Bitcoin, once the plaything of libertarians, is entering a new phase of growth. Entrepreneurs invested in the space speculate that consumer adoption will follow. Many operating in the space who are less politically motivated see rules and regulations as necessary to safeguard users. Given Bitcoin's somewhat notorious reputation, oversight seems inevitable.

The Federal Reserve Bank of St. Louis, held a conference on Bitcoin and crypto-currencies in March 2014. The technology was analysed from a banking viewpoint. Entitled "Bitcoin and Beyond: The Possibilities and the Pitfalls of Virtual Currencies," David Andolfatto, the Vice President of the St. Louis Fed and a professor at Simon Fraser University, outlined how new systems and technologies will bring great change in banking and payments. Mr. Andolfatto noted that: "The threat of entry into the money and payments system [...] forces traditional institutions to adapt or die."

While other national jurisdictions seem to be struggling with how to come to terms with this new technology, the U.S. has clearly taken the lead. No doubt regulators will be influenced by the U.S. approach, as it continues to be developed.



Source

 * Virtual Economies and Currencies: Additional IRS Guidance Could Reduce Tax Compliance Risks, at 5.

External resources

 * François R. Velde, "Bitcoin: A Primer," Chicago Fed Letter, No. 517 (Dec. 2013) (full-text).