An anonymous software developer proposed the idea for a new worldwide electronic payment system in 2008. In January 2009, Bitcoin was introduced.
What is Bitcoin?
Bitcoin is a digital currency, also known as cryptocurrency. It is completely virtual, and the physical coins you see are worthless without their matching code. The idea is that it can be used anywhere regardless of that location’s national currency, but many businesses do not accept it. Some countries have even gone as far as to ban it. It runs on a decentralized network of computers, which means that there are several users working to keep the system in check all the time. They keep track of all the transactions. It is similar to Wikipedia which is run by a worldwide group of writers and editors.
How does Bitcoin work?
Each Bitcoin has a unique code associated with it. It can be stored in an app, like a digital wallet. You can share Bitcoin through these apps, a lot like Venmo or Apple Pay. Each of these codes is decoded by a computer program when a transaction is made. The transaction is logged in what is called the blockchain, which is a public record of all Bitcoin transactions.
Where do I get Bitcoin?
You can buy Bitcoins with traditional currency. They can be created using a computer. Or you can sell something online and accept Bitcoin as payment. There are also Bitcoin ATMs. Be sure to read reviews about all these methods before investing because fake sites exist. It is easy to be scammed because nothing is truly exchanged other than a code.
How is new Bitcoin created?
Bitcoin is created through mining. Bitcoin mining involves using computer software to solve problems. When one of these problems is solved, the user is reward with Bitcoin. These Bitcoin have new codes associated with them, so they are new. Right now the reward for solving a problem is 12.5 Bitcoin. To keep inflation from occurring, the problem gets harder to solve each time, and the reward also gets smaller. By 2040, there will be 21 million Bitcoin in circulation. Then Bitcoin mining will end.
What is the value of Bitcoin?
Currently, one Bitcoin is worth $6,473, but the number fluctuates all the time, just like stocks. It has no use value. It only has exchange value. Bitcoin is only valuable because people exchange them for real goods and services, including cash. People investing in it believe it has value, so it does.
Is Bitcoin legal?
Yes, using Bitcoin is legal. Most of the transactions using Bitcoin are trades. Other legal ways to use it include using it to protect the value of the currency in countries with high inflation and moving money across international borders.
Is Bitcoin secure?
Every time a Bitcoin changes hands, it is recorded publicly in the blockchain. This prevents a lot of fraud because everyone can access this history. It also prevents people from spending coins that belong to someone else or making their own copies of someone’s coins.
Each Bitcoin address is encrypted and must be decoded by a Bitcoin app, or wallet when it changes hands. This also protects each individual bitcoin.
However, it is possible to delete your Bitcoins. And if you use a site to store your Bitcoin, you could be hacked.
How does Bitcoin affect my taxes?
In 2018 the IRS will treat Bitcoin as property so they will be taxed. This means that all transactions will most likely have capital gains implications. Mining coins will be equivalent to income, trading, converting, and spending Bitcoin will produce capital gains or losses, and receiving payments in Bitcoin will be seen as income at fair market value at the time of the transaction. The specifics of how Bitcoin will be handled by the IRS are still not clear, but it is important to understand that it will not be tax-free.
How is it different from a traditional currency?
Bitcoin is not controlled by any government or bank. This means that no one is forced to accept it as payment. It also means that anyone can accept it as payment. No one can reverse a transaction once it goes through. As mentioned previously, Bitcoin has a limited supply to prevent inflation. Traditional currency controlled by a central bank has an unlimited supply because the bank can always issue more. Another difference is that Bitcoin is traded through a digital address, which means transactions are relatively anonymous.
This article is up to date and accounts for tax law changes for tax year 2018 (tax returns filed in 2019). Learn more about tax reform enacted under the Tax Cuts and Jobs Act here.