Bitcoin, Part 2: Is the Potential Reward Worth the Risk?

In a previous post, we provided an overview of Bitcoin, an open-source, user-controlled payment network that makes it possible for businesses and individuals to send and receive digital currency without bank involvement. Bitcoin uses peer-to-peer technology to facilitate these transactions, which can be made anonymously, on a computer or mobile device.

Because Bitcoin is still in its infancy, many people are still trying to figure out how to classify it. Is Bitcoin “real” currency, like paper money and coins?

According to the Internal Revenue Service, Bitcoin is virtual currency, which operates like real currency but has no legal tender status. For federal tax purposes, the IRS views virtual currency as property and has published a document of 16 frequently asked questions that cover what federal tax laws should be applied to virtual currency such as Bitcoin.

As Bitcoin use becomes more popular, solutions are being developed to help merchants that accept bitcoins comply with complex sales tax regulations and simplify the process of tax filing. For example, a cloud-based solution from Avalara, Inc. calculates sales tax for companies that allow Bitcoin transactions.

Although Bitcoin has shown promise, it has also proven to be risky. Mt. Gox was one of the world’s largest bitcoin exchanges until its platform was hacked and 1.75 million bitcoins vanished. Mt. Gox was forced to prevent investors from withdrawing money and, within weeks after the hack, the exchange filed for bankruptcy. This incident is one major reason why the value of bitcoins is about half of what it was at its peak last year.

Questions surrounding Bitcoin led the Florida Office of Financial Regulation to issue a consumer alert in March of this year. The warning pointed to consumer losses from virtual wallets that weren’t adequately protected, links to criminal activity, and uncertainty about tax obligations. Virtual currency platforms are uninsured and unregulated, creating a certain level of risk for those who make transactions with or invest in Bitcoin.

However, the lack of regulation may be temporary. The Conference of State Bank Supervisors has formed the Emerging Payments Task Force, comprised of nine state regulators, to research evolving payment platforms and assess how they could affect “consumer protection, state law, and banks and non-bank entities chartered or licensed by the states.” The Task Force will likely develop ideas for regulating virtual currency such as Bitcoin.

While some Florida businesses that use innovative business models to attract customers continue to adopt Bitcoin, the majority are taking a wait-and-see approach. We are cautiously optimistic about the future of Bitcoin, or the next form of virtual currency, and look forward to reviewing the findings and recommendations of the Emerging Payments Task Force.