Or a nightmare called Bitcoin

An Internet search for the word “Bitcoin” while writing this post resulted in 31 million entries on Google and ten million on bing. The search report showed news articles from newspapers and news sites in many parts of the world. Perhaps the title of the article in Le Monde perfectly sums up the frenzy that exists in this regard: “Bitcoin, the e-currency that fascinates and scares” (Le bitcoin, la e-monnaie qui fascine et affole). This frenzy can be explained in part by their exchange value from $ 22 in February, to around $ 1,000 in December of this year (see this Huffington Post article: Bitcoins have never been more valuable than Right Now). At the time of writing the share price was $ 895, with a high of 980 and low of 744.

Fascination or nightmare, it is clear that, at least for now, the Bitcoin is real. The first ATM in which it can be exchanged for real currency is located in a coffee shop in Vancouver, Canada; it started operating on October 29, and according to Vancouver News, operated a Canadian equivalent of one hundred thousand dollars during the first week of operation.

But what exactly is it? In simple terms it is an encrypted digital currency carried by very sophisticated algorithms. Imagine for a moment that it a bank account that you access online, with a balance allowing you to buy products, or make transfers. Now think that the bank does not exist, and instead there is a worldwide network, that collectively manages all transactions in place. Instead of a trusted third party, there is a peer network. Think for a moment, it’s as if all bank customers had in their own computers all transactions and all balances for all accounts. The third party no longer seems necessary. A consequence is that performing a transaction must be registered collectively by the network and not by a centralized node, so any transaction requires 10 minutes to be completed; while in centralized systems a transaction usually may take a few seconds.

To get an account, you must create a pair of unique public and private keys. The public key is the address where the bitcoins balance of the account appears. To access the account and use the balance, the private key is required. Without private key, the account cannot be accessed. If for any reason a person loses the key, the money is just lost. No third party to whom reporting the loss. Bitcoin addresses can be maintained in an electronic bitcoins wallet. To fill the wallet you only need to acquire some bitcoins to be deposited in a public address in some currency exchange service. Another way is to receive transfers from other directions as a result of, for instance, sales of goods or services.

All transactions from an address and its balance are public and visible to everyone. The global transaction log called “block chain” confirms that the fund sender really has them available and that these balances are not used more than once. The existence of this block chain may make you think that this traceability would allow participants to easily identify all transactions and what happens to the money once it is received. However, since each beneficiary can create a new address for each operation because it is not necessary to identify who pays, the probability of maintaining anonymity in transactions is relatively high. To receive the funds, the receiving party must use its private key to sign the message.

The total amount of Bitcoins that can get into circulation is not, as one might mistakenly think, infinite. The maximum number to reach is 21 million, and it will be achieved by the year 2140. 21 million of monetary units do not seem a lot, but if you take into account that each bitcoin can be fractioned into satoshis (a hundred million per unit), the total number of fractions is huge. One consequence of the limited number of units is that bitcoins will not easily suffer devaluation. You could say that it looks a little gold or precious stones that you have to find and extract, but instead of miners digging the earth, here we have data miners who must solve complex algorithms. Instead of getting a diamond as a reward for their work in mining, these miners get bitcoins.

Their use as a means for buying and selling operations has received media attention for being a form of payment used in Silk Road, a website which was selling illegal substances. The relative anonymity is probably an incentive for such use. And certainly, for the same reason, it can be an incentive for those seeking to evade taxes or other tax regulations. Operations with Bitcoins can be used for legal trade transactions, like ordering a pizza, or others, to effectively transfer funds from one place to another, either by simply reducing transfer costs or, for example, bypass control exchange or departure tax, or as an investment, which could have grown by about 50 times in a year, but could also disappear very suddenly, as for instance in reaction to the announcement by a country about invalidating the transactions.

For tax administrations, in my opinion, a number of issues (1) are open to be analyzed. The first is how to deal with Bitcoin: Should it be considered as an exploitable resource? As a “commodity”? As an asset? As an investment instrument? As a foreign currency? As a barter system?  Depending on the approach, the tax situation may be very different and transactions can have tax implications for foreign exchange tax, for the income tax, and for property taxes. The second question, why not asking, is whether bitcoins could be accepted for the tax payments. The third question, and most important, is what control strategies need to be developed.

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