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12. Cryptocurrency – Taxation

At the moment Bitcoin may not be on the Tax Office’s radar in your country. Don’t bank on it remaining that way too long. Bitcoin is still experimental and new improvements are happening all the time.

As it increases it’s user base, it’s only a matter of time before all Tax Offices have legislation to enforce taxes of Bitcoin transactions. Remember all transactions are recorded and displayed openly, right back to day one. That could create a hefty tax bill further down the track. I’d think about paying the correct taxes today.

A handy trick for any business is to extract an amount to be withheld for taxes but take 20% of it and invest it in p2p funding finance. By the time the tax is due, half of the funds will be paid back and if the business cannor meet the other 10%, a payment scheme arranged with the Tax office will at worst cost half the persentage return you’ll earn on the crowd funding finance. We’ll be looking more into p2p funding after the crypto-currency topic.

The last time I searched the news, the major Australian banks were looking at adopting Blockchain security and the Commonwealth Bank was reviewing trading in Bitcoin. In Europe, several big banks are currently setting up for Bitcoin trading. It’s important to remember cybercurrencies effective shut the banks out, so the fact that banks are no longer refusing to acknowledge it, means it’s only a matter of time before it is accepted. Once a few major banks accept cybercurrency trading, it will open a floodgate of competition. Even if they try to invent their own altcurrency, it will still have to be compatible with Bitcoin, which is already well established.

Just a question that might be worth looking into; what would happen if you convert crypto-currency into a high value currency (e.g. Sterling or US dollars) then bring it back home to Australia or New Zealand when the exchange rates are favorable? The increase could offset some of the tax, if the transfer fees are not too high.

11. Cryptocurrency – Privacy

Because all Bitcoins transactions are visible, one of the ways it is proofed against fraud and manipulation, you need to take some effort to protect your privacy with Bitcoin. Because all transactions are stored publicly on the network, they show the cyber address, generated by your wallet and the balance of your Bitcoin account. The cyber address does not give away your real address until the purchase take place and even then, only to the other party in the transaction, not to anyone else on line. However anyone obtaining this address can see all the transaction related to that address. For this reason you should only use a Bitcoin address only once.

To protect your privacy, you should use a new Bitcoin address each time you receive a new payment. Additionally, you can use multiple wallets for different purposes. Doing so allows you to isolate each of your transactions in such a way that it is not possible to associate them all together. People who send you money cannot see what other Bitcoin addresses you own and what you do with them. This is probably the most important advice you should keep in mind.

Publishing a Bitcoin address on any public space such as a website or social network is not a good idea when it comes to privacy. If you choose to do so, always remember that if you move any funds with this address to one of your other addresses, they too will be publicly tainted by the history of your public address. Additionally, you might also want to be careful not to publish information about your transactions and purchases that could allow someone to identify your Bitcoin addresses.

Because Bitcoin operates on a peer to peer network, you IP address can be read with any transaction. There are ways to trace an IP address back to a physical address, so it’s a good idea to conceal your IP address with a program like Tor ( http://www.torproject.org ).

Another method of concealing your identity is using a mixing service. This is a deceptive and misleading method that is considered as akin to tax evasion in some countries. Also the mixing organisation has all your information, so you need to trust them and hope they have sufficient cyber security in force.

10. Crypyocurrency – Risk and Volatility

It pays to remember that Bitcoin and crypto-currency is in it’s infancy. The value of a Bitcoin is highly volatile and is highly unpredictable over the short term, so it should not be regarded as a way of saving money. Only try it out with money you can afford to lose. Personally I believe it will evolve to the point where financial control is wrested away from the banks, governments and a clutch of super rich with the power to manipulate the market. Like all investments, anyone getting on the ride early could reap the benefits as it grows. However, we are breaking totally new ground here. It is also likely that cryptocurrency could out perform fiat currency and be a lousy investment but useful only for short time transactions as an “on the spot” measure of value, rather than an investment instrument. For all we know, it could have passed it’s investment peak now. For my money, there are better investments that conserve the value of your hard won savings.

Initially the concept of Bitcoin took off and other cloned versions vied for leadership. It was viewed as shady and branded as a way crime would launder money, in it’s early days. Banks refused to recognise it, effectively making it valueless in the real world. Today several banks are looking at participating in Bitcoin. These ups and downs in perception have reflected in the price of a Bitcoin.

Recently several European and Australian Banks have quietly begun to purchase Bitcoins. The Commonwsealth Bank of Australia is looking into Bitcoin at the moment.

I believe that it’s only a matter of time and crypto currency will take over from the banks, leaving them to be expensive safe deposit houses. The world needs a universal currency and nationalistic pride will never accept any one currency. The answer is a cryptocurrency like Bitcoin. Currently we lose millions in transfer fees to transact overseas. Why? We’re not loading gold onto ships any more; it’s purely digital data these days (the price of an international, micro seconds long, phone call)  but we are still paying the fees fixed in the pre-computing days when it was shipped in a flotilla with armed escort vessels. With Bitcoin it will cost no extra to transact at home or overseas. The banks require staff to do this, so they can never compete with Bitcoin.

The important consideration is, there is a maximum number of Bitcoins. There can only be 21 Million Bitcoins. Unlike currency, no-one can make any more. Over time as more and more businesses come to accept Bitcoin, the demand will increase and being capped at 21 million means the value of Bitcoin should rise proportional to the demand. If the same happened with the US Dollar, for example, the Federal Reserve could print more money which would drop the value of the dollar. No-one can do this with Bitcoin.

As in all digital matters, with time any system becomes open to vulnerabilities, so you need to keep your software up to date. I would not suggest you transact in Bitcoin on a system using Windows XP, Windows 7 or Ubuntu 13.04 Linux. These operating systems are no longer supported for security updates and would invite hackers to steal your wallet. If you prefer these old stalwart systems, transact using a smartphone with updates and store your stash in a cold store,  hardware wallet that is removed from your system, the moment the transaction is complete.

9. Cryptocurrency – Transactions

It is important to note that Bitcoin transactions are not reversible. A purchase made with Bitcoin is not like one made with PayPal. Make sure you know who you are dealing with. The only way to get your “money” back is if the other party agrees to refund it. There are some safeguards in the Blockchain. It can detect typos and will not let you send Bitcoin to an invalid address. It’s still early days in crypto currency so, it’s highly probable that in the near future, more checks and balances will evolve.

Transactions in Bitcoin don’t start out as irreversible. They generate an identicle code at both the seller and the buyer, using a formula. For the transaction to take place both codes have to be idendtical. A rating is also transmitted that indicates the trustworthiness of the two parties. The codes are then used to log a transaction key which is used to label and store the transaction. As other transactions are processed, they are grouped together to form a block of transactions. This block is added to the ledger, which records every transaction, right back to day 1 when the first Bitcoin was formed. These may take anywhere from a few seconds to 90 minutes. Transactions that are small, are unusual in some way or pay a too low fee, take longer to process. The trust table is shown below with the codes and their meanings.

So you are aware of the risk, a confirmation score is sent back with each transaction. These scores are based on the history of the user you are dealing with, similar to a rating for buyers and sellers on an auction website. Below is the table of confirmations and their translations. They vary somewhat depending on the type of wallet you use.

Confirmations Lightweight wallets Bitcoin Core
0 Only safe if you trust the person paying you
1 Somewhat reliable Mostly reliable
3 Mostly reliable Highly reliable
6 Minimum recommendation for high-value bitcoin transfers
30 Recommendation during emergencies to allow human intervention

 

Bitcoin has a multi signature capability for businesses. In cases where several people need to have access to the business funds, Bitcoin has the ability to allow multiple signatures so the transaction does not validate until say 3 of the 5 trustees have signed.

8. Cryptocurrency – Digital Wallet

Every financial system, whether cyber or real, has a weaker link. The weakest point in Bitcoin is the owner of the digital wallet. It relies on you as owner to secure your stash of Bitcoin, your digital wallet.

Your digital wallet should be treated the same as your real world wallet. Because Bitcoin is able to transact anywhere in the world, without exchanges, it can also be targeted from anywhere in the world too. The Blockchain is digitally more secure than any bank, both through it’s encryption and the fact that it is visible worldwide, so any tampering is easily spotted. In a bank, we rely on our inhouse security people to spot a digital attack. In the Blockchain we have millions of people at any one time, many of them extremely competent programmers, watching for any hint of attack.

A hacker would have to be very brave to successfully crack the Blockchain, even if they could find a way. They would have every one of the world’s top hackers and security expert after them.

If a hacker was able to get to your digital wallet, they can only steal the bitcoins stored there in that one wallet. Unlike a bank, where many accounts are secured by one blanket security system, allowing the cyber theif to steal from multiple accounts. In the Bitcoin system, each wallet is completely stand alone – not connected to another wallet.

There are services that claim they can store your wallet on line. Be very wary. Very few have sufficient security to withstand a concerted cyber attack. Remember they are not banks.

You should only keep a small amount of Bitcoins in your digital wallet, on your computer or smart phone. Just like your real wallet, you wouldn’t put your life savings all in there. Should anything go wrong, like you phone get stolen and hacked, your computer get hacked, a hard disk failure and any similar disaster, you will only lose a small portion of your Bitcoins.

The remainder of your Bitcoin should be kept in what is called “cold storage”. This is kept off line, off your computer on a flash drive or some other removable memory device. This is important because any electronic device connected to the Internet (including a phone network) has the potential to be attacked. Hackers are getting more and more talented all the time. It’s not practical to say any system is foolproof.

You need to keep multiple backups of your digital wallet and cold store. I don’t mean keep a second copy on your computer on D drive, when you computer has two hard drives. Usually this is a second partition of the same disk as C drive. I mean you keep a backup copy on more than one media; say a memory stick and a removable hard drive of memory card and then remove these from your phone and or computer. DVDs and Cds will degrade with time and can be easily scratched. Memory sticks can suddenly not work. The safest practice is to use two different media (eg two memory sticks) and place a copy on each.

Passwords should be complex, not simple dictionary words and use two layers of security to identify you, eg, password and PIN or security question.

If all this sounds complicated, it’s because we are at the infancy stages of crypto-currency and the amount you think is tiny today cold be a fortune in 5 years time. If it is, you’d be grateful the today, you took these steps to make it secure. To put it into perspective, if you opened a bank account today, for the first time, the rigmarole would be worse.

Remember when Lazlo Hanyecz bought his pizza back in 2010, with Bitcoins, they were worth 0.0041 cents each, today(8th September 2016) those Bitcoins are worth over $825.13 NZD or $802.24AUD each.

7. Cryptocurrency – The basics before you start.

If you are considering exploring Bitcoin there are a few things you should know first:

Because it is a bit Geeky, there’s a few con-artists and scams that claim to have a secret formula to earn (or mine) Bitcoins or some other alternative crypto-currency. Generally the price you will pay for their secret is far greater than what the secret will earn you.

Originally, mining bitcoin was very profitable but as more and more of bitcoins are mined, the profitability of the process decreases. The algorithm that creates bitcoin grinds to a halt at 21,000,000 bitcoins. There can be no more in circulation. This is the main reason why bitcoin is the ideal cyber currency – no government can manipulate the value by creating more bitcoins, like they currently do with fiat currencies. Thus it is universal for all countries. With fiat currency the value is adjusted by the treasury. If it wasn’t, you be paying around $75 for a loaf of bread today. A despotic or incompetent treasury can ruin the value of their currency.

Bitmining -cold store wallets
Bitmining -cold store wallets

Transacting with Bitcoin is different, rather than talk of whole coins, we tend to use decimal fractions of a coin. Unlike physical money, cyber money can be cut up into smaller pieces easily, with no loss in value. If I wanted to pay you 50 cents, pulled out a hacksaw and cut a dollar coin in half, it would not be worth two pieces of 50 cents each now. However the same is not true for cyber currency; it is simply divided up with each part retaining it’s proportional value. So if one bitcoin is worth $97USD a transaction of 0-010309 BTC would be equivalent to one US dollar.

Using Bitcoin you exchange funds a little differently than you would with online banking but the actual transaction process is every bit as secure as any online banking, probably more so because it is so visible and cannot be reversed or in any way tampered with. The system is self auditing for every transaction, unlike fiat money (folding stuff backed by the government) transactions.

It’s important to realise that Bitcoins are valuable and targets for theft, the same as real money in your bank account would be. The difference is, your digital wallet is the equivalent of your bank account. The onus is on you to secure your digital wallet. Use a two password recognition system with non dictionary words. Do not store access codes on your computer. Keep your malware and antivirus ware up to date. Back up your digital wallet onto a flash drive or removable disk.

Your digital wallet is a software program that requires a password or two to access. Lose the password(s) and you lose access to your wallet permanently! There’s no way to recover the password(s).

Recently you may have heard of hacks that broke into the companies that were brokering/trading bitcoins. Millions were stolen because of their weak security. The real losers (aside from the companies that went into bankruptcy) were the people who relied on them to store their bitcoins and those doing transactions at the time the company data was stolen. As I have said all along, this is a totally new way of transacting, there’s no precedents to rely on for advice, so we are learning as we go. The lesson is, don’t rely on any company to store your bitcoin and don’t store them on your computer. Store your bitcoin in your wallet on a flash drive (memory stick etc.) and physically remove it from your computer when you are not transacting. Should any one try and hack an exchange etc. you have proof that your bitcoin was not used. If it sounds scary, it’s no different to your bank, except if they get hacked, they have your records and can take up to 90 days to investigate it. With bitcoin, you have proof the transaction did not come from you.

There are a few different varieties of digital wallet software. Some back up your digital wallet to a secured server (like the secured ones that were hacked recently). If your computer crashes, you can retrieve a backup copy but it required typing in 25 words in the exact order you were given them when you created the digital wallet. Not an easy task!

There are no free lunches and this is very true with Bitcoin mining or working online to earn Bitcoin. If you treat it as a financial system rather than a get rich quick scheme, it will serve you well. Treat it as an investment at your own risk.

Unlike currencies, purchasing with Bitcoin is simpler because there is no exchange rate, however there is a delay in the transaction going through as it gets verified.

6. Cryptocurrency – What is Bitcoin really?

It’s hard for some of us to get our head around cryp-tocurrencies like Bitcoin because although we see pictures of Bitcoins on the Internet, the coin itself is really only exists in cyberspace. It’s not even a coin, it’s a number. If that makes it sound shonky, take another look at that $10 note and ask if it is really worth $10. It’s just a bit of paper. Even with all it’s security tricks and special paper/plastic, it’s real value is around $0.005 or half a cent. It’s nothing more than a symbol of value. If you bank that $10 and then use your Eftpos card to buy something for $10, do you really think some bank guy races out the bank’s back door to the place where you made the purchase and hands over the $10.00 note? The simple fact is, the transaction is simply data on line.

That’s the first shift in thinking that people have a problem with. It might sound strange to us, used to the folding stuff, but it’s really what money has been all along – a symbol for a transaction. If you get your wages deposited directly into your bank, do you really think your employer piles all those notes in a briefcase and trots it off to the bank before Thursday? It’s a cyber transaction. No notes or coins physically change hands.

The second mental stumbling block is actually easier to understand. Because a single Bitcoin is so valuable, we tend to use fractions of the coin. Imagine we are back in the medieval times when coins ar made of precious metal. If I had a 100 dollar coin and needed to pay a dollar, I could cut a peice of metal off the coin that was one hundredth of it’s value. So it is with Bitcoin. While there is a dollar amount for one Bitcoin, most transactions are conducted in fractions of a Bitcoin. Currently, while a Bitcoin is worth over $900, many transactions are conducted in tiny fractions of a Bitcoin eg. 0.0025 Bitcoin.

The value of a Bitcoin is volatile but that shouldn’t be too hard to digest either because so is every other currency. Given that Bitcoins are so new and to most people not understood, it shouldn’t be surprising that the value oscillates with every rumour. In all honesty Bitcoin is more volatile than most other currencies however the number of Bitcoins was fixed when the original algorithm was designed, at 21 million Bitcoins, so I think we can safely say, if Bitcoin does become the universally accepted crypto currency, it’s value will eventually increase.

However therein lays the catch – ” if it is accepted as the universally accepted currency” . There are other crypto-currencies there. As far as I can tell, they don’t seem to be faring as well as Bitcoin at the moment.

5. Cryptocurrency – Volatile value

Today, only some companies will accept Bitcoin , usually via a third party, but will then immediately convert it into their own trusted currency. The problem is that the value of Bitcoins is volatile – its price relative to other financial assets varies a lot. So, as an asset, a Bitcoin is risky to hold — without warning, its value might go up, or down.
Based on historical values, Bitcoin has been twice as volatile as gold, and three-to-four times as volatile as the major currencies.
But the brilliant thing about Bitcoin is what underlies it — the block chain, the unchangeable register of every Bitcoin transaction that has ever been carried out, and that anybody can have a copy of.

Chart plotting Bitcoin's value from July 2012 to July 2016
The price of a Bitcoin has varied wildly and is far more volatile than gold or silver.

Initially there were clones of Bitcoin, trying to become the one and only cryptocurrency and this destabilised the market, creating bad press. Hackers managed to steal stashes of Bitcoins from people who had poor digital security. All these things were teething problems as the IT community got their head around the digital currency. The negative press along with public scepticism caused massive fluctuations in Bitcoin values. If there is one certainty in cryptocurrency, it is it will become the way we transact in the future and Bitcoin is looking like the favourite currency.

4. Bitcoins for pizza

Laszlo Hanyecz, a programmer, in Florida USA conducted the first real world Bitcoin transaction. He had mined’ 10,000 Bitcoins and wanted to test their real worth in the real world. He decided to use them to buy a pizza but his local pizza store did not accept Bitcoins. At that time, no commercial institution accepted Bitcoins, they were like Monopoly money.
On the 18th of May, 2010, Laszlo posted a request on the Bitcoin forum asking if anybody could use his 10,000 Bitcoins (then worth about US$41) to buy two large pizzas (then costing about US$25).

A hand holding a piece of pizza pie.
Probably the world’s most expensive pizza now but it verified Bitcoin’s real value for the first time.

As Laszlo said, ” … what I’m aiming for is getting food delivered in exchange for Bitcoins where I don’t have to order or prepare it myself, kind of like ordering a ‘breakfast platter’ at a hotel or something, they just bring you something to eat and you’re happy.”
It was an experiment as Laszlo put it, “I just think it would be interesting if I could say that I paid for a pizza in Bitcoins.”
After a few days, he was contacted by Jeremy Sturdivant, who was then 18 years old, and also living in the USA. After a bit of back-and-forth, the deal was finalised. Laszlo sent the 10,000 Bitcoins to Jeremy, who contacted a pizza store in Jackson, Florida, which delivered the two pizzas.
On May 22, 2010, Laszlo joyfully posted, “I just want to report that I successfully traded 10,000 Bitcoins for pizza.”
By August 4 that year, the value of the Bitcoins had risen to US$600, and by 29 November had reached US$2,600. Laszlo said, “I don’t feel bad about it. The pizza was really good.” By November 2013, those 10,000 Bitcoins were worth US$12.4 million. Lazlo broke two world records; the first Bitcoin trade in the real world and the world’s most expensive pizza.
To commemorate that first commercial Bitcoin transaction, May 22 is now called Bitcoin Pizza Day.

3. Blockchain, Bitcoin; where it all began.

In 2008 the anonymous programmer Satoshi Nakamoto released a paper with a program that was extremely secure, allowing a fixed number of units of value to be traded in cyberspace. It was called the Blockchain, and in this landmark paper, he described how to set up a decentralised and secure digital cash system using the peer-to-peer network combined with encrypted signatures to both generate and exchange, these units he dubbed Bitcoins. There was no need for a regulator like a bank, demanding a fat fee, to be involved because unlike the banking system, every transaction is visible, to everyone, right back to day one. The openness of the system was it’s own regulator, beyond government control.

In times of financial instability, governments inflate or deflate the value of their currency by printing or withdrawing notes from circulation – the old “supply and demand law”. The block chain stipulated that there was a maximum of 21 million Bitcoins. No-one can create more or remove any from the system. Their value is set solely by the market without any political meddling.

So a Bitcoin is not a physical coin or note; it’s an entry in an electronic ledger. Anyone can download a copy of this ledger, which is updated every 10 minutes and is a record of every transaction of every Bitcoin. Because of the brilliant mathematics behind it, this ledger has to be an honest record and once calculated, cannot be altered.

Bitcoins
Bitcoins don’t really exist as coins but they do exist!

Bitcoins can be earned (or “mined”) or bought for conventional currency. The Block chain is like the trading floor in the stock exchange. It’s where transactions are conducted , not where Bitcoins are stored. To store your Bitcoins you need a digital wallet, a digital safe place in cyberspace, which just like with conventional money, needs to be securely locked at all times. Unlike conventional notes, you need to have a backup copy of your digital wallet because like all digital things, if your computer goes down, your data (aka digital fortune) will vanish. We’ll look at this in more depth soon.