Wait, isn’t Bitcoin a peer-to-peer digital currency? It is a virtual currency equivalent in value to real money. Ideally, it can be transferred instantly and securely between any two people in the world. It can also be exchanged into U.S. dollars, euros or other real or virtual currencies.
So, if it’s a currency, why am I calling it an investment? Because the IRS deems virtual currency as property for federal tax purposes. When a virtual currency is sold, it is treated as a capital asset such as stocks or bonds. Your profits or losses in Bitcoins are realized as capital gains or losses. However, if the property is considered inventory for sale to other customers in a trade or business, then ordinary gains or losses may be taken. Additionally, the IRS wants transactions using virtual currency reported in U.S. dollars. Therefore, taxpayers must determine the fair market value as of the date of receipt. Because Bitcoins are primarily traded on exchanges, the exchange rate needed to establish fair market value is determined by supply and demand.
Bitcoins are also extremely volatile. In January 2013, Bitcoins traded for about $11.60, but by December 2013, they soared over 9,600 percent to trade at $1,132. The electronic currency now trades around $640, meaning it has fallen about 43 percent from its high. To further emphasize the volatility of Bitcoins, you should know the value rarely stays the same, even for the duration of a transaction.
The “cool” factor and recent media attention surrounding Bitcoin has added momentum, driving the value higher. Bitcoins are essentially a number corresponding to a particular Bitcoin address. It is “created” or “mined” by using sophisticated computer software to solve a mathematical computation. The number of solutions is said to be limited. Mining is no longer a hobbyist activity, as it has been taken over by specialized companies. Most users or investors acquire Bitcoins by buying them or receiving them as payment.
Bitcoins also come with a host of additional issues, theft being the main concern. Bitcoin is an unregulated currency not backed by a government or physical asset such as gold. This means there is no protection from losses if a digital wallet used to store Bitcoins is hacked. As a result, many have attempted to steal Bitcoins. More than 140 new types of malware exist with the goal of stealing Bitcoins from their owners. Needless to say, the Bitcoin feature of irreversible transactions originally designed to make fraud difficult unintentionally makes Bitcoin theft nearly as irrevocable as stolen cash.
That is a considerable amount of work and risk for a currency supposed to be regarded as an electronic form of cash. I call this a very speculative investment, if you can even call it an investment.
William G. Lako Jr., CFP, is an executive in residence at Kennesaw State University’s Coles College of Business and a principal at Henssler Financial. Lako is a certified financial planner.The Marietta Daily Journal will periodically publish columns from KSU business faculty.