Pay Attention to Cryptocurrency

CryptoCurrency – Fad?

Watch Bitcoin, Ethereum, and blockchains

Cryptocurrency isn’t a fad. I believe it’s an acorn that will grow into a tall oak tree. You have probably seen the occasional new article or blog post about cryptocurrencies like Bitcoin and Ethereum and passed them by as no more than Internet pulp fiction, but take a moment to look under the surface.  There is, however, a real story here that is worth your further attention.  We are watching the beginning of a (block)chain reaction.

What is Cryptocurrency?

Bitcoin is a unit of cryptocurrency or “computer-generated money” that uses an encoding or encryption technique to verify the exchange of funds between two parties independent of a central bank or sovereign nation.  (TechCrunch, May 22, 2016) A cryptocurrency transaction is a snippet of limited programmable code written in a scripting language, a “smart” financial contract written in a computer code unique to Bitcoin or some other cryptocurrency denomination.

Cryptocurrency scripting languages are as unique as a real sovereign currency like US dollars, the Chinese yuan, or the Japanese yen. They are a form of “programmable money” restricted by a proprietary coding language with both significant characteristics. One standard characteristic is the blockchain. One distinguishing feature among these virtual currencies are decentralized computer networks. Ethereum is also “a cryptocurrency, like Bitcoin, and a vast, decentralized computer” system connected across the Net. The Ethereum technology is currently receiving growing attention.

What are blockchains?

TechCrunch explains that “Bitcoin’s contractual language … allows for transactions that can be delayed until a particular time; or transactions that occur only if, say, 3 of 5 signatories agree to them; or crowdfunding campaigns that only transfer money if a particular total is attained; and many other possibilities. Importantly, once incorporated into the Bitcoin blockchain, these contracts require no trust and no human intervention.” Blockchains are a distributed database of individual, time-stamped contracts describing a transfer of “virtual money” between two parties.  The blockchain resembles a public ledger book replicated all over the Net.  Since many machines have a replica of this digital ledger, the network is considered decentralized. There is no single central authority storing a “master blockchain.”

The article explains that “cryptocurrencies like Bitcoin and Ethereum are, or at least could be, the Internet (sic) for money, securities, and other contractual transactions. Like the Internet, they are permissionless networks that anyone can join and use. Ethereum optimists might analogize Bitcoin as the FTP of this transactional Internet, with Ethereum as its World Wide Web.”

Science fiction? Maybe. But so were smartphones thirty years ago. Digital technology has spawned yet another potential economic disruptor. Major financial players and legitimate businesses are showing interest in blockchain technology and programmable money. Investors are backing decentralized autonomous organizations (DAOs) with significant funds. The US Postal Service, crowdfunding projects, and major business concerns are also studying the usefulness of cryptocurrency and the blockchain technology. (CoinDesk, 2016)

The DAO is a paradigm shift in the very idea of economic organization.

What is the DOA?

Seth Bannon (TechCrunch, May 16, 2016) describes an emerging paradigm in “digital democratization of business.”  Crowdfunding has now morphed into “crowd-founding.” An economic entity, modeled after traditional corporations, is called a Decentralized Autonomous Organization. Distributed computer code and “smart contracts” that define shareholder “authority.” Unlike traditional corporations, the sharing of authority and control can potentially be made accessible to all “owners” through decentralized, transparent records.  As technology improves, smarter programmable money will help the exchange of goods and services. Bitcoin and Ethereum can serve well as, at least, proof-of-concept.

The Risk and Uncertainty

Many folks, including TechCrunch, emphasize risks and uncertainty in implementing different cryptocurrency technologies like Bitcoin and Ethereum. Legal and regulatory battles are certainly brewing around the use of cryptocurrency. Unfortunately, many sovereign government agencies and tax authorities still struggle with legacy technology and thinking rooted in the last century. Despite good reasons why the Department of Defense still uses “ancient” IBM Series/1 computers, reports often surface that “the Obama administration is partially run on floppy disks.”  (Brian Fung, Washington Post, May 26, 2016; Maya Kosoff, Business Insider, January 5, 2015)  We can live with the fact that information published on the Internet is “not” always correct, but eCommerce is an entirely different matter.

Time and technology will, no doubt, forge a path discernable to those who paying attention to the forest rather than the trees. The exponential increase in mobile devices is disrupting the way commerce works both on the Net and in brick and mortar establishments. Similarly growing numbers of financial transactions will likely seek a native, distributed technology that is atomic, decentralized, and transparent. Peter Horadan of Avalara, a sales tax automation company, has recently provided an in-depth review of blockchain technology (Peter Horadan, Accounting Today, May 31, 2016). We already pay for coffee with the wave of our iPhone. Future versions of blockchain-based technologies, like Bitcoin 3.x and Ethereum 3.x, will more than likely drive this revolutionary trend to greater reliability and eventual acceptance. Pay attention.

Consult a qualified tax preparer.