Bitccoin 101

  • April 01, 2014
  • James Morton

Sign with "Bitcoin" written on itIs this the currency of the Future?

My Grandfather was a small town lawyer from the 1930s to the late 1960s.

One of his less fond memories was the difficulty of getting paid for his work (plus ça change, plus c'est la même chose). When times were difficult even good clients were short of cash. People did not have money but they did have other things and my Grandfather would often have to take his fees in chickens or eggs or firewood.

Even today, when I do work in Nunavut, I am asked to take carvings or sealskins rather than money.

Barter, as a way of doing business, is alive in Canada even today.

The problem, of course, with barter is that you do not always get what you want or need – I have plenty of carvings and have very little need of sealskins. My Grandfather had a lot more chickens than he ever wanted or needed (I can remember his backyard in the 1960s looking like a chicken farm!).

And this problem with barter is, of course, why we have currency. A sealskin is worth about $60. But if I have a sealskin and want, say, $60 worth of canned peaches I need to find a grocer who wants a fur. Or I need to go to someone who will take the sealskin, give me something less than $60 worth of peaches and make a living off the difference. A lack of currency leads to commodity arbitrage as a daily experience. If you have currency the trader in the middle is cut out and people can focus on producing what they produce instead of barter arbitrage.

Virtually all nations/states have their own currency. Except for gold or silver coinage, the value of the currency depends on the faith and trust people have in the government issuing the currency. Strong countries tend to have strong currencies. But the reverse is true of weak nations. When faith in the country vanishes so does the value of the currency – witness Zimbabwe and Germany in the 1920s. Confederate money has value only to collectors.

Oddly, a new currency has emerged from the Internet which appears to have no basis for faith and trust beyond that people have given it faith and trust – a little bit like Tinkerbell. So long as you believe in fairies, they exist, but the moment you stop believing they stop existing. (“Every time someone says I do not believe in fairies, somewhere there’s a fairy that falls down dead.”)

This new digital currency, the Bitcoin, was developed by a pseudonymous developer Satoshi Nakamoto in 2009. The Economist says “Unlike traditional currencies, which are issued by central banks, Bitcoin has no central monetary authority. Instead it is underpinned by a peer-to-peer computer network made up of its users’ machines. The mathematics of the Bitcoin system were set up so that it becomes progressively more difficult to “mine” Bitcoins over time, and the total number that can ever be mined is limited to around 21m. There is therefore no way for a central bank to issue a flood of new Bitcoins and devalue those already in circulation”. Of course, it is unclear whether that limitation will be maintained for the future. It is also unclear how easily Bitcoins will be convertible to other currency in the future.

In fact, in recent days a major exchange for Bitcoins in Japan has failed amidst allegations of fraud and defalcation of funds. While Bitcoins seems likely to survive this blow, the faith in the currency has taken a very major fall.

Despite lacking any intrinsic value, or state backing(economist Paul Krugman stated that bitcoins have "a value conjured out of thin air" (14 April 2013). "The Antisocial Network". The New York Times) some Canadian merchants have begun to accept Bitcoins for real world transactions.

Bitcoin transactions are convenient as they are sent directly and instantly from one person to another. Unlike credit card transactions there are no fees charged to the merchant selling good. There are no processing and other fees usually charged for, say VISA transactions. This is one advantage to Bitcoin over taking, say, traditional credit cards.

The value of Bitcoins, which is not regulated by any central bank, is volatile. It is unclear what the value of a Bitcoin will be in the future – or indeed if there will be a value in the future.

For a lawyer considering taking Bitcoin as payment there are a number of issues beyond the general concern about future value and convertibility.

First, Bitcoin transactions have to be accounted for as other income – a value has to be attributed for tax purposes and income taxes have to be paid and HST collected. But these taxes have to be paid in Canadian currency so there must be an exchange made at some point. The Canada Revenue Agency has said using digital currency of any sort must be included in income for tax purposes and the amount included would be the value of the good or service in Canadian dollars. Since digital currency can also be bought or sold like a commodity and any resulting gains or losses could be taxable income or capital

Second the dangers of money laundering have to be considered. Law Society rules about accepting currency must be followed but more generally Bitcoin has been associated in the past with criminal transactions. While that early reputation seems to be fading, a lawyer must be especially wary not to become a dupe of a client seeking to launder funds.

All that said, there is a growing use of Bitcoin as a currency. According to the Hamilton Spectator “Vancouver saw its first Bitcoin automatic teller machine go live in a downtown Vancouver coffee shop last fall, followed by Toronto and Ottawa. Consumers can exchange Canadian cash for the digital currency at the current exchange rate.” Depending on how the currency weathers the next few months, and while there are plenty of cautions to be wary of, there may well be a new untapped market of legal consumers ready to pay in Bitcoin for a lawyer willing to take some risks.

Several American law firms have begun accepting Bitcoin as payment for legal services; firms are also introducing a new specialty in practice: Bitcoin law (or cryptocurrency).

Bode & Grenier LLP, a civil litigation boutique based in Washington, DC, has launched, dedicated to addressing and highlighting legal issues specific to Bitcoin. On their site, they describe themselves as a “boutique law firm with focus on technology issues, including emerging legal issues related to Bitcoin.”

American IRS Defines Bitcon
as Property, not Currency

On March 25, 2014, The United States Internal Revenue Service announced that Bitcoin and other virtual currencies would be taxed as property, effectively reversing its definition as currency in the US.

According to the IRS, virtual currency "does not have legal tender status in any jurisdiction." Therefore, "virtual currency is treated as property for U.S. federal tax purposes" and "general tax principles that apply to property transactions apply to transactions using virtual currency."

Virtual currency owners can now take advantage of the capital gains tax, but those who use Bitcoin and other virtual currencies as a medium of exchange will face additional paperwork. Sellers are not eligible for capital gains and miners will have to report their earnings as taxable income. In Canada, the Canada Revenue Agency treats virtual currency similarly, applying capital gains taxes when it is treated as an investment.

James MortonAbout the Author

James Morton practises litigation law in Ontario and Nunavut. He is a past president of the OBA.