What Is Bitcoin?

Bitcoin is a decentralized cryptocurrency that uses peer-to-peer technology for instant payments between people or businesses. It can be bought and used as a currency and also as a type of investment.

Bitcoin has been around since 2009. It hit its all-time high in price on April 13, 2021, when one bitcoin was worth $64,863.10.

Definition and Examples of Bitcoin

Bitcoin is a form of digital currency that is created and held electronically on a computer. Bitcoins are not paper money like dollars, euros, or yen controlled by central banks or monetary authorities. Bitcoin is the first example of a cryptocurrency, which is produced by people and businesses all over the world using advanced computer software that solves mathematical problems.

The Commodity Futures Trading Commission (CFTC) in the U.S. designates bitcoin as a commodity since bitcoin exchanges offer derivative contracts or options on the value of the cryptocurrency. It is difficult to categorize bitcoin because it is still new and different from other assets available to market participants.

Bitcoin has several attributes that set it aside from traditional currencies as a pan-global means of exchange. Central banks or monetary authorities do not control the number of bitcoins, and bitcoin is decentralized, making it global. Anyone with a computer can set up a bitcoin address to receive or transfer bitcoins in seconds. Bitcoin is somewhat anonymous and allows users to maintain multiple addresses, and setting up an address requires no personal information.

How Bitcoin Works

Bitcoin is a method of payment or transfer of value that is independent of governmental authorities like central banks that traditionally control the money supply and the availability of currency in the global market. Transfers are made via computer with low transaction fees.

Bitcoin does not flow through the traditional banking system; rather, it flows from one digital wallet to another. Bitcoin cannot be held or kept in a pocket or physical wallet like coins or paper currency; it is purely a computer-based means of exchange.

Bitcoin is a fixed asset because there are only 21 million coins. Solving advanced mathematical problems results in the mining of bitcoins. However, bitcoin is divisible, so the growth potential for the exchange medium is unlimited. One of the most interesting inventions that came alongside bitcoin is blockchain or distributed ledger technology (DLT). DLT has amazing potential when it comes to traditional operations and settlement ramifications for businesses in the financial as well as other industries. It tracks ownership and allows for immediate and efficient transfers of bitcoin.

Notable Happenings

Satoshi Nakamoto first proposed bitcoin in a 2009 white paper as a means of payment based on mathematics. The idea behind bitcoin was to create a currency system that didn't involve banks and instead would operate using a decentralized ledger known as a blockchain.

Bitcoin's value first surpassed $1,000 in January of 2017 before hitting a peak later that year. Since that time, its value has seen periods of tremendous growth as well as big sell-offs. Bitcoin’s price raced to more than $17,000 by the end of 2017, falling to nearly $3,000 just a year later and reaching a high of almost $65,000 by April 2021. 

Is Bitcoin Legal?

Bitcoin and other cryptocurrencies are legal in the U.S. and a number of other countries around the world. Central banks in most countries have warned citizens that bitcoin and other cryptocurrencies are not legal tenders in most countries and not guaranteed by any government, therefore, any transactions are at the person’s own risk.

On June 9, 2021, El Salvador became the first country to adopt bitcoin as legal tender.

Where Are Bitcoin Transactions Prohibited?

There are some countries that have banned transactions in cryptocurrencies such as bitcoin. As of 2021, the following countries have an absolute ban on cryptocurrencies:

  • Algeria
  • Bolivia
  • Egypt
  • Iraq
  • Morocco
  • Nepal
  • Pakistan
  • United Arab Emirates
  • Vietnam.

Common Bitcoin Restrictions

There are other countries that don’t completely ban cryptocurrencies but have restrictions that make it extremely difficult for transactions to take place. For example, Qatar and Bahrain prohibit cryptocurrency locally, but citizens may transact in cryptocurrency outside their borders. Countries such as Bangladesh, Iran, Thailand, Lithuania, Lesotho, China, and Colombia indirectly prohibit cryptocurrency transactions by imposing restrictions on financial institutions that may facilitate them.

Do I Need to Pay Taxes on Bitcoin?

The IRS recognizes cryptocurrencies as property and taxes them based on their value. For example, if you perform a service and are paid in bitcoin, you would be required to report income equivalent to the value of the amount of bitcoin you received at the time you received it.

Money earned from buying and selling bitcoin should be reported as capital gains just as money earned from buying and selling other commodities should be reported.

Alternatives to Bitcoin

Bitcoin is not the only cryptocurrency available, but its market cap is 40% higher than the value of the next 10 largest cryptocurrencies combined. Bitcoin's market cap is over $654 billion as of June 2021, followed by Ethereum at over $234 billion and XRP at over $68 billion. As of June 2021, there are 18 different cryptocurrencies with market caps of at least $1 billion.

Key Takeaways

  • Bitcoin is a virtual currency held on computers and not controlled by any single bank, nation, or monetary agency.
  • The Commodity Futures Trading Commission (CFTC) treats bitcoin as a commodity.
  • The IRS treats cryptocurrencies like bitcoin as property and taxes them as such.
  • Since late 2017, the value of a single bitcoin has fluctuated between about $3,000 and nearly $65,000.