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Bitcoin in plain financial language
It was 10 years ago on January 3rd, 2009 the very first
bitcoin was mined. Yet it remains to be poorly understood even amongst those
who work in financial industry full-time. Many materials
out there explaining what it is all about only touch on its high-level
characteristics. This white paper is written for those who have experiences or
understanding of banking and financial systems so that the readers can
appreciate unique aspects of bitcoin vis-à-vis existing financial systems. The
popular misconception of the bitcoin is it’s akin to a new currency as if some
country has been born and new currency created. There are similarities but
thinking it as yet another currency issued by a government will be quite
misleading. It turns out learning bitcoin necessitates the study of monetary
policy and banking system.
The sections that follow
will show:
-
What is bitcoin?
-
Summary comparison of bitcoin vs. existing financial systems
-
Deeper comparison
-
Considering what might come
-
Bitcoin technical mechanism (coming soon)
What is bitcoin?
Simply put bitcoin system is a publicly viewable ledger distributed and
replicated across internet. The ledger records bitcoin movement from one
address (aka account) to another. Address and transaction IDs are
cryptographically created and they reveal no identity. Bitcoin transfer occurs
on a peer-to-peer basis without intermediary such as banks and credit card
companies that play a central clearing house role in the traditional system.
Bitcoin itself is a fiat currency with no backing by any assets. This
is fundamentally the same as major currencies as they are not backed by any
assets; rather they say “trust us – this is valuable for your commerce.” Somehow
the users agree it has certain value and willing to conduct business with it.
People think and agree USD has a value in conducting business, thus they accept
USD for the goods and services. Bitcoin transactions are very similar in this
fashion.
It appears most of the stories we hear in the media centers around
volatile exchange rate between bitcoin and traditional currencies such as USD
and EUR. Such volatility itself is nothing unusual in financial markets. What
is truly unique about bitcoin is examined in the sections that follow.
Summary comparison of bitcoin vs. existing financial systems
|
|
Bitcoin |
Existing financial systems |
|
Transactions |
·
Generally low cost and settles fast |
·
Cost set by institutions and can take days to settle |
|
Central authority |
·
Does not exist and systems are distributed |
·
Central banks and financial institutions |
|
Reliability |
·
Fault tolerant ·
Integrity is guaranteed cryptographically |
·
Vulnerable to system outage ·
Central authorities ensure the system integrity |
The summary table is obviously over simplified. The
following sections further examine each category and reveals bitcoin and
underlying blockchain’s unique strength. In order to appreciate the key
discussion points it will be necessary to revisit foundation of monetary policy
and banking system especially when it comes to the missing central authority, a
consequence that perhaps most people who begin to learn about bitcoin do not
anticipate.
Deeper comparison: transactions
A bitcoin transaction is nothing but a transfer of bitcoin from one
address (account) to another. In the existing financial systems, the same
happens, too; money moves from one owner to another. Or it could be between two
accounts owned by the same individual. Below table lists additional details
that compare nature of the transactions and related attributes:
|
Transactions |
Bitcoin |
Existing financial systems |
|
Cost |
·
Driven by the data size processed as opposed to the monetary amount
transacted ·
Market determined and the spender specifies the cost; the higher more
likely to be processed ·
Could be extremely low even for significant amount |
·
Fixed cost and/or proportion to the amount transacted ·
Set by institutions. The spender may be able to go to another
financial institution for different cost schedule ·
Generally perceived as proportion to the size |
|
Transfer speed |
·
For a transaction with competitive cost it will be done in 10 minutes ·
In one hour considered guaranteed and irreversible |
·
Physical cash transfer is instant ·
Electronic transfer could take a few days to confirm ·
Certain transactions could be reversed via intervention by central
authority |
|
Conversion to other currency |
·
Generally major banks shy away in bitcoin exchanges ·
The process and mechanism that facilitates exchange are evolving. The
coin owner may not be fully informed of the unique risks involved |
·
Exchange between currency pairs is facilitated by the central
authority, which assumes well-known risks ·
Processes are well-established and the funds availability is
guaranteed by the clearing bank |
Cost: For bitcoin transaction
cost varies considerably time to time in various measures, whether as a bitcoin
amount, percentage to the transaction amount, or post conversion to traditional
denomination such as USD. One key factor that affects the fee is the data size
processed. However, the cost per byte processed is not fixed, either. Unlike
existing financial systems that have clearly stated elastic cost schedule,
bitcoin cost is market determined. While transactions within existing financial
systems are guaranteed by the respective system operators provided the deterministic
known cost is paid, certainty of bitcoin transaction varies depending on the
transaction cost that the bitcoin owner is willing to pay. It is similar to
submitting a bid in a very liquid market where if it’s too low your order is
unlikely to be filled whereas highest bid is virtually guaranteed to be filled
immediately. There are many websites that publish such range of bitcoin
transaction cost with varying degree of certainty in terms of whether
transaction will be processed or not.
Here are five samples of actual bitcoin transactions that have taken
place. They illustrate the nature of the bitcoin transaction fee well.
|
|
(A) |
(B) |
(C) |
(D) |
(E) |
(F) |
(G) |
(H) |
(I) |
(J) |
(K) |
(L) |
|
ref # |
Date |
block ID |
transaction ID |
transfer amount |
transaction fee |
fee % |
USD value for 1 BTC |
transfer amount in USD |
fee in USD |
transaction size (KB) |
fee per KB (BTC) |
fee per KB (USD) |
|
1 |
12/18/2017 |
500001 |
7d88a566bd8ff9e907a0ec 96864f1de38f40e0638501 6258a3bc155f25fc7d29 |
322.4964212 |
0.01263615 |
0.0039% |
$ 18,696.70 |
$
6,029,618.84 |
$ 236.25 |
2.040 |
0.00619 |
$115.81 |
|
2 |
12/18/2017 |
500001 |
e9f47478cac3920904a8df f83294b70150b11a8aa10 a41a2c81f9c1e3ef8d7f3 |
270.1155211 |
0.00292688 |
0.0011% |
$ 18,696.70 |
$
5,050,268.86 |
$
54.72 |
0.440 |
0.00665 |
$124.37 |
|
3 |
12/18/2017 |
500001 |
c714ed6a0bca18a3bfce5 70b3735220f074b4fa14f 44eb22d14d8305905e08a4 |
0.00177618 |
0.00069382 |
39.0625% |
$ 18,696.70 |
$ 33.21 |
$
12.97 |
0.226 |
0.00307 |
$
57.40 |
|
4 |
1/19/2018 |
505000 |
4dc805408cdbef13c37d555 7f0998845eb8b664931cebf fd0a10d4f103287142 |
313.0689791 |
0.01282115 |
0.0041% |
$ 11,809.50 |
$
3,697,188.11 |
$ 151.41 |
2.343 |
0.00547 |
$
64.62 |
|
5 |
1/24/2019 |
560000 |
87ade3633496d22fbd166e 3dea636b9c4e4d05fca6a88 92166510d1d7f7231e6 |
1104.1301 |
0.0003568 |
0.0000% |
$
3,603.91 |
$
3,979,185.51 |
$
1.29 |
0.223 |
0.00160 |
$
5.77 |
(A): the date the
transaction was completed
(B): bitcoin transactions
are grouped into a block, which is sequentially created roughly every 10
minutes. The first block (genesis block) was created on January 3, 2009. 6
blocks per hour -> 144 blocks/day; multiply by 365, we get 52,560
blocks/year
(C): transaction ID uniquely
identifies specific transaction within the entire history of bitcoin
transactions
(D): the amount of bitcoin
transferred to other accounts
(E): total transaction fee
in bitcoin. The bitcoin owner must have the sum of transfer amount and the fee
(D + E)
(F): the level of fee
compared to the transaction amount; (E / D)
(G): one bitcoin value in
USD from the prevailing market rate
(H): transfer amount in USD
(D x G)
(I): total transaction fee
in USD (E x G)
(J): the transaction size in
kilobyte
(K): fee in bitcoin per
kilobyte (E / J)
(L): transaction fee in USD per kilobyte (G x K)
The first three transactions were processed at the same time in block
500001 on 12/18/2017. The close examination of them tells us a lot about
bitcoin transaction fee. The first two are in the same magnitude in terms of
amount transferred, yet the total fee is considerably different. $6M transfer
cost $236 whereas $5M transfer cost $54. It turns out the cost per data size
processed are about the same. The second transaction had only two bitcoin
recipients whereas the first transaction had 55 recipients. This seems to
explain larger transaction size in KB. The third transaction, a transfer of
mere $33, actually cost whopping $13. The bitcoin paid to process this
transaction in terms of the percentage of the transferred amount was almost
40%. The only bargain this transaction got was the fee paid per data size
processed compared to the first two. The fourth and fifth transactions took
place in 2018 and 2019, respectively, for roughly the same in USD term. Notice
the fifth transaction among the examples shown cost the lowest in all measures
– absolute bitcoin amount, fee %, and USD amount in total as well as per
transaction data size fee. These examples prove a transaction fee varies. At
least one can see bitcoin transaction even for millions in USD could be
extremely low.
Transfer speed: the bitcoins are processed by “bitcoin miners” – they operate
computer programs to process transactions that are grouped into a block. The
miners collect transaction fee and thus they include transaction with higher
fee and may discard the ones with lower fees. This is why depending on
transaction volume and the fee associated with a transaction, which indicates
the bitcoin owner’s willingness to pay and the level of desire to process in a
timely manner, the likelihood to be processed varies. In the prior example, one
can speculate that the fifth transaction was something the bitcoin owner had
little immediate need. Thus the cost was kept in extremely low. Likewise the
first and the second transaction it appears the bitcoin owner really wanted to
process immediately as the fee per KB was higher amongst examples shown.
Since a new bitcoin block is created roughly every ten minutes if you
pay relatively high transaction fee, the transfer should be done in that time
frame. One catch here is that since it is a distributed system that synchs with
each other, for critical transaction, you want to be absolutely sure that all
the systems are fully in synch and validated your transaction. It is generally
recommended to wait couple more blocks to be processed, or one hour roughly
speaking. Then it is considered guaranteed, completely non-reversible.
There is one unique advantage the existing system has over bitcoin. It
is physical cash settlement. The settlement is immediate when it is
transferred, not even 10 minutes that is considered minimum for bitcoin. Of
course if you want to transfer $1M cash, today it is difficult if not
impossible given anti-money laundering laws that enforce strict rule in amount
of physical cash one can withdraw in a short period of time. While one can
print the proof of bitcoin ownership and physically transfer the printout just
like giving physical cash, it must be proven or assured that nobody else has
received such printed bitcoin. Thus existing financial system remains to have
an advantage over bitcoin when it comes to physical cash settlement albeit the
amount could be limited.
Conversion to other currency: this could be a challenge and potentially very
risky for bitcoin. There are plenty of bitcoin exchanges and websites that
allows you to exchange bitcoin to other crypto and existing (traditional)
currencies. This gives an impression that bitcoin is now just like any other
currency, as if one more currency is introduced. Bitcoin is actually
dramatically different than traditional currencies and brings new risks. One of
the most infamous incidents highlight the risk of relying and thus trusting the
exchange is Mt. Gox based in Tokyo that used to
handle majority of bitcoin exchange. Long story short it lost track of 650,000
bitcoins and filed for bankruptcy in 2014. The key security vulnerability that
probably the exchange users never informed or even understood was that the
digital proof of the ownership was managed by the exchange as opposed to the
actual owners and thus vulnerable to the security breach. It was believed to be
hacked and stolen from Mt. Gox server – gone from the
legitimate owners. This is probably one of the stories that contributed to the
vague notion that bitcoin was a fraud.
It varies but generally major banks are not willing participants when
it comes to conversion of existing currencies to bitcoin. They even stopped
bitcoin purchase with credit cards. For the purpose of appreciating what it
takes to convert, considering a similarity between bitcoin vs. what money launderers
struggle with is an interesting one. Converting cash to money in electronic
bank account is as if as challenging as converting existing currency to
bitcoin. This is not to say bitcoin is money laundering but it does illustrate
the difficulty in converting from one to the other when banks are not the
willing participants.
The conversion process and risk mitigation seem to be an evolving
process that the user should be very careful of. Anyone who want to use bitcoin
for significant amount must study very thoroughly the risks involved, how the
services used actually operate in managing risks.
The process of wider public to gain comfort as well as businesses to be
engaged in bitcoin exchanges is probably very similar to how credit card
transactions over internet were adopted in the 1990’s. Initially skepticism was
dominant. Poorly architected transactions such as sending credit card numbers
via non-encrypted email fueled fears in less than well-informed audience.
Eventually though enough people began to feel comfortable that internet
commerce began to prosper. Bitcoin exchanges seem to be going through the
similar adoption processes.
Deeper comparison: central authority
The lack of central authority for bitcoin is by far the most
intriguing. The implications could be almost scary to existing central banks
and financial institutions. Some speculates this is precisely the reason major
financial institutions shy away from bitcoin. The more you learn and think
about this the more you would be compelled to study existing financial systems,
the roles of central banks, commercial banks, credit companies, and similar
intermediaries. Below table shows the comparison of key characteristics that
have to do with the central authority:
|
Central authority |
Bitcoin |
Existing financial systems |
|
Central authority |
·
Does not exist ·
Cryptographic logics that can be verified by anyone govern the system |
·
Central banks and financial institutions have the authority, and they
are influenced by government and stock owners ·
Laws and regulations ultimately dictate |
|
Monetary policy |
·
Known money supply schedule ·
Completely predictable ·
Lost coin is permanently lost and the money supply is decreased by
that amount |
·
Managed by central banks ·
Unpredictable policy ·
Central authority manages money supply |
|
Intervention |
·
Once completed transactions are permanently irreversible |
·
Central authority can reverse transactions and seize assets |
|
Participants |
·
Anyone can participate in bitcoin transaction anonymously ·
Anyone can assume any role ·
Controlling participation is virtually impossible |
·
Other than physical cash transaction legal status of an individual
(or corporation) is required to join ·
Financial institutions are heavily regulated by various laws and
requires considerable resource to run ·
Central authority can deny the participants |
|
Surveyance |
·
System can be used without any hint of identity and KYC cannot be
enforced ·
Everyone can track entire chain of all historic bitcoin transactions
but cannot identify who own what |
·
KYC is typically enforced ·
All electronic transactions are logged and track exactly who did
exactly what |
Central authority: For bitcoin there is
nothing like central authority or intermediary that can intervene. Transactions
are between the bitcoin sender and receiver, unlike how a bank clears a check
or credit card company facilitates a purchase. Further anyone can join the
network and assume any role at will. Transaction integrity is guaranteed by
cryptographic logics that anyone can verify from the publicly available
distributed ledger that stores the entire history of bitcoin transactions. This
eliminates the need for central authority. In a way the participants trust the
built-in logic (computer code) to transact in the bitcoin system. In the
existing financial system participants don’t have a choice but to trust the
integrity of central authorities. While they generally appear to operate for
public benefits in a sound and fair fashion, the last financial crisis raised
serious questions as to their ability and even morale. The fundamental weakness
of existing central authorities is that they are run by people. While people
wrote bitcoin program code, bitcoin transactions are all done by computer code
and transaction integrity is unquestionable.
Monetary policy: Bitcoin has equivalent of
monetary policy. Roughly every 10 minutes new bitcoin is mined, which means the
total bitcoin circulation increases every 10 minutes. The rate of supply
diminishes over time in a known schedule. 10 years ago when bitcoin started,
every 10 minutes 50 bitcoin entered into circulation. Today it’s 12.5.
Actually, the reward for mining bitcoin halves approximately every 4 years.
After almost 21 million bitcoins are cumulatively mined in over 100 years from
now, no more bitcoin will be mined. Today bitcoin miners take transaction fees
and reward for mining except fees remain fractions compared to the reward for
mining. In the future where no more mining is possible, the reward is purely
from the transaction fees.
Such publicly known money supply schedule is
completely unlike what central banks do. Central banks can change interest rate
and issue new debt, which results in borrower having more cash to spend. When
they conduct such actions is determined in closed door by limited number of
experts and influencers. As such the participants in the existing financial
systems are bound to trust them that they are doing for the benefits of overall
economy. In fact, a corrupt country with poor monetary policy will face
considerable FX devaluation and departure of the business – i.e. they don’t
trust such ineffective central authority. They can only choose to leave such
system or demand high premium (i.e. high interest rate and devaluation of the
currency).
Since central authorities in existing financial
systems have various techniques in increasing money supply, it comes as a major
surprise to realize bitcoin has limited, scheduled known money supply. Further,
if bitcoin is lost, it cannot be recovered and permanently lost from the
system. This means total bitcoin circulation is decreased by the lost amount.
Each bitcoin has cryptographically associated unique, secret key that is the
only tool to prove the ownership. Should this key be lost, no one can use bitcoin
associated with this secret key. This is different from a stolen key where a
thief will presumably use the stolen key. However, the lost key is
irrecoverable and the fund is gone forever.
Intervention: One critical service that central authority provides is ability to
intervene. A good example is a stolen credit card transaction. After a victim
has seen an illicit charge, the credit card company can reverse the charge and
there is no harm to the victim. There are many other forms of intervention and
transaction reversal by the central authorities. When it comes to bitcoin,
however, first of all there is no central authority to begin with, and all
transactions are immutable. If you realized you had sent bitcoin to the wrong
address, if the transaction had been confirmed, there is no way to reverse it.
The only way to reverse is contact the wrong recipients and ask the refund. It
is even possible that the wrong address used could be owned by nobody, in which
case the fund is lost permanently.
Participants: Anyone can participate in bitcoin transaction anonymously. This is
because transactions are processed with cryptic IDs with no hint of identity.
Further anyone can start bitcoin mining or run ledger without taking any legal
licensing processes. Those bitcoin participants have no ability to freeze
bitcoin. These are characteristics that are sharply different from existing
financial institutions that are heavily regulated requiring significant
resources to run. In fact becoming such institution is extremely difficult
given resource needs and regulatory clearances required.
There are numerous examples that central authority
prohibits the participation of certain individuals and entity. Sanctioned
nations are examples of such where no one could wire money to that nation, for
example. There are also what appear to be very troubling trend recently where certain
politically active individuals are banned from using well-known financial
services. This is a reality today that certain U.S. financial institutions have
banned or limited the service to a U.S. citizen, who happens to be considered
politically active. Bitcoin in contrast without central authority there is no
politics that affect the accessibility.
Surveyance: All bitcoin transactions are publicly viewable yet none contain
credible hint to an identity. As anyone can join bitcoin network and transact,
and all transactions are anonymous, there is no way to trace who is doing what.
Perhaps government can seize some suspect’s assets and dig through all computer
resources to find bitcoin keys. But this is quite limited and passive way to
identify. It should be assumed that bitcoin transactions are unrelatable to any
legal beings. Since all bitcoin transactions are public, it is possible to
trace chain of bitcoin transactions. Suppose someone has been confirmed to own
certain secret key. Then all related transactions can be easily identified from
publicly available ledger, but that’s where identification stops. There is no
way to figure out exactly who were the recipients. Basically KYC is not
possible in the bitcoin world. What’s almost counter intuitive is that all
bitcoin transactions are publicly viewable yet no one knows who did what.
Deeper comparison: reliability
Bitcoin has unique reliability over existing financial systems.
|
Reliability |
Bitcoin |
Existing financial systems |
|
System durability |
·
Distributed system that is unlikely to fail |
·
Financial institutions have occasional unexpected down time |
|
Safeguarding ownership |
·
To use the fund a secret key must be used. Only the key owner can use
the fund ·
The key to unlock the fund must be kept safely and accessible only by
the owner ·
The safety is cryptographically guaranteed and the key is impossible
to fake |
·
Bank/credit card, PIN, and knowledge of private information such as
SSN to claim the valid identity, who is known to possess assets in the system ·
Central authority can intervene to insure from theft and other
illegitimate transactions |
|
How an ownership could be lost |
·
Lost key is permanently gone from the entire system ·
If a system that stores the key is hacked consider it is stolen for
good ·
One can print the key and store physically; it acts similar to bearer
bond |
·
Physical cash can be stolen ·
Illicit transactions can be created by those with access to central
system |
|
Counterfeit |
·
Considered impossible |
·
Possible and have been done many times |
|
Intrinsic value |
·
Fiat money since inception – no intrinsic value ·
Participants in the system agree in the value in a market competitive
fashion |
·
Today it is fiat money – no intrinsic value ·
Many currencies in the past were backed by precious metals |
System durability: The fact that anyone can
join and assume any role in bitcoin, so many players joined the network.
Failures of several systems do not degrade the integrity and operation of
bitcoin systems at all. TCP/IP protocol used for internet is similar in that it
assumes network systems are unreliable and many nodes can break and become
unavailable, yet it can relay data between origin to destination in a reliable
fashion. Bitcoin nodes are very similar in that sense, and this makes it
virtually fault tolerant. In contrast, existing financial systems experience
occasional unplanned system failures due to bugs or hacking. To cripple bitcoin
system, a hacker must be able to attack considerable amount of distributed
systems and the resource needs to do so makes it impossible.
Safeguarding ownership: bitcoin ownership is
claimed by having a secret key, which is a 256-bit binary number, or 2^256. In
other words, flip a coin 256 times and that defines the key. It is roughly
1.16x10^77. When the Sun’s atom count is less than this number, you can
appreciate how large the secret key’s possibilities are. You are free to
generate your own secret key to use for bitcoin transactions. The two most
critical things to keep in mind is only the owner must have an access and the
key must have been generated truly randomly. Considering such large possibility
of secret key value – imagine identifying one specific atom in the Sun – it is
virtually impossible to fake.
How an ownership could be lost: Bitcoin exchanges offered /
still offer secret key management at the central server, which could be a
hacker’s target. If you created a secret key without using a system that is
connected to a network and you guarantee no one else has an access to the key,
you can assume it is safe. But keep in mind since you are the only custodian of
the key, if you lose it, or if you die without telling how to discover the key,
it will be lost forever. This is one area that the existing financial
institutions have advantage over bitcoin since as central authority they can
reverse, recover, and redo transactions. Or suppose your spouse dies. The
survivor can contact the financial institution to claim the remaining asset. In
the bitcoin system if a spouse dies and never told how to get the secret key,
the survivor has no way of recovering the bitcoin. This has actually happened.
As for bitcoin, transactions are permanent and immutable. Lost keys and
associated bitcoins are permanently gone.
One interesting way to safeguard bitcoin is to print
the secret key; use your printer to do so. Suppose generation of the key and
printing is done with the system that is not connected to network. Provided the
key is generated in a non-repeatable fashion, this printing the hardcopy of the
key and not storing electronically is actually a reliable way to safeguard
bitcoin. This is very much like a bearer bond. As with bearer bond, if the
hardcopy is lost, then it is lost. A unique difference compared to bearer bond
or any other currencies is that the owner prints physical copy, as opposed to
central mint doing so.
Counterfeit: There are so many stories of counterfeiting bills and coins
throughout the history of humankind. In contrast, counterfeiting bitcoin is
considered impossible due to cryptographical logics in place. Similar to
counterfeit, “double spending” of bitcoin is also not possible. This is because
bitcoin network has distributed history of entire bitcoin transactions where
which address (account) owns exactly how much is public, it is not possible to
pretend you own more than you do.
Intrinsic value: The study of the history of currency reveals all currencies were
something that were physical and valuable, such as gold and precious / pretty
sea shells. Eventually such actual physical gold and the like were replaced by
printed paper that guarantees conversion to precious metal. This meant
ownership of such paper was equivalent of owning precious metal. Eventually
such physical backing was eliminated, which led to today’s economy. Bitcoin in
contrast has been fiat money since birth.
Considering the fact that existing financial systems are based on fiat
money, bitcoin actually offers no different. If you are in the system where you
agree to transact, exchange bitcoin against certain value, such as physical
asset and services, then this is no different than USD based transactions.
Think of this – someone agrees to drive you from point A to B, and the driver
is indifferent in taking $50 or .001 bitcoin. If you have both, you may not
care which currency to use to pay.
It is probably very helpful to think about the difference between
physical ownership of something (with varying degree of value) vs. logical
ownership of fiat currency. Physical ownership is undeniable and ultimately any
dispute is resolved via physical contest. Fiat currency is all about trust,
logic, and agreement amongst participants. This is why today’s bills with no
intrinsic value is considered valuable because system participants operate as
such. This is no different than those who participate in the bitcoin system.
Considering what might come
The last financial crisis more likely discredited
the integrity of existing financial systems in terms of both transparency and
fairness since the decision making process in de-risking the crisis was not
entirely public. While it seems unlikely for the time being, one could argue
that this could lead to the loss in the integrity of the current financial
system. Keep in mind that fiat currency system that we are in today is based on
us trusting the system and behaving accordingly. Consider this possibility that
gradually more people and businesses begin to accept bitcoin in exchange for
goods and services. Further another crisis hits that totally discredit the
integrity of the existing financial system. If so, wouldn’t it make sense to
accept bitcoin? While exchange rate against other currencies might be volatile,
the bitcoin system is completely transparent with known monetary policy, and no
central authority run by people to execute surprise actions. This could
literally change the whole system.
In fact, whether bitcoin or existing financial
systems, you are either in the system and abide the bylaws, or you are out of
the system, in which case you can’t transact in the currency that the system
supports. Again from this perspective bitcoin is no different than any other
existing currencies.
Tax
Suppose the world where fair number of individuals
and businesses readily take bitcoin in addition to existing currencies.
Transactions done in existing currencies are governed by central authority and
thus they can audit all you have done. From a taxation perspective this makes
it difficult to avoid paying tax. Bitcoin transactions are anonymous unless the
secret key owner somehow reveals the identity. As such if a business is run
with substantial amount of bitcoin payments, isn’t it possible to hide true
cost, revenue, profit, and thus tax owed to the authority? Perhaps a smart
enterprise would run some transactions in existing currencies but fair amount
done in bitcoin, it is probably not so difficult to assert very low values in
bitcoin transactions to save tax. This actually looks very much like cash-based
transaction. Enough businesses take cash to under-report revenue and thus save
tax.
There is no way tax collecting agencies to forfeit
the tax collecting opportunities. Yet when all bitcoin transactions are
anonymous, it appears very difficult to audit full business activities to
determine exact tax. One might cooperate fully but that is a naïve assumption.
Conversion to existing currencies gives an opportunity to tax, but that still
hides all the bitcoin transactions happened until the conversion.
Bitcoin technical mechanism
This section will be updated soon.
Final thought
Bitcoin offers unique features that are advantageous
over existing financial systems if not controversial. Bitcoin and existing
financial systems are all based on trust, which is arguably vulnerable
depending on how many people and businesses trust the system they are in. From
this perspective there could be time when the bitcoin or similar so-called
crypto currency-based economy reaches critical mass. When that happens who
knows what might be the role of financial institutions. Or what monetary policy
is in place. Considering how bitcoin evolved in the past 10 years since
inception, no one knows what financial system we live in a decade from now.
The
last update: 2/26/2019
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Ozeki ozekia@gmail.com
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