What is Bitcoin?

Bitcoin with a capital B is the name of the payment system and Bitcoin with a lower case b is the name of the virtual currency unit. Often you will see these mixed up but at least you know which is which now. It is called a virtual currency because it does not exist in physical form, only as numbers on a computer. That doesn’t freak me out too much as I believe all currencies are virtual when a central bank can create them out of thin air but that’s a discussion for another day. Despite the name Bitcoin there is no coin as such or any other physical entity to put in your pocket. Bitcoin is one of many crypto-currencies that exits in the marketplace today but it is the first one that looks like it might get become universally adopted.

How long have bitcoins existed?

Bitcoins have been around for about five years.

 

Why was Bitcoin created in the first place?

If you are a  member of the “Inner Circle” you already know that there’s something very fishy about using a currency that can be printed at will by a central bank at the press of a button. The idea of a virtual currency like bitcoin is that it is independent of both banks and governments and is beyond their control and manipulation. This means you don’t have to pay exorbitant bank fees for just moving your own money from one place to another nor are there any delays in the transfer of the funds.

Furthermore it cannot be stolen as they can only be spent by the original owner. Nor can the bitcoin transfer be traced as it is completely anonymous.

 

Who created Bitcoin?

No one is sure where bitcoins came from and there is much debate but it is often credited to a Japanese guy called Satoshi Nakamoto.

 

I’ve never seen a Bitcoin. Where exactly can I spend it?

This is a very important question for me. 

I’ve been very sceptical about Bitcoin fearing that anything outside the control of the government and anything that allows financial transactions anonymously would be very quickly banned or restricted.

These concerns still prevail but I have been mightily impressed at the rate of uptake for this new currency.

For example, on February 10th eBay is opening a ‘virtual currency’ marketplace for the exchange of Bitcoin.

It’s estimated that there are over 50,000 Bitcoin transactions a day.

Last week, the University of Cumbria announced it will accept Bitcoin for tuition fees, the first UK University to do so. OK who else?

Well, the list is getting longer by the day.

France has officially recognised Bitcoin as a currency and the French can now get their salary paid in Bitcoin.

The first Bitcoin ATM opened in Vancouver at the end of last year. Hong Kong has just got its own ATM which is due to start operating any day now. 50 more ATMs selling bitcoins have been sold and awaiting installation around the world. New York, Berlin, and London are all expected to get theirs soon.

Chrome and Firefox browsers have recently incorporated Bitcoin through either an app or a downloadable plug-in. 

The rate of adoption has been quite staggering. In the UK there’s been over 10,000 searches on the word “Bitcoin” in the last 12 hours alone.

Bitcoin is also traded on all the global money exchanges.

 

Yes, OK, but is bitcoin really money as we know it?

Yes, simply because it’s exchanged for goods or services around the world every minute of the day.

 

If Bitcoins cannot be traced, surely governments will be keen to outlaw it?

Yes, that’s certainly my view, and one of the key reasons I was not an early adopter. However, it is claimed that it is impossible for any government to hack into a “peer to peer” network with encryption like the one used by Bitcoin. No doubt governments around the world are already trying to figure out ways to control this new currency. Only time will tell what they come up with. 

Clearly it is a problem for them that the unique code that enables two people to carry out a sale and purchase in this way is completely anonymous.

One burger cafe in London takes 20% of its revenue for burgers in Bitcoins. Clearly there are tax issues that will have to be sorted out here if things continue as they have.

 

What is the tax situation if you buy £10,000 of Bitcoins and one year later they are worth £100,000?

The question for bitcoin gains is one of capital gains tax. At the moment there is no ruling so no one knows the answer. As you may know from my Newsletter articles on gold, coins of the realm are not subject to CGT. So the question is, will governments say that Bitcoins are a currency of the realm?

All of this will become obvious in the months ahead. These are very early days for this infant currency.

 

Surely the entire Bitcoin system is open to fraud or theft?

It would appear not. Despite tens of thousands of bitcoins swap ownership every day there’s not been one single reported act of fraud. 

It is obvious that people will use Bitcoins to but things they shouldn’t like drugs. They currently do this with cash but that’s not an argument for getting rid of cash.

 

Where do I get Bitcoins from?

There are three ways you can get Bitcoins:

  1. You can be given bitcoins by someone else (in payment for product or service).
  2. You can buy them with your local currency at the prevailing rate.
  3. You can ‘mine’ bitcoins.

I understand the first two but what on earth do you mean by ‘mining bitcoins’.

Mmmmm – hard question but I will give it a go. Bitcoins are mined in the same way that gold is mined but instead of mining in the ground you mine bitcoins on a computer. This is an extremely complicated process and one that is usually undertaken by groups of people working together since it requires a huge amount of energy and computer processing power to achieve the desired task. Anyone mining for Bitcoins is required to run a software programme that constantly searches for the solution to an extremely complex mathematical problem.

The number of Bitcoins produced per hour is regulated so it is constant. The difficulty of the mathematical task is regulated to ensure this constant hourly supply.

At present there are 150 Bitcoins produced every hour. Never more and never less. Every time a further 210,000 bitcoins are mined the network’s software reduces the reward for mining by 50%. 

Ultimately the number of Bitcoins that can be put into circulation has been capped at 21 million. A figure we are likely to see achieved in 2140.

What is the smallest unit of currency for a Bitcoin?

At the moment you can divide a Bitcoin to eight decimal places or 0.00000001 if you prefer and this is known, in reverence to its possible creator as the satoshi). 

I think it is fair to say that none of this technical stuff is relevant to anyone who simply wants to trade in Bitcoin or use it as a way of making money if it rises in value against the fiat currency you normally use.

 

Where do I keep my Bitcoins?

You keep your virtual currency in a “wallet”.

Lots of companies offer bitcoin wallets and there are lots out there to choose from.

The original Bitcoin wallet is called Bitcoin-Qt. For the purist this is probably the best wallet of all since it offers the highest levels of security and anonymity. It can be downloaded at www.bitcoin.org. However, it does take a day to download and install and it is not web based.

Beginners may well prefer something that can be set up in minutes using an on-line system. There are many to choose from:

www.coinbase.com is very popular and can be set up in minutes.

You will get an incentive if you refer other people to open a bitcoin wallet (as with many other wallets) so expect lots of ‘helpful‘ people to recommend a particular wallet to you.

 

What are Bitcoin Exchanges?

Bitcoin is traded now on all the major exchanges. In the same way as you can exchange sterling for dollars or Euros you can also exchange your currency for Bitcoins. All of this can be done electronically on the internet. 

If Bitcoin has grown so much, surely that’s a bubble?

Mmm – that’s a key question. The argument goes that the price of a Bitcoin is only proportional to the number of people that use it. As it’s popularity increases, so will its price until eventually it will stabilise at a level appropriate to the number in existence and the popularity. The problem for you and I is that during this growth phase the swings will be quite violent, as we have already seen. A quick foray into the markets now could just as easily see a sharp fall as a sharp rise. The big question is not what it does in the short-term but in the long-term. What will the price of a Bitcoin be 12 months from now?

As you can see, Bitcoin is still a very high risk play with the potential for massive gains if it’s popularity continues.

 

What’s the big advantage of Bitcoin? 

One of the big advantages of bitcoin is that it keeps the government and the banks out of the loop is that they can’t keep fleecing us for massive fees. Businesses have to pay 3%-4% for every transaction and as a businessman myself I find it outrageous that I have to pay for the privilege of paying cash into my account and again when I draw cash out. If I don’t have to pay 3% for every credit card or PayPal transaction I can pass that saving straight on to my clients making me cheaper than the competition.

Also there are no delays with Bitcoin. The transaction is instantaneous. Why should we all wait for our money to be transferred when we know that the transaction takes place instantly on the cloud? We all know the banks are just using our money in the delay periods that they have created.

Bitcoin also eliminates the freezing of funds which is common place with PayPal and merchant banks. Despite being in business for over 30 years, PayPal currently insists on holding on to 25% of my cash assets held with them for ‘security purposes’.

 

Should you invest in Bitcoin now?

Now you know a bit more about Bitcoin and how it works, the big question is can we make money from it.

If we buy Bitcoins now will they go up in value?

I don’t know is the short answer.

If Bitcoin goes mainstream, and it looks like it might, then there’s every chance that the price will rise. We certainly missed the first boat, that’s for sure. To be fair, very few people would have had the balls 

If Bitcoin takes the sort of market share that people are talking about then the price could easily go through the roof.

So where do I stand?

I remain skeptical of anything that operates outside of the government’s control but it’s important to understand the difference between outside the government’s control and outside the banking systems control. There will be many announcements over the coming months about how the tax authorities plan to treat Bitcoin and these will no doubt make the headlines and affect the price.

However, if Bitcoin is adopted by business in the way it has been suggested, then Bitcoin can still be a major player competing with the likes of PayPal and credit cards without the associated fees. So it all comes down to Bitcoin’s role in the financial world. I am sure that those people looking to use Bitcoin to avoid tax or to trade in illegal products will be disappointed but I am hopeful that as a commercial tool this could be a major player.

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