Bitcoin comes of age in a year when a virus changed everything

Jan 10, 2021

 

Originally posted on Business Post 10 January 2021.

Whether despite of or because of the pandemic, 2020 has seen radical changes in the way we expect the business world to behave. There were negative interest rates, but there were also negative oil prices. Contrary to all expectations, Irish property prices did not collapse.

And amid the chaos, one particular class of asset, bitcoin, is worth four and a half times more now than a year ago. As I write, one bitcoin is quoted at €33,640.

That is, if bitcoin can be regarded as an asset at all. It is one of around 2,000 forms of crypto currency which exist in a computer file to which their owner has access.

A record of their validity is distributed across multiple databases on different computer platforms on the web. This so-called blockchain approach ensures that a bitcoin cannot, for instance, be duplicated or used for multiple transactions with multiple vendors.

It seems that 2020 was the year when some serious investors got over bitcoin’s twin barriers of intangibility and technological mystique. There are reports that several established funds have begun to regard trading in the cryptocurrency as a component of their investment strategy, just like trading traditional currencies such as the dollar, the euro or sterling.

As happens so often in the markets, the decision to legitimise investment in bitcoin has been a self-fulfilling prophecy. Declare an asset to be of value, and it will become so.

Bitcoin investments are taxed much like any foreign currency. When you use euro to buy foreign currency, say US dollars, you are acquiring an asset. You can gain or lose on that asset depending on the relative value of euro to dollars when you go to sell it.

The same goes for bitcoin. Gains are taxable, losses are allowable to offset future gains. While 2020 was a good year for bitcoin investment, it’s not for the faint-hearted. The value of bitcoin has peaked before in 2017 only to fall back to a mere fraction of its peak a year later.

Treating bitcoin as an investment is not what its inventors apparently intended back in 2009. The original white paper which proposed the system set out “a purely peer-to-peer version of electronic cash [that] would allow online payments to be sent directly from one party to another without going through a financial institution”.

Bitcoin was supposed to take financial institutions out of the payment loop. Instead it is becoming an asset for financial institutions to trade, yet its point of interest for governments and regulators still derives from its original purpose of facilitating the transfer of value from purchasers to vendors.

Where bitcoin really differs from other types of currency is that it dispenses with the need for an independent institution, like a bank or a credit card company, to verify its issue and use.

That makes it tricky for the likes of the Revenue Commissioners or the Criminal Assets Bureau to trace, certainly far harder than tracing euro, sterling or dollars which tend to end up somewhere in some bank account to which the police or fiscal authorities can request access.

Bitcoin, along with other cryptocurrencies, can be convenient tools for money laundering, blackmail, drug purchases, terrorist financing and bogus investment schemes.

Law enforcement agencies may have to think about the ways of tracing bitcoin-derived activity, for example, by tighter regulation of businesses that convert bitcoin to and from the more traditional currencies.

It would be incorrect, however, to regard the use of bitcoin and other forms of cryptocurrency as the sole preserve of criminal behaviour. Illegal activity tends not to advertise itself so it is difficult to accurately gauge the extent to which cryptocurrencies have a role.

One recent estimate by a US cryptocurrency consultancy Chainalysis puts the share of cryptocurrency in illicit use at less than 2 per cent of the total in circulation. Even if that estimate is on the low side, it does suggest that much of cryptocurrency use is entirely legitimate. Where bitcoin is used for legitimate trading purposes, most of the normal tax rules apply.

The Court of Justice of the European Union held some time ago that bitcoin constitutes a currency for Vat purposes.

Companies making profits or incurring losses when trading with bitcoin are taxed in the normal way, except that despite the Court of Justice ruling, they cannot make up and submit accounts denominated in bitcoin to the Revenue. The submissions must be in euro or in another traditional currency.

The online payments environment has become increasingly sophisticated in the 12 years since bitcoin was invented. Online payment processing and anti-fraud tools such as those offered by PayPal and Stripe are now in widespread use.

The EU’s Second Payment Services Directive has resulted in much more mandatory authentication and verification of online payments via financial institutions. Bitcoin now has more competition as a payment method.

The events of 2020 may also have changed how bitcoin is seen. It may become less a payment method than an investment. Such a shift in expectation has happened before with that most tangible of assets – gold. It just took a lot longer.

Dr Brian Keegan is Director of Public Policy at Chartered Accountants Ireland