bitcoins
TRANSCRIPT
© 2014 4imprint, Inc. All rights reserved
In 2010, a programmer in Jacksonville, Fla., convinced a pizza shop to give him
two piping-hot pizzas worth $30 for the 10,000 bitcoins he had “mined” on his
computer. This is the fabled first-ever bitcoin transaction.1 Today, those bitcoins
are worth about $3.6 million, but at one point they were worth $6 million.
Welcome to the wild, wild world of Bitcoin.
This headline-grabbing, digital currency promises consumers total control
over their money and low fees for businesses. But it polarizes supporters and
detractors. Fans believe it allows people to buy anything without interference
from third parties, such as banks. Detractors, on the other hand, think Bitcoin is a
house of cards that will collapse as soon as people realize that zeros and ones on
a computer have no value.
The reality may be somewhere in between. Bitcoin is unlikely to upend the
world’s financial networks2, but it is having an impact, as companies look to adopt
it and consumers seek opportunities to spend it. For companies, Bitcoin provides:
• Reliable payments designed not to be reversible or fraudulent;
• Low (less than 1 percent) or no fees—the
customer pays for the transaction; and
•Quick transfers.
Bitcoin’s security is based on well-understood
cryptography used by the U.S. Government3.
Its algorithms are as trustworthy as credit card
transactions or any type of electronic bank
transfer. So people who doubt the security of its transactions should have similar
doubts about the security of any credit card transaction.
The system protects against fraud by ensuring the whole network sees the
transactions that have happened and that bitcoins have moved. This is like the
serial numbers being scanned every time money is spent, making it possible
to trace money as it moves around, making it almost impossible to introduce
counterfeit money.4
And accepting bitcoins can be as easy as downloading an app onto a computer or
phone that provides a bitcoin wallet that will take care of pretty much everything,
1 Bilton, Nick. “Disruptions: Betting on a Coin With No Realm.” Bits.blogs.nytimes.com/. The New York Times Company, 22 Dec. 2013. Web. 10 Oct. 2014. <http://bits.blogs.nytimes.com/2013/12/22/disruptions-betting-on-bitcoin/?_php=true&_type=blogs&_r=0>.
2 Pagliery, Jose. Bitcoin and the Future of Money. Chicago: Triumph LLC, 2014. Print.3 “Myths.” En.bitcoin.it. Bitcoin Project, 20 Sept. 2014. Web. 10 Oct. 2014. <https://en.bitcoin.it/wiki/Myths>.4 Hill, Kashmir. “21 Things I Learned About Bitcoin From Living On It For A Week.” Forbes.com. Forbes, 9 May
2013. Web. 13 Oct. 2014. <http://www.forbes.com/sites/kashmirhill/2013/05/09/25-things-i-learned-about-bitcoin-from-living-on-it-for-a-week/>.
© 2014 4imprint, Inc. All rights reserved
including requesting and confirming payments, as well as converting bitcoins into
dollars straight away.
Customers are using bitcoins, too, but the numbers are small. For example, about
three customers a day are using bitcoins to pay for their sandwiches at a Subway®
location in Allentown, Pa.5 And in its first week accepting bitcoins, CheapAir.com®
made sales worth $6,8006. Reno, Nev., barber Josh Arias7 also accepts bitcoins and
would like to see customers adopting it as he does not have to pay the merchant
fees incurred when customers swipe their credit cards.
Before we go any further, let’s just say it: Bitcoin is weird. This is
a payment network based on an “imaginary” currency. And most
people when they first hear about Bitcoin say the same thing:
“No, this cannot possibly work.” But to-date, it is defying the
doubters, which is why we should all be paying attention to the
rise of crypto-currencies.
So, how does it work? Put simply, Bitcoin is electronic money—nothing more than
bits in a computer or smartphone. First, let’s just say that electronic money is not
money stored electronically. Whereas services like Google Wallet® stores credit
cards, debit cards and loyalty cards. Bitcoin is different. It reimagines what money
is. Anyone can receive it—and spend it—by simply transferring bitcoins between
one another. Bitcoin is really more like cash than credit cards. Like cash, people
either have bitcoins or they don’t. And if they have bitcoins, they are handed over
to the business there and then, without any third-party involvement. There is no
bank or other middle man.
The Bitcoin network is a bit like a BitTorrent® peer-to-peer network8, which
is created when two or more computers connect and share resources directly,
without going through a separate server computer. These networks are best
known for helping people share such files as films, games and music over the
Internet. In Bitcoin’s case, however, instead of music or movies, the computers
share a digital ledger, or a transaction database known as a blockchain, with
every computer on the network. And this ledger is automatically updated
anytime someone spends bitcoins. This ledger contains details of every single
bitcoin transaction there has ever been. This provides Bitcoin’s transparency. Every
transaction is visible to everyone in the network. Now before we get bogged
5 “8 Things You Can Buy with Bitcoins Right Now.” Money.cnn.com/. CNN Money, n.d. Web. 3 Oct. 2014. <http://money.cnn.com/gallery/technology/2013/11/25/buy-with-bitcoin/>.
6 “8 Things You Can Buy with Bitcoins Right Now.” Money.cnn.com/. CNN Money, n.d. Web. 3 Oct. 2014. <http://money.cnn.com/gallery/technology/2013/11/25/buy-with-bitcoin/>.
7 “8 Things You Can Buy with Bitcoins Right Now.” Money.cnn.com/. CNN Money, n.d. Web. 3 Oct. 2014. <http://money.cnn.com/gallery/technology/2013/11/25/buy-with-bitcoin/>.
8 Pagliery, Jose. Bitcoin and the Future of Money. Chicago: Triumph LLC, 2014. Print.
© 2014 4imprint, Inc. All rights reserved
down in privacy concerns, let’s just say that transactions appear as strings of
numbers and letters that are not associated with anyone’s real-world identity.
The transactions in this ledger are not confirmed by banks or any other third
party. They are confirmed using complex math problems, or algorithms. Bitcoin
users are trusting math, not people, to verify transactions. Whoever solves these
problems, through a process known as mining, verifies the bitcoin network’s
transactions and wins new bitcoins for their trouble. So, people literally are
mining for bitcoins. And it is the limited supply of this currency combined with
the high demand for it that is the secret of its value9, and indeed the value of
more traditional currencies. So, who is using this currency? In the U.S., the typical
user is a tech-savvy male, aged 25 to 40, earning above-average income, and
usually living on one of the coasts.10
In this Blue Paper, we will discuss the history of Bitcoin, how it works, its pros and
cons, and how companies can start accepting this digital currency. We will also run
through how transactions work, and the tax implications of accepting bitcoins.
The history of Bitcoin
Let’s start at the beginning, which was Friday,
October 31, 2008—Halloween, appropriately
enough. On that day, the mysterious Satoshi
Nakamoto posted a message on the cypherpunks
mailing list entitled “Bitcoin P2P e-cash paper.”11
His—hers, or their, no one knows—message was
simple: “I’ve been working on a new electronic
cash system that’s fully peer-to-peer, with no trusted third party.” And his initial
paper is still available online, but be warned, it’s not an easy read.
He argued: “What is needed is an electronic payment system based on
cryptographic proof instead of trust, allowing any two willing parties to transact
directly with each other without the need for a trusted third party.” Cryptography
involves the enciphering and deciphering of messages in secret code, or cipher.
Nakamoto wanted to create a math-based currency whose value couldn’t be
“watered down” by a central authority, like the Federal Reserve.
9 McMillan, Robert, and Cade Metz. “Bitcoin Survival Guide: Everything You Need to Know About the Future of Money.” Wired.com. Condé Nast, 25 Nov. 2013. Web. 18 Sept. 2014. <http://www.wired.com/2013/11/bitcoin-survival-guide/all/>.
10 Brennan, Morgan. “Why More Businesses May Adopt Bitcoin.” Usatoday.com. CNBC, 12 Jan. 2014. Web. 10 Oct. 2014. <http://www.usatoday.com/story/money/personalfinance/2014/01/12/cnbc-bitcoin-business/4393905/>.
11 Pagliery, Jose. Bitcoin and the Future of Money. Chicago: Triumph LLC, 2014. Print.
© 2014 4imprint, Inc. All rights reserved
But the concept of a “crypto-currency” predates Nakamoto and was actually first
described in 1998 by Wei Dai on the cypherpunks mailing list.12 He suggested
a new form of money could use cryptography to control its creation and
transactions, rather than a central authority.
But it wasn’t until after Nakamoto’s paper that the first crypto-currency came into
being. And when Nakamoto left the project quietly in late-2010, without his/her
identity ever being revealed, the Bitcoin community had taken up the challenge
to create a new currency and since then, it has grown exponentially.
To appreciate why people would take up Nakamoto’s challenge and help establish
a digital currency, it is a good idea to look at the cypherpunk community.
Nakamoto launched his idea on a mailing list for this community. Cypherpunks
advocate using cryptography to drive social and political change and put a lot of
store on privacy and personal liberties. They were attracted to Nakamoto’s idea
that a network capable of processing tens of millions of transactions each day
without the need to work through financial institutions would make it easier for
people to make small, casual payments
to one another. So, it was politics that
got Bitcoin up and running. However,
the Bitcoin community has broadened
beyond cypherpunks. It now speaks to
a wider audience that sees its potential
for reducing the costs and friction
of global e-commerce and other
commercial transactions.13
Nakamoto’s idea was for a digital currency that would reside on a network
of computers. This network would support a system that verifies transactions
and “mines” for new bitcoins, delivering new bitcoins at a steady rate, to help
manage inflation.14 Bitcoins cannot be inflated by “printing” new money above
and beyond the expected issuance rate. The name of the new system would
be Bitcoin, with a capital “B”; a lowercase “b” would be used for the units of
currency, bitcoins.
Here’s where bitcoins get even weirder: the truth is they don’t exist, not even on
a hard drive. So, while all the talk is of bitcoins, you cannot point to an account,
like a bank account with dollars, that actually contains bitcoins. Instead, what you
see in a bitcoin account, or address, are records of transactions between different
addresses, with balances that increase and decrease. We will further explain
12 Pagliery, Jose. Bitcoin and the Future of Money. Chicago: Triumph LLC, 2014. Print.13 “Myths.” En.bitcoin.it. Bitcoin Project, 20 Sept. 2014. Web. 10 Oct. 2014. <https://en.bitcoin.it/wiki/Myths>.14 Pagliery, Jose. Bitcoin and the Future of Money. Chicago: Triumph LLC, 2014. Print.
© 2014 4imprint, Inc. All rights reserved
transactions a little later, but here’s a brief overview. Transactions comprise:15
• An input—this is the bitcoin address, or account, that sent the bitcoins to the
account holder that is now looking to spend them. This provides evidence
that the bitcoin holder has the right to spend them.
• An amount—this simply describes the amount of bitcoins that are being
spent.
• An output—this is the address to which the bitcoins are now being sent. The
recipient will then have the right to spend these bitcoins.
Every transaction that takes place is stored in the ledger, or block chain.
Ok, let’s return to talking about bitcoins as if they were real. Only a few bitcoins
were made available initially. But the system was designed to slowly expand the
currency to produce a total of 21 million bitcoins—no more, no less. This number
was completely random; it has no secret meaning. But that has not stopped a
lot of speculation. It is worth noting that while the number of bitcoins is set at
21 million, it is possible to divide each bitcoin into 100 million pieces, known as
satoshis, after the anonymous Bitcoin founder. So the total number of currency
units there will ever be is 2,100,000,000,000,000. Bear in mind that Bitcoin was
viewed as an alternative way for people to make small payments to one another.
It was never viewed as a replacement for existing systems, so a finite marketplace
is not a major stumbling block for Bitcoin. But if you still think there may be more
to this number, Bitcoin Magazine™ does a great job analyzing it.
Nakamoto estimated that the amount of bitcoins produced would fall by half
every four years—10.5 million by 2013, another 5.25 million by 2018, and 2.625
million by 2023, and so on until the last bitcoin is mined some time around 2140,
if the currency survives that long. As of October 2014,
there were 13.38 million bitcoins in circulation, valued
at around $5.06 billion, but the market is volatile.
So, where is the value in these non-existing currencies?
Bitcoin is designed so people can subjectively value the currency, which is
happening because individuals are freely exchanging products and services for
bitcoins. It’s also possible to think about the value of the network, like a phone
network, rather than of individual bitcoins.16 Phones only have value because
they are connected to a network. Without a network, phones are useless.
Bitcoins are similar—their value comes from the global network of merchants,
exchanges, wallets, etc., that accept them as a currency. Just like the phone is
needed to transmit voice, text and multimedia messages, bitcoins are needed to
15 “How Do Bitcoin Transactions Work?” Coindesk.com. CoinDesk, 6 Mar. 2014. Web. 10 Oct. 2014. <http://www.coindesk.com/information/how-do-bitcoin-transactions-work/>.
16 “Myths.” En.bitcoin.it. Bitcoin Project, 20 Sept. 2014. Web. 10 Oct. 2014. <https://en.bitcoin.it/wiki/Myths>.
© 2014 4imprint, Inc. All rights reserved
transmit economic information through the network. Ultimately, though, the
value is determined by supply and demand—what people are prepared to give in
exchange for bitcoins.
And the number of businesses prepared to trade for bitcoins is growing.
According to Bitcoin Pulse, there are more than 5,500 businesses now accepting
bitcoins and that number is growing at around 5.14 percent per month:
The number of businesses accepting bitcoins is growing at about 5.14 percent.17
The Bitcoin ledger
OK, so let’s start with getting our heads around Bitcoin. Deep down in the pit of
the mine, at its core, Bitcoin is a digital file with a list of accounts and balances.
Think of it as a typical business ledger, called a “blockchain” in the Bitcoin world.
A copy of this ledger is stored on every computer in the Bitcoin network. When
someone spends bitcoins, the transaction is broadcast across the network, so every
copy of the ledger is updated, indicating which account is going down and by
how much and which account now has a higher value. Computers update their
copy of the ledger and pass along the transaction to other computers, which
then pass it on, until every copy of the ledger has been updated. At the end of
the day, just like business ledgers, the Bitcoin ledger has to reconcile to zero.
This and some math-based security is all there really is to Bitcoin: A system that
lets a network of computers maintain a ledger and in doing so lets people spend
electronic cash.
The beauty of the “ledger” is that it means for the first time two parties can
exchange value online without a third-party intermediary, such as MasterCard®,
PayPal® or Visa®, who maintain the ledger in traditional online transactions18. This
third-party was needed because online transactions involve exchanging digital
17 “Bitcoin Pluse.” Bitcoinpulse.com/. Bitcoin Pulse, n.d. Web. 13 Oct. 2014. <http://www.bitcoinpulse.com/>.18 “Everything You Need to Know About Bitcoin: VICE Podcast 027.” Youtube.com. Vice Media Inc., 9 Jan. 2014.
Web. 1 Oct. 2014. <https://www.youtube.com/watch?v=SNssKmeXrGs>.
The increasing acceptance of bitcoinsCategory Source Metric
Weekly Avg. Growth Last
30 Days
Monthly Avg. Growth Last
180 DaysAbsolute
Consumer BlockchainMy Wallet
Number of Users0% 7.53% 2,331,810
Consumer Coinbase Num Wallets 0% 7.52% 1,700,000
Merchants Coinmap Num Venues 0% 5.14% 5,544
Merchants CointerestNum Bitcoin
Venues0.72% 6.67% 6,248
Technical GithubNum Created Repositories
1.14% 4.49% 4,395
© 2014 4imprint, Inc. All rights reserved
files, which are pretty much like Word® documents or image files. Copies of these
files remain on the sender’s computer when he or she sends them to someone
else. There is nothing to stop the sender from sending the file to someone else.
The same would apply with spending money using digital files. This is why third-
parties have been needed: to ensure the same money is not spent more than
once19. This is known as the double-spending problem—successfully spending
the same money more than once—and this is what Bitcoin’s math solves with its
ledger.
Bitcoin mining
Bitcoin has come up with an ingenious way of verifying transactions using the
crowd, basically users. The process is called mining. Now, this mining doesn’t
involve any hard hats, head lamps or long periods underground chipping away at
rock or dirt. But like mining, it requires expertise in knowing where the valuable
seam of gold is and what specialist tools are required to get access to that seam
in a profitable way. With mining for gold, there was a time when panhandlers
could get rich quick in a gold rush. But now, the major conglomerates dominate
the mining businesses. Bitcoin has a similar story. There was a time when anyone
could use their home computers to mine for bitcoins. But now the competition
has become so tough that there are large businesses with rooms full of specialized
machines that exclusively mine for bitcoins.
Think of something like a giant crossword puzzle or game of Sudoku® when you
consider bitcoin mining. And instead of miners chipping
away at rock think of complex computers computing
away with one thing in mind: solving that puzzle or
game. This explains why even though receiving a payment
is almost instant with Bitcoin, there is a 10-minute delay
on average before the network confirms the transaction.
This delay is needed to solve the puzzle, let every miner
know the puzzle has been solved and update every copy
of the ledger with the new solution. A confirmation
means there is a network consensus that the bitcoins
you have received have not been sent to anyone else and are considered your
property.20 Mining is Bitcoin’s clearing house, but it uses complex algorithms, or
math, rather than a bank, to balance accounts. Everything depends on math. And
that is why complete strangers are prepared to trust bitcoins—the math means
they don’t have to trust people.
19 “Everything You Need to Know About Bitcoin: VICE Podcast 027.” Youtube.com. Vice Media Inc., 9 Jan. 2014. Web. 1 Oct. 2014. <https://www.youtube.com/watch?v=SNssKmeXrGs>.
20 Pagliery, Jose. Bitcoin and the Future of Money. Chicago: Triumph LLC, 2014. Print.
© 2014 4imprint, Inc. All rights reserved
To ensure puzzles are solved on time—every 10 minutes or so—Bitcoin does
something really simple, in theory, not in practice: it adjusts the difficulty of the
puzzle, making it easier or harder as required. Ok, so why every 10 minutes? This
number is actually a compromise between the first confirmation time and the
amount of work wasted by miners who were not the first to solve the puzzle21.
After a block is mined, it takes time for the losing miners to learn about it. And
until they do, they are still competing to solve the problem. So, 10 minutes
helps get the word out that the problem has been solved and the miners should
stop what they are doing on that puzzle and should update their copy of the
ledger. It was also felt that shortening the confirm time,
to say five minutes, would not provide that great a
benefit to companies accepting bitcoins. Weighing the
needs of miners and companies using bitcoins led to a
compromise number of 10 minutes to verify transactions.
As for changing the difficulty of the problem: If you were
chipping away at rock down a mine, it’s like someone
giving you a pick axe or a jackhammer depending on how
fast they want you to work. In reality, what this means is
that there is a sort of mining gold rush, with ever more
computing power needed to solve bitcoin formulas.22
So mining verifies transactions. But it has another role: introducing new bitcoins.
The first miners to solve the puzzle are rewarded with new bitcoins—25 bitcoins,
or about $8,640—but that number will fall over time as the system works to
control the number of bitcoins on the market. That is where the motivation
comes from for miners to monitor transactions on the site. When production stops
after 21 million bitcoins hit the market, miners will most likely be supported by
small transaction fees23.
Bitcoin benef i ts
That’s pretty much how Bitcoin works, but what benefits can companies expect
for adopting this crypto-currency.
• Easy payments—Users can send and receive any amount of money instantly,
anywhere in the world at any time.
• Low fees—Bitcoin payments involve little or no fees today. But users
can include fees to have transactions confirmed faster than the standard
10 minutes.
21 “Bitcoin: Frequently Asked Questions.” Bitcoin.org. Bitcoin Project, n.d. Web. 3 Oct. 2014. <https://bitcoin.org/en/faq>.
22 Popper, Nathaniel. “Dealbook: Into the Bitcoin Mines.” Http://dealbook.nytimes.com/. The New York Times Company, 21 Dec. 2013. Web. 3 Oct. 2014. <http://dealbook.nytimes.com/2013/12/21/into-the-bitcoin-mines/>.
23 “Bitcoin: Frequently Asked Questions.” Bitcoin.org. Bitcoin Project, n.d. Web. 3 Oct. 2014. <https://bitcoin.org/en/faq>.
© 2014 4imprint, Inc. All rights reserved
• Secure transactions—Bitcoin transactions are secure, irreversible, and do not
require personal details.
• No need for PCI compliance—This is the security standard for processing
credit card transactions on the Web.
• New markets—Businesses can enter new markets where credit cards may not
be available. This can help keep fees and administrative costs lower.
• No need to join a credit card merchant network—Businesses can simply
download an app and start accepting bitcoins.
• Identity protection—Payments can be made without personal information
tied to the transaction, providing protection against identity theft.
• Transparency—All bitcoin transactions are visible to everyone in the
network.
• Easy to get started—Businesses can get started by downloading an app that
will accept payments and convert bitcoins into dollars immediately.
How to get started
Companies still interested in exploring Bitcoin now have a decision to make:
How much control do they want? Most businesses will just want to accept bitcoin
payments and have them converted into dollars straight away. But let’s quickly
review the options:
Full client
Companies that want to handle Bitcoin
transactions on their own, with no help, can opt
for a full client service. This stores the bitcoin
ledger, manages wallets and conducts transactions
directly on the bitcoin network. Think of a
standalone email server in a cool corner office.
Lightweight client
This is a middle option. The client stores the wallet but relies on third-parties to
access the bitcoin transactions and network. This is similar to an email client that
connects to a mail server for access to a mailbox, such as Microsoft Outlook®, in
that it relies on a third party for interactions with the network.
Web client
This is like Gmail®. The client is accessed through a Web browser and stores the
wallet on a server owned by a third party.
The reality is that for most companies and consumers, Bitcoin will rarely be more
than a mobile app or computer program that provides a personal Bitcoin wallet
© 2014 4imprint, Inc. All rights reserved
that allows users to send and receive bitcoins.
Let’s run how this would work in practice with a Bitcoin newbie, Alice.
The first thing Alice needs to do is to get a wallet from a hosted service, such as
blockchain.info®. Alice could also access bitcoin apps through the iPhone® and
AndroidSM App Stores. The wallet’s software holds the addresses and manages the
keys that are needed to complete bitcoin transactions.
Bitcoin wallet makes it easy to send and receive bitcoins.
Bitcoin wal let
Addresses are critical for transactions. Like an email address, Alice can share
her address and anyone can use it to send her bitcoins. A Bitcoin address looks
something like this: 1Cdif9KGAaasrcxBaBttQcwXMOpvM9t7FK. But a QR-code,
containing these address details is also usually available on the digital wallet.
It is also possible to create a new address for every transaction. This provides
transparency about every transaction.
Once Alice has set up a wallet she faces the challenge of getting her first bitcoins.
There are exchanges that buy and sell bitcoins for local currencies: Bitstamp, for
example. But it can take a number of days to set up these accounts as they require
various forms of identification. Other ways Alice may get her first bitcoins are:
•From a friend who has some
• From local services that sell bitcoins for cash, which can be found at
localbitcoins.com
•Selling something for bitcoins
But let’s assume a friend, Bob, is giving Alice some bitcoins. Bob opens his Bitcoin
© 2014 4imprint, Inc. All rights reserved
digital wallet, selects “send coins,” and provides the destination address, Alice’s,
and how much he wants to deliver. Bob can type in the destination address
or scan the QR code with the address information on Alice’s phone. Now, the
transaction will initially appear in Alice’s wallet as “Unconfirmed”, as it still
needs to be confirmed by a miner. Once that has happened, Alice is free to spend
the money.
So, let’s say Alice decides to buy lunch in a café that accepts bitcoins. The
prices at the café are listed in dollars and bitcoin. The café could have point-
of-sale hardware, such as CoinKite’s bitcoin terminals, to automatically convert
the price into bitcoins at the market rate and display a QR code containing
a payment request. Alice can now use her phone to scan the barcode, which
will show the payment request in her bitcoin wallet. She then just needs to hit
send to authorize the payment. Finally, in about the same time as a credit card
authorization, the transaction will be visible on the register. And that’s it, the
transaction is complete.
Coinbase24 uses QR codes to make payment simple in its mobile app
How a transaction works using the Coinbase® digital app to create QR codes:
1. The merchant enters details of the sale
2. The merchant taps “Request payment” to display the QR code
3. The customer scans the QR code with her phone and taps to pay
4. Both parties receive payment confirmation—sale complete!
So, for businesses, there really isn’t a lot of difference between accepting bitcoins
and accepting credit cards. But there is a lot going on behind the scene.
24 “Point of Sale.” Coinbase.com. Coinbase, n.d. Web. 28 Oct. 2014.
© 2014 4imprint, Inc. All rights reserved
Bitcoin pr ivacy
Bob and Alice’s identities are never revealed in the Bitcoin ecosystem—they are
completely anonymous. They are known under pseudonyms called public keys.
These keys are generated using addresses and private keys known only to the
owner. Public keys are a string of letters and numbers that do not need to have
any relationship to Bob and Alice’s real world identities. Anyone who knows the
address can deposit bitcoins into it. It’s as simple as Bob hitting the send button.
But only those with the right permissions can move bitcoins out of an account.
This means access to the private key, another series of letters and numbers. So, the
final step for Bob and Alice is for Bob to use his private
key to confirm he has the right to send bitcoins from his
wallet to Alice’s. And that is why it is so important to
keep the private key safe. Anyone with access to it can
move funds. This is one of the weaknesses of the Web-
based services that most people use when using bitcoins.
These Web services store the keys and the bitcoins. If they
are compromised, hackers can access the bitcoins and
move them across the Internet in a fraction of a second.
But to summarize, to send bitcoins to a friend, you
need his or her public key, which is kind of like a routing number on a checking
account, to know where to send it and your private key to complete the deal.
But even then, miners have to do their work before the money can be spent. The
miners use the math associated with keys and addresses to check every transaction
that happens on the network. If the math does not work, the transaction is
rejected. If it works, the transaction is added to the Bitcoin ledger and every copy
of the ledger on the network is then updated.
Setting prices
Every business has some choices to make about their bitcoin prices. Many apps
will convert bitcoins into dollars automatically at the time of the transaction—
merchant services like BitcoinPay, Bit-pay, Coinbase® and Paysius will do this
automatically. Companies can also decide to do some trading in bitcoins by
not converting them into dollars and keeping the bitcoins for investment
purposes. Bitcoins can fluctuate quite a bit, so this decision really depends on
each company’s attitude to risk. You can track bitcoin exchange rates at sites like
BitcoinPrices.com.
Pretty much, every kind of business can start to accept bitcoins: brick and mortar
stores, ecommerce companies and business-to-business organizations.
© 2014 4imprint, Inc. All rights reserved
Brick and mortar stores
As with the previously mentioned café example, brick and mortar operations can
have customers pay using hardware terminals; touch screen apps, on their phones
or tablets; or simple wallet addresses through QR Codes. For example, merchants
could have a QR code, with an address embedded in a poster near a cash register.
Customers can scan this QR code with their phones and pay. Or, they can make it
easier for the customer by using a dedicated app to generate the QR code with
both the address and bill amount embedded.
Merchants can also integrate custom hardware—such as Coinkite®, XBTerminal®
and BitStraat®—with existing registers and point-of-sales solutions.
Ecommerce companies
Ecommerce websites can use a Bitcoin merchant solution, which provides payment
processing services, to accept bitcoins and have them automatically converted
to dollars. This avoids having to manage bitcoin prices based on the current
exchange rate. Ecommerce companies, and any company with a website, can also
help customers by creating a landing page that allows them to get the address to
make a Bitcoin payment by typing in the invoice number. Customers can copy and
paste an address generated by a form on the page.
BitPay25 and other services allow websites to embed bitcoin invoices into pages.
Services like BitPay also enable websites to embed bitcoin invoices into their
website using iframes, which is really just a small separate Web page inside
another Web page.
Ecommerce companies can also use plugins, or software components that add
a specific feature to an existing software application, with many shopping cart
interfaces to accept bitcoins, including Wordpress®, Shopify®, Magento®, Woo
Commerce®, and ZenCart®. And, invoices can be emailed out that include bitcoin
payment requests.
25 “Bitcoin Payment Gateway API.” Bitpay.com. BitPay, n.d. Web. 28 Oct. 2014.
© 2014 4imprint, Inc. All rights reserved
Dell26 has teamed up with Coinbase to accept bitcoins.
Buy a Dell® computer with bitcoins
Dell now accepts bitcoins as payment online. After a consumer adds an item to a
cart and chooses bitcoin as their payment option, they are sent to Coinbase.com
to complete purchases. At Coinbase, customers can choose to pay directly from
their bitcoin wallets by using the generated payment address or by scanning the
QR codes with their smartphones. They can also log in to a Coinbase account if
they have one and send payment directly. Dell says it is accepting bitcoins because
transactions “can be made easily from anywhere in the world, and offer reduced
payment processing costs.”
Businesses that mail invoices to customers
Businesses who regularly mail out invoices to clients can mention they accept
bitcoins on their invoices, near where they list other payment options, such as
Visa or MasterCard. It is a good idea to include the bitcoin price and the date by
which the bill must be paid to avail of that price—this is important as the bitcoin
exchange rate for dollars can fluctuate quite a bit. Companies should create a
new address for every invoice for transparency. Bitcoin addresses are cumbersome
to type, as they comprise a mix of uppercase and lowercase letters, but should still
include them in the invoice, as it helps provide a paper trail. And the customer
can also prove payment through the Bitcoin Block Explorer®, which keeps a record
of every payment. Using each address just once removes any ambiguity for clients
about who is making the payment.
Paying taxes on Bitcoin income
Tax compliance is a topic of concern for small businesses. But in many respects,
Bitcoin transactions work very much like cash. According to the IRS, taxpayers
who receive bitcoins as payment for goods or services must, “in computing gross
26 “Dell Now Accepts Bitcoin.” Dell.com. Dell, n.d. Web. 28 Oct. 2014.
© 2014 4imprint, Inc. All rights reserved
income, include the fair market value of the virtual currency, measured in U.S.
dollars, as of the date that the virtual currency was received.27”
The downside of bitcoins
There are a number of disadvantages beyond the
deflationary issue and threat of losing all bitcoins in
the way you can lose cash:28
• Deflationary currency—as the number of
bitcoins will max out at 21 million, the value
of coins will rise after the limit is reached. This
creates an incentive for holding on to coins
until they rise in value rather than spending
them today. This can put downward pressure
on product prices to create an incentive to
spend. This is one of the main criticisms of the theory behind Bitcoin: It
encourages people to not spend money.
• The level of acceptance—while more businesses are accepting bitcoins, the
level of market acceptance is low and has to grow to benefit from network
effects.
• Price fluctuations—the small market size of bitcoin means that relatively
small events, trades, or business activities can significantly affect the price.
Bitcoin supporters argue that this volatility will ease when the market grows
and matures.
• Beta status—Bitcoin remains incomplete. Security developments are still in
process and most Bitcoin businesses are so new, they offer no insurance on
transactions carried out using those services. Credit card companies, on the
other hand, do offer insurance on transactions using their financial system.
• Public/private key system security—the key system for transactions is
only secure as long as the private key is kept secret. Web-based apps store
everything on a server. If that server is compromised, all the bitcoins on that
server can be lost. This is what happened with Japanese bitcoin exchange
Mt Gox—almost $500 million worth of bitcoins were taken when hackers
accessed the exchange’s server. There are two ways to store bitcoins. A hot
wallet involves storing public and private keys on a device that’s connected
to the Web, which is like walking around with all your cash in your pocket.
A cold wallet means storing everything offline, on an external drive for
example. However, if you lose your drive or it stops working—you lose your
bitcoins. It is also possible to take a hybrid approach: Storing most of your
27 Irs.gov. IRS, 25 Mar. 2014. Web. 1 Oct. 2014. <http://www.irs.gov/pub/irs-drop/n-14-21.pdf>.28 “Bitcoin: Frequently Asked Questions.” Bitcoin.org. Bitcoin Project, n.d. Web. 3 Oct. 2014. <https://bitcoin.org/en/faq>.
© 2014 4imprint, Inc. All rights reserved
4imprint serves more than 100,000 businesses with innovative promotional items throughout the United States,
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bitcoins offline but moving coins to your hot wallet as you need them.
• New digital currency—it is possible that a new digital currency could
enter the marketplace and take the place of Bitcoin, reducing its value
significantly. However, Bitcoin may now be too well-established for it to be
easily replaced.
Summary
Bitcoin is a new crypto-currency that holds real benefits for business and
consumers, including more control over their money, low fees and quick transfers,
even internationally. And companies can easily start accepting bitcoins using apps
on their phones or computers or using Bitcoin merchant solutions. There are a
growing number of companies adopting this digital currency, including Subway
and Dell. And there are consumers who want to use it. But the truth is that right
now it is not a major source of new revenue. But Bitcoin may be heralding a new
way for businesses and consumers to think about money. And in the next several
years, it may develop into a niche electronic currency that serves as an alternative
to other electronic payment processing platforms, such as credit cards and PayPal.
It is easy set up, so does not take much effort to give it a try. Accepting bitcoins
may also give a company’s public relations operations a shot in the arm, as there is
a lot of local coverage for companies that adopt Bitcoin.