What is Bitcoin?

Bitcoin has been in the news extensively in 2014, and as the most prominent virtual currency, we expect it to stay there. So, we’re taking a look at bitcoin, its current status, its pros and cons, and its relationship with identity verification.

What is Bitcoin?

Bitcoin is a payment system designed by Satoshi Nakamoto and introduced as open-source software in 2009. Payments are recorded in a public ledger using a unit of account called bitcoin. The payments work peer-to-peer, meaning that a central repository like a bank, isn’t used. Although its status as a currency is highly disputed, many experts refer to bitcoin as a virtual currency, digital currency, or cryptocurrency. The three terms are similar but not necessarily mutually exclusive.

The Financial Action Task Force (FATF) defines a virtual currency as “a digital representation of value that can be digitally traded and functions as (1) a medium of exchange; and/or (2) a unit of account; and/or (3) a store of value, but does not have legal tender status (i.e., when tendered to a creditor, is a valid and legal offer of payment) in any jurisdiction.”

Virtual currency differs from “real currency” or “national currency” because it is not issued or guaranteed by a jurisdiction. Most coin and paper currency, also called fiat money, is designated as a country’s legal tender, and is produced, circulated, and accepted as the currency of the issuing country. Virtual currency is also not e-money, which is merely a digital representation of fiat currency in order for it to be traded quickly and easily in an electronic form.

If virtual currency isn’t produced by a government, then where does it come from? It depends on the type of virtual currency. Bitcoins are created as a payment for solving math problems—not just any simple math problems, but complex math problems that allow bitcoin payments to be verified, recorded, and securely transferred. Basically, people who work on the Bitcoin payment processing system are paid in bitcoins. These bitcoins are then traded or sold for fiat money. Again, there is no guarantee for this money, so the trade and sales are all based on peer agreements.

What's the current status of Bitcoin?

Bitcoin has had a volatile history. While fiat money is actively managed to achieve price stability, Bitcoin does not have centralized oversight. There have been significant peaks and drops in bitcoins. In 2011, bitcoin prices peaked in the middle of the year at $32.00 but then bottomed out at $2 in November, 2011. A technical glitch caused a sharp sell-off in March of 2013, and the price of bitcoins declined 33%. The collapse of a single bitcoin exchange, Mt. Gox, caused a price decline of 61%. The peak price of bitcoins right before the crash was $266. Recently, bitcoins peaked again reaching an estimated value of over $1100, but they are currently sitting at slightly above $600 per unit.

Some consider Bitcoin or similar virtual currencies to be an important part of the future of legal and commercial payment systems. Others consider Bitcoin to be a popular tool for criminals, who need to store and move illicit funds without the scrutiny of law enforcement and other governmental authorities.

The changes within Bitcoin in 2014 directly follow these two perceptions. The first view is driving the commercial economy of Bitcoin to grow.

Big-name retailers are joining the list of retailers who accept bitcoins. Overstock, TigerDirect, Sacramento Kings, Lord and Taylor, REEDS Jewelers, DISH, Expedia, and Newegg all accept or are planning to accept bitcoin by the end of 2014. Additionally, venture capitalism investments in bitcoin reached $57 million in Quarter 1, and $73 million in Q2.

Regulations, Identity Verification, and Bitcoin

The second view, that Bitcoin enables money laundering, is driving the quick growth of Bitcoin regulations. As more retailers are choosing to accept bitcoins, governments and bitcoin participants are both focusing on regulations and transparency. Historically, Bitcoin has been criticized for its lack of regulation and for aiding illegal activities. During the black market Silk Road shutdown, the US FBI seized 144,000 bitcoins worth $28.5 million at the time.

The FATF report on virtual currencies and Bitcoin argues that the following aspects of Bitcoin are cause for concern:

  • Allows greater anonymity than traditional non-cash payment methods
  • May permit anonymous funding and transfers
  • Does not require or provide identification and verification of participants
  • Does not have a central oversight body
  • Reaches globally so money can be moved easily and quickly across borders

Ultimately, the FATF believes that convertible virtual currencies “are potentially vulnerable to money laundering and terrorist financing abuse.” For the full report, please visit the FATF documents.

In order to address concerns about the misuse of bitcoins, some countries are moving forward with regulations. Governor Jerry Brown has granted Bitcoin legal money status in California, and Switzerland is considering legal money regulations for Bitcoin. France announced last week that they have an identity verification initiative for virtual currencies expected to be fully implemented by the end of the year. Similarly, many people interested in virtual currencies are pushing for more transparency and auditing within Bitcoin organizations.

Bitcoin and similar virtual currencies have the potential to improve payment efficiency and reduce transaction costs. However, regulation and transparency are clearly needed to ensure the safety and legality of virtual currency systems. Identity verification will be an integral part of Bitcoin, if the virtual currency has a future in global, commercial economy.

Trulioo is paying attention to ID verification possibilities specifically for bitcoin exchanges. If you have the need for identity verification for bitcoin transactions within your company, then please contact us to discuss possibilities.