Will that be cash, credit or bitcoin? The pros and cons of digital currency
September 23, 2015
Whether buying or selling, cryptocurrencies may change the way monetary transactions are conducted.
Also known as digital or virtual currencies, cryptocurrencies are a unique peer-to-peer system that transfers monetary value without the exchange of physical coins or bank notes. There are many different types of cryptocurrencies available, but how they work depends on the platform that is being used. The most common digital currency is bitcoin, and it’s becoming increasingly popular.
Designed based on certain principles of cryptography, the bitcoin was the first cryptocurrency to be created and was introduced in 2009 by a group or individual that goes by the alias “Satoshi Nakamoto.”
The idea behind the invention of bitcoins was to eliminate the middle man — the government and financial institutions and their regulations — and to offer anonymity to users of the system. This raises some concerns about who is using the bitcoin system and for what intentions.
“People would say the pros are that it’s anonymous, that you can use it and no one really knows who you are,” says Jacqueline Shinfield, a Partner in the Financial Services group at Blake, Cassels & Graydon LLP. “And some people would say that it’s a con because it’s anonymous and no one knows who you are.”
While the bitcoin system provides users with increased privacy and protection against potential hackers, it can also open the door to illegal activity that is difficult to detect or control. Unlike other peer-to-peer networks, such as those used for illegally downloading music or videos, the bitcoin system is considered a bigger threat because of the increased level of obscurity. There is real concern from government regulators around the world that criminal organizations are using the bitcoin system for shady business dealings, such as money laundering and drug trafficking.
However, unlike cash, bitcoins leave a trail by way of the block chain. The block chain, also known as a public ledger, is where all transactions are posted, and each user is provided with a private key (a type of secret code). The private key is used to make secure transactions together with a public key that identifies the sender or recipient. Although this can help track illicit transactions to some degree, it can pose a potential security risk for legitimate users.
“Your private key must be secure because if someone can get your private key, they can hack into your bitcoin account,” says Jacqueline.
Bitcoin exchanges are responsible for creating private keys. But the most important role exchanges play is providing security to users and their electronic wallets where bitcoins are stored.
“A lot of the services that exchanges provide include storing your private key for you,” continues Jacqueline. “Most have really secure procedures.”
So then the “key” to security is the exchanges. And exchanges are really trying to expand the market. They’re not only funded very well by venture capitalists, which means there’s quite a bit of money to play with, but they’re also really compliant because they want the technology to work.
Another interesting fact about the bitcoin is that it’s a decentralized currency, which means it’s not regulated by any government or financial institution, unlike regular currency and credit cards. This is beneficial for merchants because without any regulations in place, the fees for accepting bitcoins are much lower than those established by credit card companies.
Despite growing in popularity, it’s important to remember that cryptocurrencies are not legal tender, says Jacqueline. “When you’re exchanging and paying for things in cryptocurrency from a Canadian perspective, it’s not legal currency. It just represents an amount of money that’s being exchanged.”
In Canada, the plan is to regulate cryptocurrencies to protect users, to make the currency more stable and to deter illegal activity. Bitcoin and other digital currencies will be regulated by Bill C‑31, An Act to implement certain provisions of the budget tabled in Parliament on February 11, 2014 and other measures, under changes made to proceeds of crime legislation. Exchanges will have to be registered and verify the identity of the people who are buying and selling digital currency beyond certain thresholds.
So how does one go about obtaining bitcoins? One way, as mentioned earlier, is to exchange cash for bitcoins through exchanges (which is done via open-source software for online transactions). You can also exchange them for goods and services as you would with any merchant, or you can generate bitcoins through a process called “mining.” With bitcoin mining, you’re mining for virtual keys to unlock transactions on the block chain so that you can verify them. The more transactions you verify, the more bitcoins you receive (25 bitcoins per transaction). The glitch is that mining requires a certain amount of computer processing power to search for the key that decrypts a particular file. Not only is this time consuming, but also most home and office computers don’t have that capability, so it can be very limiting from a technology perspective.
Overall, the process for obtaining bitcoins can be complicated, and their use is not so widespread in Canada.
“It’s still a little bit of a closed community, but it’s definitely growing,” comments Jacqueline. “For everyday Canadians to be able to go into the bitcoin world and buy and sell, you have to find someone who would exchange in Canada. And then when you go on, you need to get an ID and comply with a process. You really have to want to do this to be involved.”
What also makes some people weary about using bitcoins is the variation and fluctuation in their value, which can change drastically and within a short period of time. According to the U.S. Congressional Research Service, in mid-January 2015, one bitcoin was valued close to US$220. However, it was less than US$20 in January 2013, over US$1,100 in December 2013 and about US$320 in mid-December 2014. This means that if you’re selling a product and you wait a few days to cash in your bitcoins, you may lose the value of the bitcoin you accepted for that product. Once bitcoin becomes more acceptable and standard, this likely won’t be a concern, but it is something to consider for the time being.
There are also issues under the consumer protection legislation in Canada on refunding consumers for their purchases. Currently, a bitcoin exchange is meant to be final and irrevocable. However, if someone makes a claim under the consumer protection legislation, the merchant will be obligated to return the funds. This can be a bit tricky. Unlike refunds for purchases made with dollars, the question is whether or not the refund should be made in bitcoins or another form of currency. And what if the value of the bitcoin has changed? Do you make the refund based on the current value or the value of the bitcoin at the time of the purchase?
Another use for bitcoins is smart contracts. Smart contracts are computer programs that facilitate the execution of a contract. They can be simpler to use than traditional contracts because, as Jacqueline points out, there are no intermediaries, just two or more people who are dealing through the platform (dubbed “Bitcoin 2.0”).
One example of how smart contracts could be used is for betting on sporting events. Each party participating in the bet would place bitcoins in a neutral account controlled by the smart contract. Once the game is over, and the smart contract verifies the winning team via certain sports broadcasters, the person who won the bet would automatically receive the winnings in his or her account.
Regardless of what purpose the bitcoin will serve, one thing is certain: no one knows what its future looks like. “There are people who swear by this, and there are people who say it’s going to die. It doesn’t have full adoption yet, but it is likely that the platform will survive regardless,” says Jacqueline.
For now, digital currencies are a fact of life. How and if you choose to use them will likely be determined by your business needs, your interest in learning a new technology, and your level of trust in a relatively new and unregulated system. Either way, it may just be a matter of time before we all become part of the cryptocurrency world.
For more information on cryptocurrencies, please read Digital Currency: You Can’t Flip This Coin! and A Quick Guide to Digital Currency, both published by Canada’s Standing Committee on Banking, Trade and Commerce.
Jacqueline Shinfield can be reached either by email or at 416-863-3290.
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