Bitcoin and Digital Currencies
Bitcoin is one of several digital currencies that can be used to buy goods and services. Digital currencies are fundamentally different from ordinary currencies, such as dollars, euros, pounds, and yen. Specifically, digital currencies have no central issuing authority and they are not backed by any government.
In theory, and no third party can control the currency. Most digital currencies are scarce by design, to preserve their value, and avoid the problem of inflation. For example, there will only ever be a maximum of 21 million Bitcoins in existence. Each Bitcoin consists of 100 million Satoshis. Just as there are 100 cents to a dollar, there are 100,000,000 Satoshis to a Bitcoin. 1 Satoshi equals 0.00000001 BTC.
Transactions involving digital currency are encrypted so that each exchange or transfer is anonymous. Digital currencies like Bitcoin are exchanged over a worldwide peer-to-peer network. Whenever Bitcoin is exchanged or transferred, a record of the transaction is entered on a global, decentralized ledger known as a blockchain.
To understand how blockchain works, imagine a poker game where the players aren’t using chips or cash. To track the amounts won and lost, there is no central authority “keeping score.” Instead, the players keep notebooks in which they write down the starting balances and the amounts won and lost by each player. They continuously compare their notes to verify the transactions and eliminate discrepancies. Collectively, all of the notes regarding the individual transactions constitute the blockchain system. Whenever a person pays for goods or services with digital currency, the transaction will be recorded in the blockchain indicating the account number of the payor, the account number of the recipient, and the amount of currency transferred.
The block chain ledger is publicly available. For example, each Bitcoin’s entire life can be tracked backwards to the computer that originally mined it. Encryption is used to verify the transactions and maintain the integrity of the ledgers.
Encryption can also help keep the names of the account holders anonymous. This anonymity is vitally important for privacy purposes. However, anonymity can be a huge problem when transactions are subject to disputes, criminal transactions, or fraud, as it may be impossible to determine the identity of the person with whom you are dealing. Moreover, digital currency transactions are irreversible. There are no “chargebacks” or dispute resolution procedures in place.
Bitcoin may be the most well-known digital currency, but it isn’t the only one. Other popular digital currencies include Ethereum, Litecoin, Ripple, ZCash, and Tether.
There are real risks in dealing with digital currencies. The value of one Bitcoin, for example, can vary wildly from day to day. One Bitcoin was worth $327 on November 20, 2015. It climbed to $19,650 on December 17, 2017. By February, 2018, the price had fallen to below $7,000. By December 15, 2018, it was down to $3,192. By May, 2019, it was back over $8,000.
Another risk is that there are tax consequences when dealing in digital currency. The IRS considers digital currencies such as Bitcoins as capital assets. That means all transactions are subject to being treated as capital gains or losses. The more popular digital currency wallets, such as Coinbase, do track gains and losses. However, the burden falls on the currency holder to report gains and losses from digital currency transactions for a particular tax year on his or her income tax returns. The IRS has warned that “taxpayers could be subject to criminal prosecution for failing to properly report the income tax consequences of virtual currency transactions.”
Another potential risk is regulation. Because digital transactions do not require the use of banks make them useful for countries trying to avoid international sanctions, for example. To the extent that they provide an alternative to the legal currency in any nation, they potentially pose a threat to that nation’s ability to control the value of its own currency. Thus, it is entirely possible that countries may want to criminalize the use of digital currencies.
In divorce cases, the anonymity provided by digital currency transactions can present a real challenge to litigants and their lawyers. It is crucially important to know what documents to demand, and how to deal with digital currencies in negotiation and at trial. Additionally, it is important to know what questions to ask. For example, if a spouse is mining Bitcoin, there wouldn’t be any record of cash for digital currency. At Kollias & Giese, our lawyers have an understanding of how digital currency transactions work, how to go about tracking them, and how to go about valuing them.