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Digital Currency Creates Bitcoin Drama

by on March 16, 2014 7:50 AM

Currencies exist for easy commerce, and they work based on the belief that they'll be in the future to buy goods and services.

A U.S. dollar may lose buying power over time through inflation but the fairly certain knowledge that one U.S. dollar will buy one U.S. dollar's worth of goods or services is what allows for trust in the dollar now and into the future.

In the United States, all commerce can currently be done with that dollar so that people can buy airplane tickets with their credit card which uses a dollar denomination, buy breakfast at the Waffle Shop with a ten dollar bill and pay a neighbor to shovel the walkway with U.S. cash.

Currency is overall a medium of exchange.

An idea for a digital currency was floated in 2008 in a white paper by the future creator of the bitcoin. It is not a new idea and many individuals who are leery of governments have wanted an alternative currency without government interference (think bailouts and artificially low interest rates) for some time.

Satoshi Nakamoto, who wrote the white paper, is the pseudonym for the mysterious developer (or developers) of bitcoin. There have been many investigations into the bitcoin creator(s) and there is still uncertainty as to the identity or identities of the bitcoin mastermind(s).

Bitcoin is a digital currency that went into use in January 2009 and uses cryptography to control its creation. People 'mine' bitcoins by solving complex math puzzles or buy and sell them on peer-to-peer exchanges.

Unlike other currencies, it does not rely on a central bank or government to create, regulate or track, and is strictly peer-to-peer. A person can go to a Bitcoin exchange and purchase bitcoins; however, a Wired study showed that 45% of Bitcoin exchanges close down.

This is a developing currency and faces hurdles even with purchasing and holding the coin. You won't put an actual bitcoin in your leather wallet. Rather, these coins are held in an electronic wallet. Unlike purchasing and holding a security, such as Apple (AAPL) stock in an electronic brokerage account, which has SIPC insurance or additional insurance and regulation to maintain the integrity of that account, bitcoin has none of this by design.

That's the main advantage to the currency, which allows for a true free floating currency separate from any government, bank or middlemen, and that also allows for abuses.

Because digital currency and bitcoin in particular can be used to buy merchandise anonymously, it is ripe for money laundering. Large cash transactions raise red flags with FinCEN (Financial Crimes Enforcement Network), a government regulatory authority whose major mission it is to police for money laundering.

Any deposit or payment in cash of $10,000 or more better have backup and an explanation because this group is taking a closer look. Bitcoin has created a workaround for this rule and rather large currency transactions can be done anonymously, without this oversight.

Thus, when two Florida men were accused of money laundering using bitcoins, their defense was that they could not be money laundering because by law that crime only applies to currency issued by the U.S. or another country. Can you say loophole? Typically, governments and regulators will close these loopholes quickly.

The other downside of holding bitcoins in an electronic system is the integrity of that virtual wallet. Mt. Gox collapsed when it declared bankruptcy last week after a large theft of the electronic currency. Flexcon, another bitcoin startup, announced it was shutting down after a theft of $620,000 worth of bitcoins (at the time 896 coins). Flexcon was a cloud based storage and exchange for bitcoins. Because the currency and exchanges are unregulated and uninsured, your $620,000 is not restored as it would be in a bank theft (if you are under FDIC limits).

There is much opportunity for global commerce in alternative currencies and the very idea and process that has created the Bitcoin universe will most likely not stop here. For instance, internet entrepreneurs, the Winklevoss twins, just bought tickets for outer space from Virgin Galactic with bitcoins.

I am telling you folks, you just can't make this stuff up.

While I still can't use a bitcoin to buy a Penn State sweatshirt at McLanahan's, we have not heard the last of alternative currencies.

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Judy Loy, ChFCâ, is a Registered Investment Advisor and CEO at Nestlerode & Loy Investment Advisors, State College, Pa. A graduate of Penn State University, Loy has been with the firm since 1992, assisting clients with retirement planning, brokerage services and investment advice. She can be reached at jloy@nestlerode.com.
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