Bitcoin, Xerocoin, Litecoin, Zcash, Dash etc otherwise known as Cryptocurrencies seem to be everywhere at the moment. So what are they? A cryptocurrency is a digital or virtual currency that uses cryptography (complex code solving by computers) for security. The common characteristics that are different from traditional (fiat) currency such as the Australian dollar, US Dollar or Euro are:
- It is not issued by a central authority such as a central bank rendering it theoretically immune to government manipulation or interference;
- There are typically minimal to no transaction costs for payments between parties. This is unlike a traditional payment system such as a credit card for an overseas purchase where an intermediary bank charges a fee for processing the transaction;
- The use of ‘block chain’ technology which is an online ledger providing checks and balances by making public every transaction ever made. This provides legitimacy and makes theft or forgery close to impossible. Block chain technology replaces a bank which performs this duty in a traditional payment system; and
- Anonymity of the user.
While innovative, cryptocurrency has become infamous for the use of purchasing illegal products (given the anonymity it provides) and the euphoria surrounding price rises (driven by supply and demand similar to precious metals). Cryptocurrencies present numerous challenges to regulators where it is banned in China and Russia, the US IRS has ruled Bitcoin as property and subject to capital gains tax whilst others are still trying to understand the implications. As an unregulated market with massive price volatility, one needs to be aware of the significant risks before considering any transfer of hard earned $ into such markets.