Insights | Bitcoins and Blockchain (part 1)

Digital crypto-currencies and blockchain self-executing contracts and instruments are this week’s buzz words.  So how does the law, tax and GST fit into the equation?

In Part 1 of our Insights | Bitcoins and Blockchain series, we provide a brief introduction to the Bitcoin and Blockchain technology.  In future installments, we will discuss the application of law, Australian income tax and GST to Bitcoins and provide insight as to the future implications of evolving technologies to the fields of law and tax.

What is this “Bitcoin” everyone keeps talking about?

Conceptually, Bitcoin is a peer-to-peer mathematically driven crypto-currency Ouroboros.

What did I just say?

Essentially, it is a means by which counterparties may exchange units of value (called “Bitcoins”) for goods or services and the digital encryption mechanism by which each such transaction is recorded, validated and stored in a central digital ledger.

The digital system rewards 25 Bitcoins for, in layperson’s terms, converting a data set or “block” of global Bitcoin transactions for a discrete period into a mathematical code which then gets added to a series of converted blocks known as a “blockchain”; each block is then used to validate the block preceding it so that transactions cannot be faked, as doing so would be readily spotted mathematically in the congo line of encrypted blocks.

There are only so many Bitcoins to be created in the world – apparently 21,000,000 of them, albeit the smallest Bitcoin denomination (called a “Satoshi”) is one-hundred millionth of a Bitcoin.  Once a Bitcoin comes into existence, it may be on-traded for other things, like goods and services, or say national currencies like the USD or AUD.

For more reading on the technical aspects of Bitcoin, we recommend a Bitcoin trading site like Coindesk as a starting point.

So why use Bitcoin?

Aside from anonymity of participating in the Bitcoin exchange system (which has led many people to castigate it for its use in Silk Road/underworld activities), there are quite a few reasons why digital crypto-currencies are still gaining traction in the commercial world:

  • Speed of transactions: ever had to wait a few days for a cheque to clear with your bank?  Ever worked on a complex international transaction requiring staggered steps of money transfers and teams of lawyers and bankers to complete?  Bitcoin transactions take, at their peak, under 13 minutes to verify using the blockchain technology.
  • Reduced transaction fees: anybody can set up as many Bitcoin accounts as they wish and Bitcoin transaction attract a nominal charge.  Chances are, if you pay a subscription fee to a Bitcoin intermediary, they are charging you for the service of creating, maintaining and executing transactions on a Bitcoin account set up on your behalf.
  • Data security: ever been the victim of credit card fraud?  How many victims of Bitcoin fraud have you heard of?  It doesn’t happen due to the encryption technology inherent in the Bitcoin system and so long as a merchant insists on blockchain validation of payment before releasing the goods or providing the service.
  • Autonomous wealth generation: if you have spare and copious amounts of computing power and the means to pay the electricity to run it, you could task your network to mining Bitcoins.  A word of caution before you try to install the Bitcoin software on a laptop computer to mine a few ‘coins on the side – there are probably hundreds of thousands if not millions of dedicated and networked computers currently “mining” Bitcoins right now and you won’t be making much progress without serious computing power.

Limitations to Bitcoin technology

Due to the mathematical nature of Bitcoin and its ever growing chain of blocks of transaction data, it takes 10 or more minutes for a transaction to get validated by reference to other blocks in the series.  Most vendors do not want the risk of completing a transaction with unverified Bitcoin data; this is a major deterrent to the take-up of Bitcoin as vendors with point of sale transactions don’t have the luxury of waiting 10 minutes or more unless they are willing to accept counterparty default risk.

This leads us to the evolution of blockchain technologies and rival networks which continue to emerge and develop internationally.

Blockchain technology

Bitcoin is one example of Blockchain technology.  There are others.  For example, a rival blockchain entrant Ethereum has been making headlines recently with third party push to develop applications called Smart Contracts to standardise and automate banking transactions and corporate governance practices.  In the future, it is contemplated that human intervention will not be necessary or minimised in other cases.

Already, some proponents of blockchain technology are envisaging a Shakespearean world where Smart Contracts are used to metaphorically “kill all the lawyers”.  Others are envisaging a brave new world where lawyers become proficient programmers as it becomes necessary to digitise contracts into programming language.

For our part, we consider this technology in its very infant stages with significant implementation risks and limitations from a “futurist” legal and tax perspective which will be explored in Part 2 of our Insights | Bitcoins and Blockchain series.

Disclaimer

This article is intended to provide commentary and general information. It should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this article.

Did you find this article helpful?  Please share with other readers.

Keep an eye out next week for Part 2 of our Insights | Bitcoins and Blockchain series.

 


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