Forget the Gold Standard -- What about Bitcoin?

"All money is a matter of belief."
- Adam Smith

We have lived through the rise of the personal computer, e-mail, Skype, smart phones. What's next? How about a digital currency?

It's called Bitcoin.

Bitcoin is not managed by any government or central authority. It relies on an Internet-based network. Bitcoins get issued at the rate of about 25 every 10 minutes now, and they are due to level off from the current 11 million at 21 million in 2040. The creation of new Bitcoins is automated and given to "Bitcoin miners" who confirm Bitcoin creation as they add codes to a decentralized and archived log approximately every 10 minutes. New Bitcoins are not created by fiat, but in exchange for valuable labor. They are paid to computer hobbyists who monitor the Bitcoin system to keep it running and prevent counterfeiting. Bitcoins can be transferred through a computer or smartphone locally or internationally without an intermediate financial institution.

The security comes from the encryption and registration of every Bitcoin issued. The encryption has the same effect as putting a combination lock on each coin that needs 100 numbers entered to unlock it. Every coin's every movement is recorded on a public log, each log being issued every ten minutes.

The value of a Bitcoin depends on its exchange rate. The US dollar/Bitcoin exchange rate is currently very volatile and is increasing. The exchange rate for one Bitcoin reported in an article in the April 22 edition of Time magazine was stated at $200, probably spurred by Spaniards buying Bitcoin heavily during the recent European banking crisis. That means if you spend a Bitcoin for something, the exchange rate tomorrow might mean you paid a dollar for a pound of coffee or one hundred dollars. The goal is for it to be a currency that no government can debase and no bank can control.

Bitcoin is accepted in trade by over 500 individuals and merchants (none of them named Amazon or Walmart) in many parts of the world. It is also used in illicit drug and gambling transactions. Although Bitcoin is promoted as a digital currency, many commentators have criticized Bitcoin's volatile market value, relatively inflexible supply, and minimal use in trade. But it is new, after all.

On March 18, 2013, the Financial Crimes Enforcement Network (or FinCEN), a bureau of the United States Department of the Treasury, issued a report regarding centralized and decentralized "virtual currencies" and their legal status within "money services business" (MSB) and Bank Secrecy Act regulations. It classified digital currencies and other digital payment systems such as Bitcoin as "virtual currencies" because they are not legal tender under any sovereign jurisdiction. FinCEN cleared American users of Bitcoin of legal obligations by saying, "A user of virtual currency is not an MSB under FinCEN's regulations and therefore is not subject to MSB registration, reporting, and recordkeeping regulations."

Anonymity, while significant, is not absolute. This seems like a magnet for crime, but the (apparent) inability to counterfeit Bitcoin and the public log of transactions tends to make it difficult at best to abuse.

So, how is income involving Bitcoin taxed? It's taxed the same way as income in Euros or Yen or any other currency is taxed. It is taxed the same was as bartering income is taxed. You keep records of its value when you get it, its value when you sell it and report the gain just as if it were reported to you with a 1099-B.

If you are paid in Bitcoin for work you do, report it as income.

If you sell goods for Bitcoin, the value of the Bitcoin at the time of sale minus the value of the goods you sold (i.e. the cost of material, labor, and other business costs directly related to that unit that was sold) is profit that you declare. The basic principal of income minus deductions yielding a taxable income, the tax on which may have credits available to reduce the tax still applies.

Just as in bartering, you may think that the system is ripe for tax evasion, but people who barter in business tend to be more compliant that people who do not. The key for compliance as in any finance or business venture is to keep accurate records and update them daily, before you forget to look up the US Dollar value of your Bitcoin income for Tuesday.

Will Bitcoin become the credit card of the future? It needs time to stabilize and acquire more users if it can. It will need the government to accept payment for "all debts public and private" in Bitcoin to truly succeed.

Michael Sivy writing for Time Business & Money says: "Governments will fight back, no doubt. But virtual currencies will be no easier to control than Facebook. Stopping the movement of capital will be possible only if countries are willing to impose harsh taxes and capital controls. Once alternative currencies are frictionlessly available on the Internet, every laptop will become its own Cayman Islands. However the current boom-and-bust plays out, Bitcoin is the beginning of something, not the end."