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Opinion: Cryptic Crypto: Decoding the mania

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Bitcoin, litecoin, ethereum, tether, dogecoin and 8,000 other names make up the rapidly expanding cryptocurrency market. This exploding, currently unregulated market for a new-age digital bartering system that resides outside of the banking system has lured in well over $1 trillion in speculative investments. Individuals, merchants, charities and some governments are now accepting cryptocurrencies as legal tender.

Use by countries
El Salvador became the first country to recognize bitcoin as legal tender in September 2021. Citizens were incentivized with seed money of $30 in bitcoin to download an app. The government recently announced a delay to later this year of the launch of its $1 billion bitcoin bond issue. According to reports, half of the proceeds are set to purchase bitcoin and the other half to help build a city near a volcano that will use geothermal energy to help mine bitcoin, dubbed Bitcoin City.

China, by contrast, has outright banned all cryptocurrency citing a threat to destabilize its financial system. Officials defended their position citing concerns over the negative impact on the environment from the intense computing power required to mine the data and its potential to be used as an avenue for illegal money laundering and illicit activities. Media reports indicate the ban came during the development of China’s state-owned digital yuan currency that is currently being piloted.

Domestically, bitcoin and other cryptos are legal and currently unregulated. The unpredictable price swings and threat of regulation could delay wider acceptance. U.S. Securities and Exchange Commission Chair Gary Gensler has referred to crypto as the “Wild West,” which could mean taming regulations are on the horizon.

Crypto was built on the premise of creating a medium of exchange to allow peer-to-peer transactions. It is a decentralized digital currency that does not require a bank to process payments and even eliminates currency exchange rates for international transactions.

As for market cap, bitcoin’s nearly $900 billion towers over other cryptocurrencies. Second is ethereum’s market cap of over $400 billion, followed by tether’s $81 billion market cap.

Exploring bitcoin
Bitcoin was created by a person or group under the pseudonym Satoshi Nakamoto. Bitcoin’s launch in January 2009 had impeccable timing. As the banking system came under immense pressure during a U.S. financial crisis, mistrust of financial systems grew, and cryptocurrency became an interesting alternative to government-regulated fiat currency.

At its launch, one bitcoin was worth less than a penny. In November 2021, one bitcoin hit a high of nearly $68,000. Unlike stocks or bonds, bitcoins trade 24/7. The price is set by investors bidding up or selling down the asset, which continues to be quite volatile.

Bitcoin is built on blockchain technology – think of a bank ledger system that keeps track of transactions. However, the transactions in the ledger are recorded by individuals all over the world who are independent from one another, not a centralized group or government.

The reward for recording the transactions, aka mining the data, is payment in bitcoin. To get paid, miners must do two things: Verify one megabyte of bitcoin transactions (one block) by solving complex mathematical puzzles and rendering a 64-digit hexadecimal code as the answer, and be the first to arrive at the answer.

Once a set number of transactions have been recorded, the block is complete, and another block begins. For every 210,000 blocks mined, the bitcoin reward for mining the data is halved. This happens roughly every four years. When bitcoin launched, the reward for mining one block was 50 bitcoins. Today, the reward is around 6.25 bitcoins.

To date, nearly 19 million bitcoins have been put into circulation, or 90% of the total supply. The cap is set at 21 million coins, which is expected to be reached in the year 2140. By having a finite number in circulation worldwide, bitcoin stands a better chance at holding its value.

To transact with bitcoin, you must first have an online wallet. Then, you can fund it with a debit/credit card or bank account and purchase your crypto. You can then transact with other individuals or spend it at a growing list of participating merchants using QR codes.

The IRS taxes bitcoin as if it were an investment. Each swipe of the crypto debit card is counted as a short-term capital gain if held for less than a year or a long-term capital gain when more than a year. The standard capital gains tax rates apply, which is ordinary income on short-term gains, and 0%, 15% or 20% on long-term gains depending on your tax bracket.

Even though cryptocurrency is in its infancy, based on the enormous market cap and growing acceptance as a medium of exchange, bitcoin and perhaps a few others are likely here to stay.

Andy Drennen is a certified financial planner and senior portfolio manager at Simmons Private Wealth in Springfield. He can be reached at andy.drennen@simmonsbank.com.

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