No other digital currency has stirred up the pot more than Bitcoin.
Reaching an all time high market value of over $1,200 on November 2013, bitcoin became a household name fueling the pipe dreams of individual “miners” and large corporations alike. Given that the amount of daily transactions in bitcoin was over 66,000 in April 2014, the IRS had to issue guidelines on how to treat transactions in the virtual currency for tax purposes.
Given these stats, it is just a matter of time until your organization receives an offer or considers conducting business in bitcoin. Here are the top 5 things to consider when drafting contracts involving bitcoin.
1. Legality
While most countries consider bitcoin to be a legal currency to conduct business with, there are other countries that don’t. For example, on May 2014 Bolivia’s Central Bank banned the use of bitcoin within the country. However, if you cross the border to Argentina or Brazil, then you are legally allowed to accept bitcoin as a form of payment. Regulations change constantly so do your best in keeping up. To get started, check out the summary of regulation of bitcoin in selected jurisdictions from the Library of Congress.
2. Currency or Property
Once you find out whether bitcoin is legal in the country that you plan to run your transaction, then you need to double check whether tax laws consider bitcoin currency or property. Even though the Reserve Bank of India warns businesses about the use of bitcoins, the financial institution still considers bitcoin as a currency. On the other hand, the IRS has explicitly stated that bitcoin “is treated as property for U.S. federal tax purposes”. This means that all transactions in bitcoin in the U.S. are subject to extensive record keeping and reporting, no matter how small. Here is a primer on the main takeaways from IRS Notice 2014-21 for U.S. bitcoin users.
3. More than One Type of Bitcoin
To be more specific, bitcoin is a cryptocurrency. This means that bitcoin is a medium of exchange designed around certain cryptography processes. Created in 2009, bitcoin became the very first cryptocurrency but it is no longer the only one. As of July 2014, there are over 440 different types of cryptocurrencies, ranging from Aegis to Zimstake. While some coins have funny names, such as Dogecoin and Cloakcoin, their market capitalizations are no laughing matter (over $18.1 million and $7.7 million respectively). Before signing anything, make sure to understand the ins and outs of how your target cryptocurrency works.
4. Volatility
Bitcoin has been the target of speculators almost since its inception.This is why it is not unusual for its market value to fluctuate heavily. Remember the all time high market value of over $1,200 back in November 2013? Now in July 2014, that market value hovers around $550. And of course, that depends on the exchange that you are trying to use the trade your coins. It goes without saying that appropriate hedging and risk management clauses are necessary whenever dealing with bitcoin.
5. Liquidity
To make matters more complicated, you need to account on how fast you can convert your coins to actual dollars. Each cryptocurrency sets different rules on how fast transactions are processed. For example, a bitcoin transaction is idityprocessed in 10 minutes versus 2.5 minutes for a litecoin one. Additionally, every cryptocurrency exchange determines its own rules on how to process transactions and what fees are applicable. Finally, even the biggest bitcoin exchanges have fallen prey of hackers or financial regulators, meaning that your hard earned coins may be stolen by cybercriminals or frozen by law enforcers.
Takeaway
From home purchases to pizza orders, there are several thousands bitcoin transactions happening every day. Before entering in a contractual relationship in bitcoin make sure to do your due diligence. This includes determining the legality of bitcoin, the tax treatment in the applicable jurisdiction, the type of cryptocurrency to be used in the transaction, and the volatility and liquidity for the monies to be used and exchanged.
