Bitcoin – the way to the future or the path to financial ruin?

Bitcoin, hailed in some quarters as the future of currency, is having a rough week, with a flurry of rumours that China is to shut down its exchanges and the head of a major US bank calling bitcoin ‘a fraud’.

Plummeting prices have again raised questions about the wisdom of owning it, if not its legitimacy. The digital, or crypto, currency tumbled 15 per cent on Thursday to about $3,300 against the dollar. Bitcoin, which has had bouts of volatility in the past, has shed about a third of its value since 1 September but it is still up about $600 compared with this time last year.

Bitcoin is a digital currency created and exchanged without the involvement of banks or governments. Transactions allow anonymity, which has made it popular with people who want to keep their financial activities, and their identities, private. The digital coins are created by so-called ‘miners’, who operate computer farms that verify other users’ transactions by solving complex mathematical puzzles. These miners receive bitcoin in exchange. Bitcoin can be converted to cash when deposited into accounts at prices set in online trading.

A look at Bitcoin’s recent data suggests that this is not necessarily the digital currency’s swansong. In mid-July the value of bitcoin was around $1,900 per dollar, dropping from nearly $2,500 at the end of June. Users forced a change in the computer code, which was designed to improve capacity on the increasingly clogged network. The manoeuvre worked, helping to avoid a split in bitcoin and driving the value up to roughly $2,800 by the end of July.

Bitcoin’s value has fluctuated since then. At the beginning of August, it stood at about $2,710 and shot up to more than $4,700 by the month’s end. But there has been a steady decline this month, with the value slipping to approximately $3,300 on Thursday, according to Blockchain.info.

This week, one of China’s biggest bitcoin exchanges announced that it will cease trading following reports that Beijing is to order all Chinese exchanges to close. And on Tuesday, JPMorgan Chase CEO Jamie Dimon called bitcoin a fraud, saying that if any of his traders were dealing in the currency, he would fire them. Bitcoin tumbled six per cent between Tuesday and Wednesday.

How are sovereign nations dealing with bitcoin? In the US, the IRS has issued guidelines on the currency, calling it an ‘intangible asset’ subject to taxation. But in the end, cash talks.

According to IRS guidance: “Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as 'convertible' virtual currency. Bitcoin is one example of a convertible virtual currency: it can be digitally traded between users and can be purchased for, or exchanged into, US dollars, Euros, and other real or virtual currencies."

And it is an asset being hotly pursued by US intelligence agencies which – in some instatnces – see bitcoin as a funding vehicle for groups or individuals that intend to do harm.

China’s Central Bank has yet to respond to questions about bitcoin’s future. However, in the past it has warned that the digital currency is being traded without regulatory oversight and might be linked to fraud and last week, the bank banned initial offerings of new digital currencies.

Following the failure of a bitcoin exchange in Japan called Mt Gox, that country has enacted new laws to regulate bitcoins and other cryptocurrencies. Mt Gox shut down in February 2014, saying it had lost about 850,000 bitcoins, possibly to hackers.

The Japanese government has also spelled out regulations to help prevent the misuse of bitcoins and other virtual currencies for terrorism or other illegal activities, and is now requiring banks and other businesses to verify identities, keep records and report suspicious transactions. The regulations implemented in April require virtual currency traders to keep customers’ assets separate from their own, partly because of the losses suffered in the Mt Gox bankruptcy.