A quick lesson on blockchain for accountants: Part 2 – mining cryptocurrency
In Part 1 two weeks ago, I wrote about currency. Here, I’ll explain how “miners” help a cryptocurrency like bitcoin be useable.
To be honest, I had no idea until recently what bitcoin mining actually means – and remember bitcoin is just one cryptocurrency, but I will use it here as an example.
Some weeks ago, I visited a friend of mine who owns and runs a technology maintenance firm. His office is always full of various parts of computers, but on this visit I noticed the office was quite warm and there was a hum of computer fans. So, I stuck my head around a corner and I seen something like what is in the picture above. So, joking I said, “what are you at now, mining bitcoin?”. “Yep” was the reply. So I took the opportunity to lean on my friend for some explanations.
The bottom line for me as an accountant, is that a “bit-coin mining rig” like that in the photo costs about €3,000 and can earn about €500 per month before energy costs – I will come back to these costs in a later post. So what the hell is it and what does it do I hear you ask? In my previous post, I established that bitcoin is not really a currency (yet) in the sense of dollars, euro or pounds. It also does not have a central bank behind it, or commercial banks taking it on board as a major currency. So this creates a problem, which in essence is if I want to pay you one bitcoin, how is this to be done – and remember bitcoin is an electronic medium, there are no paper notes.
Well, if I were to pay for a coffee with my credit/debit card, there is an extensive payments processing system behind the payment – think of the credit card machine, Visa/Mastercard/Amex systems and ultimately the retailer’s bank. Also, you may know that for every card transaction, the retailer is charged by the bank so they never get the full value of a card sale. For a bitcoin payment, where is the system? This is where the “miners” come in. A miner is someone who essentially processes bitcoin payments. My friend mentioned above told me the steps roughly are as follows:
- you get a rig (like the picture above). The faster the better, so rigs tend to use the fastest available memory cards – think about the graphics in a gaming console – these use really fast memory.
- Join a mining community
- Start solving hashes (encryption puzzles)- that is, process and verify bitcoin transactions. This includes working with blockchain, which will be explained in an upcoming post.
- Get a commission for each transaction
- Transfer the commission to a bitcoin wallet – for example, the Coinbase app
- Transfer to your bank account as you see fit.
So, in essence, a bitcoin miner like my friend is taking the place of the commercial banks and/or credit companies and processing payments. It is basically a form of distributed computing.
So from an accounting perspective what does this mean? Well, not very much actually. But, and this is a big but, would/could we trust people like my friend to effectively become a banking system. Personally, I am not sure. We have decades of regulation around our banking systems, and even with all the oversight, it still fails from time to time. The counter-argument could be something like the redundancy of systems or devolvement of the now rather central power of the banking and finance systems. But I’m not so sure just yet.
My next post will explain the basics of encryption.
Blockchain for accountants/accounting
I hope to write a few posts on this topic in the coming weeks, as we hear so much about blockchain and bitcoin and how it affects accounting/accountants. Before I do, this article in a great primer. For example, it relays the fact that bitcoin (for now) is an asset not a currency in accounting terms. Have a read, more to come soon.
You may have heard of bitcoin, the online “currency” causing quite a stir in recent times. Unlike many other online payment systems, bitcoin is outside the normal banking and currency systems – see more here about its history etc.
Being outside the normal banking and currency systems means the value of a bitcoin is difficult to determine. And, without going into too much detail here, speculators have caused the value of bitcoin to rise.
So now for the tax bit. An article from the Wall Street Journal last December noted some difficulties the IRS (and other tax authorities I’m sure) are facing. First, is a holding of bitcoin an asset which might be subject to capital gains taxes? It may be, but the first thing one needs to value an asset is a value ideally based on a market or cost basis. This might be tricky with bitcoin, given that it is not a real currency and the market is unregulated. Second, could gains or losses be treated as income? This is probably workable, as a gain or loss could be recorded on sale of bitcoins. But normally, marginal income taxes are higher than capital taxes. This would be fine for the tax authority I am sure, but holders of bitcoins might argue for the asset option – and so might their tax advisors. Only time will tell which option will be used.