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Mining for B i tco ins

© 2014 4imprint, Inc. All rights reserved

In 2010, a programmer in Jacksonville, Fla., convinced a pizza shop to give him

two piping-hot pizzas worth $30 for the 10,000 bitcoins he had “mined” on his

computer. This is the fabled first-ever bitcoin transaction.1 Today, those bitcoins

are worth about $3.6 million, but at one point they were worth $6 million.

Welcome to the wild, wild world of Bitcoin.

This headline-grabbing, digital currency promises consumers total control

over their money and low fees for businesses. But it polarizes supporters and

detractors. Fans believe it allows people to buy anything without interference

from third parties, such as banks. Detractors, on the other hand, think Bitcoin is a

house of cards that will collapse as soon as people realize that zeros and ones on

a computer have no value.

The reality may be somewhere in between. Bitcoin is unlikely to upend the

world’s financial networks2, but it is having an impact, as companies look to adopt

it and consumers seek opportunities to spend it. For companies, Bitcoin provides:

• Reliable payments designed not to be reversible or fraudulent;

• Low (less than 1 percent) or no fees—the

customer pays for the transaction; and

•Quick transfers.

Bitcoin’s security is based on well-understood

cryptography used by the U.S. Government3.

Its algorithms are as trustworthy as credit card

transactions or any type of electronic bank

transfer. So people who doubt the security of its transactions should have similar

doubts about the security of any credit card transaction.

The system protects against fraud by ensuring the whole network sees the

transactions that have happened and that bitcoins have moved. This is like the

serial numbers being scanned every time money is spent, making it possible

to trace money as it moves around, making it almost impossible to introduce

counterfeit money.4

And accepting bitcoins can be as easy as downloading an app onto a computer or

phone that provides a bitcoin wallet that will take care of pretty much everything,

1 Bilton, Nick. “Disruptions: Betting on a Coin With No Realm.” Bits.blogs.nytimes.com/. The New York Times Company, 22 Dec. 2013. Web. 10 Oct. 2014. <http://bits.blogs.nytimes.com/2013/12/22/disruptions-betting-on-bitcoin/?_php=true&_type=blogs&_r=0>.

2 Pagliery, Jose. Bitcoin and the Future of Money. Chicago: Triumph LLC, 2014. Print.3 “Myths.” En.bitcoin.it. Bitcoin Project, 20 Sept. 2014. Web. 10 Oct. 2014. <https://en.bitcoin.it/wiki/Myths>.4 Hill, Kashmir. “21 Things I Learned About Bitcoin From Living On It For A Week.” Forbes.com. Forbes, 9 May

2013. Web. 13 Oct. 2014. <http://www.forbes.com/sites/kashmirhill/2013/05/09/25-things-i-learned-about-bitcoin-from-living-on-it-for-a-week/>.

© 2014 4imprint, Inc. All rights reserved

including requesting and confirming payments, as well as converting bitcoins into

dollars straight away.

Customers are using bitcoins, too, but the numbers are small. For example, about

three customers a day are using bitcoins to pay for their sandwiches at a Subway®

location in Allentown, Pa.5 And in its first week accepting bitcoins, CheapAir.com®

made sales worth $6,8006. Reno, Nev., barber Josh Arias7 also accepts bitcoins and

would like to see customers adopting it as he does not have to pay the merchant

fees incurred when customers swipe their credit cards.

Before we go any further, let’s just say it: Bitcoin is weird. This is

a payment network based on an “imaginary” currency. And most

people when they first hear about Bitcoin say the same thing:

“No, this cannot possibly work.” But to-date, it is defying the

doubters, which is why we should all be paying attention to the

rise of crypto-currencies.

So, how does it work? Put simply, Bitcoin is electronic money—nothing more than

bits in a computer or smartphone. First, let’s just say that electronic money is not

money stored electronically. Whereas services like Google Wallet® stores credit

cards, debit cards and loyalty cards. Bitcoin is different. It reimagines what money

is. Anyone can receive it—and spend it—by simply transferring bitcoins between

one another. Bitcoin is really more like cash than credit cards. Like cash, people

either have bitcoins or they don’t. And if they have bitcoins, they are handed over

to the business there and then, without any third-party involvement. There is no

bank or other middle man.

The Bitcoin network is a bit like a BitTorrent® peer-to-peer network8, which

is created when two or more computers connect and share resources directly,

without going through a separate server computer. These networks are best

known for helping people share such files as films, games and music over the

Internet. In Bitcoin’s case, however, instead of music or movies, the computers

share a digital ledger, or a transaction database known as a blockchain, with

every computer on the network. And this ledger is automatically updated

anytime someone spends bitcoins. This ledger contains details of every single

bitcoin transaction there has ever been. This provides Bitcoin’s transparency. Every

transaction is visible to everyone in the network. Now before we get bogged

5 “8 Things You Can Buy with Bitcoins Right Now.” Money.cnn.com/. CNN Money, n.d. Web. 3 Oct. 2014. <http://money.cnn.com/gallery/technology/2013/11/25/buy-with-bitcoin/>.

6 “8 Things You Can Buy with Bitcoins Right Now.” Money.cnn.com/. CNN Money, n.d. Web. 3 Oct. 2014. <http://money.cnn.com/gallery/technology/2013/11/25/buy-with-bitcoin/>.

7 “8 Things You Can Buy with Bitcoins Right Now.” Money.cnn.com/. CNN Money, n.d. Web. 3 Oct. 2014. <http://money.cnn.com/gallery/technology/2013/11/25/buy-with-bitcoin/>.

8 Pagliery, Jose. Bitcoin and the Future of Money. Chicago: Triumph LLC, 2014. Print.

© 2014 4imprint, Inc. All rights reserved

down in privacy concerns, let’s just say that transactions appear as strings of

numbers and letters that are not associated with anyone’s real-world identity.

The transactions in this ledger are not confirmed by banks or any other third

party. They are confirmed using complex math problems, or algorithms. Bitcoin

users are trusting math, not people, to verify transactions. Whoever solves these

problems, through a process known as mining, verifies the bitcoin network’s

transactions and wins new bitcoins for their trouble. So, people literally are

mining for bitcoins. And it is the limited supply of this currency combined with

the high demand for it that is the secret of its value9, and indeed the value of

more traditional currencies. So, who is using this currency? In the U.S., the typical

user is a tech-savvy male, aged 25 to 40, earning above-average income, and

usually living on one of the coasts.10

In this Blue Paper, we will discuss the history of Bitcoin, how it works, its pros and

cons, and how companies can start accepting this digital currency. We will also run

through how transactions work, and the tax implications of accepting bitcoins.

The history of Bitcoin

Let’s start at the beginning, which was Friday,

October 31, 2008—Halloween, appropriately

enough. On that day, the mysterious Satoshi

Nakamoto posted a message on the cypherpunks

mailing list entitled “Bitcoin P2P e-cash paper.”11

His—hers, or their, no one knows—message was

simple: “I’ve been working on a new electronic

cash system that’s fully peer-to-peer, with no trusted third party.” And his initial

paper is still available online, but be warned, it’s not an easy read.

He argued: “What is needed is an electronic payment system based on

cryptographic proof instead of trust, allowing any two willing parties to transact

directly with each other without the need for a trusted third party.” Cryptography

involves the enciphering and deciphering of messages in secret code, or cipher.

Nakamoto wanted to create a math-based currency whose value couldn’t be

“watered down” by a central authority, like the Federal Reserve.

9 McMillan, Robert, and Cade Metz. “Bitcoin Survival Guide: Everything You Need to Know About the Future of Money.” Wired.com. Condé Nast, 25 Nov. 2013. Web. 18 Sept. 2014. <http://www.wired.com/2013/11/bitcoin-survival-guide/all/>.

10 Brennan, Morgan. “Why More Businesses May Adopt Bitcoin.” Usatoday.com. CNBC, 12 Jan. 2014. Web. 10 Oct. 2014. <http://www.usatoday.com/story/money/personalfinance/2014/01/12/cnbc-bitcoin-business/4393905/>.

11 Pagliery, Jose. Bitcoin and the Future of Money. Chicago: Triumph LLC, 2014. Print.

© 2014 4imprint, Inc. All rights reserved

But the concept of a “crypto-currency” predates Nakamoto and was actually first

described in 1998 by Wei Dai on the cypherpunks mailing list.12 He suggested

a new form of money could use cryptography to control its creation and

transactions, rather than a central authority.

But it wasn’t until after Nakamoto’s paper that the first crypto-currency came into

being. And when Nakamoto left the project quietly in late-2010, without his/her

identity ever being revealed, the Bitcoin community had taken up the challenge

to create a new currency and since then, it has grown exponentially.

To appreciate why people would take up Nakamoto’s challenge and help establish

a digital currency, it is a good idea to look at the cypherpunk community.

Nakamoto launched his idea on a mailing list for this community. Cypherpunks

advocate using cryptography to drive social and political change and put a lot of

store on privacy and personal liberties. They were attracted to Nakamoto’s idea

that a network capable of processing tens of millions of transactions each day

without the need to work through financial institutions would make it easier for

people to make small, casual payments

to one another. So, it was politics that

got Bitcoin up and running. However,

the Bitcoin community has broadened

beyond cypherpunks. It now speaks to

a wider audience that sees its potential

for reducing the costs and friction

of global e-commerce and other

commercial transactions.13

Nakamoto’s idea was for a digital currency that would reside on a network

of computers. This network would support a system that verifies transactions

and “mines” for new bitcoins, delivering new bitcoins at a steady rate, to help

manage inflation.14 Bitcoins cannot be inflated by “printing” new money above

and beyond the expected issuance rate. The name of the new system would

be Bitcoin, with a capital “B”; a lowercase “b” would be used for the units of

currency, bitcoins.

Here’s where bitcoins get even weirder: the truth is they don’t exist, not even on

a hard drive. So, while all the talk is of bitcoins, you cannot point to an account,

like a bank account with dollars, that actually contains bitcoins. Instead, what you

see in a bitcoin account, or address, are records of transactions between different

addresses, with balances that increase and decrease. We will further explain

12 Pagliery, Jose. Bitcoin and the Future of Money. Chicago: Triumph LLC, 2014. Print.13 “Myths.” En.bitcoin.it. Bitcoin Project, 20 Sept. 2014. Web. 10 Oct. 2014. <https://en.bitcoin.it/wiki/Myths>.14 Pagliery, Jose. Bitcoin and the Future of Money. Chicago: Triumph LLC, 2014. Print.

© 2014 4imprint, Inc. All rights reserved

transactions a little later, but here’s a brief overview. Transactions comprise:15

• An input—this is the bitcoin address, or account, that sent the bitcoins to the

account holder that is now looking to spend them. This provides evidence

that the bitcoin holder has the right to spend them.

• An amount—this simply describes the amount of bitcoins that are being

spent.

• An output—this is the address to which the bitcoins are now being sent. The

recipient will then have the right to spend these bitcoins.

Every transaction that takes place is stored in the ledger, or block chain.

Ok, let’s return to talking about bitcoins as if they were real. Only a few bitcoins

were made available initially. But the system was designed to slowly expand the

currency to produce a total of 21 million bitcoins—no more, no less. This number

was completely random; it has no secret meaning. But that has not stopped a

lot of speculation. It is worth noting that while the number of bitcoins is set at

21 million, it is possible to divide each bitcoin into 100 million pieces, known as

satoshis, after the anonymous Bitcoin founder. So the total number of currency

units there will ever be is 2,100,000,000,000,000. Bear in mind that Bitcoin was

viewed as an alternative way for people to make small payments to one another.

It was never viewed as a replacement for existing systems, so a finite marketplace

is not a major stumbling block for Bitcoin. But if you still think there may be more

to this number, Bitcoin Magazine™ does a great job analyzing it.

Nakamoto estimated that the amount of bitcoins produced would fall by half

every four years—10.5 million by 2013, another 5.25 million by 2018, and 2.625

million by 2023, and so on until the last bitcoin is mined some time around 2140,

if the currency survives that long. As of October 2014,

there were 13.38 million bitcoins in circulation, valued

at around $5.06 billion, but the market is volatile.

So, where is the value in these non-existing currencies?

Bitcoin is designed so people can subjectively value the currency, which is

happening because individuals are freely exchanging products and services for

bitcoins. It’s also possible to think about the value of the network, like a phone

network, rather than of individual bitcoins.16 Phones only have value because

they are connected to a network. Without a network, phones are useless.

Bitcoins are similar—their value comes from the global network of merchants,

exchanges, wallets, etc., that accept them as a currency. Just like the phone is

needed to transmit voice, text and multimedia messages, bitcoins are needed to

15 “How Do Bitcoin Transactions Work?” Coindesk.com. CoinDesk, 6 Mar. 2014. Web. 10 Oct. 2014. <http://www.coindesk.com/information/how-do-bitcoin-transactions-work/>.

16 “Myths.” En.bitcoin.it. Bitcoin Project, 20 Sept. 2014. Web. 10 Oct. 2014. <https://en.bitcoin.it/wiki/Myths>.

© 2014 4imprint, Inc. All rights reserved

transmit economic information through the network. Ultimately, though, the

value is determined by supply and demand—what people are prepared to give in

exchange for bitcoins.

And the number of businesses prepared to trade for bitcoins is growing.

According to Bitcoin Pulse, there are more than 5,500 businesses now accepting

bitcoins and that number is growing at around 5.14 percent per month:

The number of businesses accepting bitcoins is growing at about 5.14 percent.17

The Bitcoin ledger

OK, so let’s start with getting our heads around Bitcoin. Deep down in the pit of

the mine, at its core, Bitcoin is a digital file with a list of accounts and balances.

Think of it as a typical business ledger, called a “blockchain” in the Bitcoin world.

A copy of this ledger is stored on every computer in the Bitcoin network. When

someone spends bitcoins, the transaction is broadcast across the network, so every

copy of the ledger is updated, indicating which account is going down and by

how much and which account now has a higher value. Computers update their

copy of the ledger and pass along the transaction to other computers, which

then pass it on, until every copy of the ledger has been updated. At the end of

the day, just like business ledgers, the Bitcoin ledger has to reconcile to zero.

This and some math-based security is all there really is to Bitcoin: A system that

lets a network of computers maintain a ledger and in doing so lets people spend

electronic cash.

The beauty of the “ledger” is that it means for the first time two parties can

exchange value online without a third-party intermediary, such as MasterCard®,

PayPal® or Visa®, who maintain the ledger in traditional online transactions18. This

third-party was needed because online transactions involve exchanging digital

17 “Bitcoin Pluse.” Bitcoinpulse.com/. Bitcoin Pulse, n.d. Web. 13 Oct. 2014. <http://www.bitcoinpulse.com/>.18 “Everything You Need to Know About Bitcoin: VICE Podcast 027.” Youtube.com. Vice Media Inc., 9 Jan. 2014.

Web. 1 Oct. 2014. <https://www.youtube.com/watch?v=SNssKmeXrGs>.

The increasing acceptance of bitcoinsCategory Source Metric

Weekly Avg. Growth Last

30 Days

Monthly Avg. Growth Last

180 DaysAbsolute

Consumer BlockchainMy Wallet

Number of Users0% 7.53% 2,331,810

Consumer Coinbase Num Wallets 0% 7.52% 1,700,000

Merchants Coinmap Num Venues 0% 5.14% 5,544

Merchants CointerestNum Bitcoin

Venues0.72% 6.67% 6,248

Technical GithubNum Created Repositories

1.14% 4.49% 4,395

© 2014 4imprint, Inc. All rights reserved

files, which are pretty much like Word® documents or image files. Copies of these

files remain on the sender’s computer when he or she sends them to someone

else. There is nothing to stop the sender from sending the file to someone else.

The same would apply with spending money using digital files. This is why third-

parties have been needed: to ensure the same money is not spent more than

once19. This is known as the double-spending problem—successfully spending

the same money more than once—and this is what Bitcoin’s math solves with its

ledger.

Bitcoin mining

Bitcoin has come up with an ingenious way of verifying transactions using the

crowd, basically users. The process is called mining. Now, this mining doesn’t

involve any hard hats, head lamps or long periods underground chipping away at

rock or dirt. But like mining, it requires expertise in knowing where the valuable

seam of gold is and what specialist tools are required to get access to that seam

in a profitable way. With mining for gold, there was a time when panhandlers

could get rich quick in a gold rush. But now, the major conglomerates dominate

the mining businesses. Bitcoin has a similar story. There was a time when anyone

could use their home computers to mine for bitcoins. But now the competition

has become so tough that there are large businesses with rooms full of specialized

machines that exclusively mine for bitcoins.

Think of something like a giant crossword puzzle or game of Sudoku® when you

consider bitcoin mining. And instead of miners chipping

away at rock think of complex computers computing

away with one thing in mind: solving that puzzle or

game. This explains why even though receiving a payment

is almost instant with Bitcoin, there is a 10-minute delay

on average before the network confirms the transaction.

This delay is needed to solve the puzzle, let every miner

know the puzzle has been solved and update every copy

of the ledger with the new solution. A confirmation

means there is a network consensus that the bitcoins

you have received have not been sent to anyone else and are considered your

property.20 Mining is Bitcoin’s clearing house, but it uses complex algorithms, or

math, rather than a bank, to balance accounts. Everything depends on math. And

that is why complete strangers are prepared to trust bitcoins—the math means

they don’t have to trust people.

19 “Everything You Need to Know About Bitcoin: VICE Podcast 027.” Youtube.com. Vice Media Inc., 9 Jan. 2014. Web. 1 Oct. 2014. <https://www.youtube.com/watch?v=SNssKmeXrGs>.

20 Pagliery, Jose. Bitcoin and the Future of Money. Chicago: Triumph LLC, 2014. Print.

© 2014 4imprint, Inc. All rights reserved

To ensure puzzles are solved on time—every 10 minutes or so—Bitcoin does

something really simple, in theory, not in practice: it adjusts the difficulty of the

puzzle, making it easier or harder as required. Ok, so why every 10 minutes? This

number is actually a compromise between the first confirmation time and the

amount of work wasted by miners who were not the first to solve the puzzle21.

After a block is mined, it takes time for the losing miners to learn about it. And

until they do, they are still competing to solve the problem. So, 10 minutes

helps get the word out that the problem has been solved and the miners should

stop what they are doing on that puzzle and should update their copy of the

ledger. It was also felt that shortening the confirm time,

to say five minutes, would not provide that great a

benefit to companies accepting bitcoins. Weighing the

needs of miners and companies using bitcoins led to a

compromise number of 10 minutes to verify transactions.

As for changing the difficulty of the problem: If you were

chipping away at rock down a mine, it’s like someone

giving you a pick axe or a jackhammer depending on how

fast they want you to work. In reality, what this means is

that there is a sort of mining gold rush, with ever more

computing power needed to solve bitcoin formulas.22

So mining verifies transactions. But it has another role: introducing new bitcoins.

The first miners to solve the puzzle are rewarded with new bitcoins—25 bitcoins,

or about $8,640—but that number will fall over time as the system works to

control the number of bitcoins on the market. That is where the motivation

comes from for miners to monitor transactions on the site. When production stops

after 21 million bitcoins hit the market, miners will most likely be supported by

small transaction fees23.

Bitcoin benef i ts

That’s pretty much how Bitcoin works, but what benefits can companies expect

for adopting this crypto-currency.

• Easy payments—Users can send and receive any amount of money instantly,

anywhere in the world at any time.

• Low fees—Bitcoin payments involve little or no fees today. But users

can include fees to have transactions confirmed faster than the standard

10 minutes.

21 “Bitcoin: Frequently Asked Questions.” Bitcoin.org. Bitcoin Project, n.d. Web. 3 Oct. 2014. <https://bitcoin.org/en/faq>.

22 Popper, Nathaniel. “Dealbook: Into the Bitcoin Mines.” Http://dealbook.nytimes.com/. The New York Times Company, 21 Dec. 2013. Web. 3 Oct. 2014. <http://dealbook.nytimes.com/2013/12/21/into-the-bitcoin-mines/>.

23 “Bitcoin: Frequently Asked Questions.” Bitcoin.org. Bitcoin Project, n.d. Web. 3 Oct. 2014. <https://bitcoin.org/en/faq>.

© 2014 4imprint, Inc. All rights reserved

• Secure transactions—Bitcoin transactions are secure, irreversible, and do not

require personal details.

• No need for PCI compliance—This is the security standard for processing

credit card transactions on the Web.

• New markets—Businesses can enter new markets where credit cards may not

be available. This can help keep fees and administrative costs lower.

• No need to join a credit card merchant network—Businesses can simply

download an app and start accepting bitcoins.

• Identity protection—Payments can be made without personal information

tied to the transaction, providing protection against identity theft.

• Transparency—All bitcoin transactions are visible to everyone in the

network.

• Easy to get started—Businesses can get started by downloading an app that

will accept payments and convert bitcoins into dollars immediately.

How to get started

Companies still interested in exploring Bitcoin now have a decision to make:

How much control do they want? Most businesses will just want to accept bitcoin

payments and have them converted into dollars straight away. But let’s quickly

review the options:

Full client

Companies that want to handle Bitcoin

transactions on their own, with no help, can opt

for a full client service. This stores the bitcoin

ledger, manages wallets and conducts transactions

directly on the bitcoin network. Think of a

standalone email server in a cool corner office.

Lightweight client

This is a middle option. The client stores the wallet but relies on third-parties to

access the bitcoin transactions and network. This is similar to an email client that

connects to a mail server for access to a mailbox, such as Microsoft Outlook®, in

that it relies on a third party for interactions with the network.

Web client

This is like Gmail®. The client is accessed through a Web browser and stores the

wallet on a server owned by a third party.

The reality is that for most companies and consumers, Bitcoin will rarely be more

than a mobile app or computer program that provides a personal Bitcoin wallet

© 2014 4imprint, Inc. All rights reserved

that allows users to send and receive bitcoins.

Let’s run how this would work in practice with a Bitcoin newbie, Alice.

The first thing Alice needs to do is to get a wallet from a hosted service, such as

blockchain.info®. Alice could also access bitcoin apps through the iPhone® and

AndroidSM App Stores. The wallet’s software holds the addresses and manages the

keys that are needed to complete bitcoin transactions.

Bitcoin wallet makes it easy to send and receive bitcoins.

Bitcoin wal let

Addresses are critical for transactions. Like an email address, Alice can share

her address and anyone can use it to send her bitcoins. A Bitcoin address looks

something like this: 1Cdif9KGAaasrcxBaBttQcwXMOpvM9t7FK. But a QR-code,

containing these address details is also usually available on the digital wallet.

It is also possible to create a new address for every transaction. This provides

transparency about every transaction.

Once Alice has set up a wallet she faces the challenge of getting her first bitcoins.

There are exchanges that buy and sell bitcoins for local currencies: Bitstamp, for

example. But it can take a number of days to set up these accounts as they require

various forms of identification. Other ways Alice may get her first bitcoins are:

•From a friend who has some

• From local services that sell bitcoins for cash, which can be found at

localbitcoins.com

•Selling something for bitcoins

But let’s assume a friend, Bob, is giving Alice some bitcoins. Bob opens his Bitcoin

© 2014 4imprint, Inc. All rights reserved

digital wallet, selects “send coins,” and provides the destination address, Alice’s,

and how much he wants to deliver. Bob can type in the destination address

or scan the QR code with the address information on Alice’s phone. Now, the

transaction will initially appear in Alice’s wallet as “Unconfirmed”, as it still

needs to be confirmed by a miner. Once that has happened, Alice is free to spend

the money.

So, let’s say Alice decides to buy lunch in a café that accepts bitcoins. The

prices at the café are listed in dollars and bitcoin. The café could have point-

of-sale hardware, such as CoinKite’s bitcoin terminals, to automatically convert

the price into bitcoins at the market rate and display a QR code containing

a payment request. Alice can now use her phone to scan the barcode, which

will show the payment request in her bitcoin wallet. She then just needs to hit

send to authorize the payment. Finally, in about the same time as a credit card

authorization, the transaction will be visible on the register. And that’s it, the

transaction is complete.

Coinbase24 uses QR codes to make payment simple in its mobile app

How a transaction works using the Coinbase® digital app to create QR codes:

1. The merchant enters details of the sale

2. The merchant taps “Request payment” to display the QR code

3. The customer scans the QR code with her phone and taps to pay

4. Both parties receive payment confirmation—sale complete!

So, for businesses, there really isn’t a lot of difference between accepting bitcoins

and accepting credit cards. But there is a lot going on behind the scene.

24 “Point of Sale.” Coinbase.com. Coinbase, n.d. Web. 28 Oct. 2014.

© 2014 4imprint, Inc. All rights reserved

Bitcoin pr ivacy

Bob and Alice’s identities are never revealed in the Bitcoin ecosystem—they are

completely anonymous. They are known under pseudonyms called public keys.

These keys are generated using addresses and private keys known only to the

owner. Public keys are a string of letters and numbers that do not need to have

any relationship to Bob and Alice’s real world identities. Anyone who knows the

address can deposit bitcoins into it. It’s as simple as Bob hitting the send button.

But only those with the right permissions can move bitcoins out of an account.

This means access to the private key, another series of letters and numbers. So, the

final step for Bob and Alice is for Bob to use his private

key to confirm he has the right to send bitcoins from his

wallet to Alice’s. And that is why it is so important to

keep the private key safe. Anyone with access to it can

move funds. This is one of the weaknesses of the Web-

based services that most people use when using bitcoins.

These Web services store the keys and the bitcoins. If they

are compromised, hackers can access the bitcoins and

move them across the Internet in a fraction of a second.

But to summarize, to send bitcoins to a friend, you

need his or her public key, which is kind of like a routing number on a checking

account, to know where to send it and your private key to complete the deal.

But even then, miners have to do their work before the money can be spent. The

miners use the math associated with keys and addresses to check every transaction

that happens on the network. If the math does not work, the transaction is

rejected. If it works, the transaction is added to the Bitcoin ledger and every copy

of the ledger on the network is then updated.

Setting prices

Every business has some choices to make about their bitcoin prices. Many apps

will convert bitcoins into dollars automatically at the time of the transaction—

merchant services like BitcoinPay, Bit-pay, Coinbase® and Paysius will do this

automatically. Companies can also decide to do some trading in bitcoins by

not converting them into dollars and keeping the bitcoins for investment

purposes. Bitcoins can fluctuate quite a bit, so this decision really depends on

each company’s attitude to risk. You can track bitcoin exchange rates at sites like

BitcoinPrices.com.

Pretty much, every kind of business can start to accept bitcoins: brick and mortar

stores, ecommerce companies and business-to-business organizations.

© 2014 4imprint, Inc. All rights reserved

Brick and mortar stores

As with the previously mentioned café example, brick and mortar operations can

have customers pay using hardware terminals; touch screen apps, on their phones

or tablets; or simple wallet addresses through QR Codes. For example, merchants

could have a QR code, with an address embedded in a poster near a cash register.

Customers can scan this QR code with their phones and pay. Or, they can make it

easier for the customer by using a dedicated app to generate the QR code with

both the address and bill amount embedded.

Merchants can also integrate custom hardware—such as Coinkite®, XBTerminal®

and BitStraat®—with existing registers and point-of-sales solutions.

Ecommerce companies

Ecommerce websites can use a Bitcoin merchant solution, which provides payment

processing services, to accept bitcoins and have them automatically converted

to dollars. This avoids having to manage bitcoin prices based on the current

exchange rate. Ecommerce companies, and any company with a website, can also

help customers by creating a landing page that allows them to get the address to

make a Bitcoin payment by typing in the invoice number. Customers can copy and

paste an address generated by a form on the page.

BitPay25 and other services allow websites to embed bitcoin invoices into pages.

Services like BitPay also enable websites to embed bitcoin invoices into their

website using iframes, which is really just a small separate Web page inside

another Web page.

Ecommerce companies can also use plugins, or software components that add

a specific feature to an existing software application, with many shopping cart

interfaces to accept bitcoins, including Wordpress®, Shopify®, Magento®, Woo

Commerce®, and ZenCart®. And, invoices can be emailed out that include bitcoin

payment requests.

25 “Bitcoin Payment Gateway API.” Bitpay.com. BitPay, n.d. Web. 28 Oct. 2014.

© 2014 4imprint, Inc. All rights reserved

Dell26 has teamed up with Coinbase to accept bitcoins.

Buy a Dell® computer with bitcoins

Dell now accepts bitcoins as payment online. After a consumer adds an item to a

cart and chooses bitcoin as their payment option, they are sent to Coinbase.com

to complete purchases. At Coinbase, customers can choose to pay directly from

their bitcoin wallets by using the generated payment address or by scanning the

QR codes with their smartphones. They can also log in to a Coinbase account if

they have one and send payment directly. Dell says it is accepting bitcoins because

transactions “can be made easily from anywhere in the world, and offer reduced

payment processing costs.”

Businesses that mail invoices to customers

Businesses who regularly mail out invoices to clients can mention they accept

bitcoins on their invoices, near where they list other payment options, such as

Visa or MasterCard. It is a good idea to include the bitcoin price and the date by

which the bill must be paid to avail of that price—this is important as the bitcoin

exchange rate for dollars can fluctuate quite a bit. Companies should create a

new address for every invoice for transparency. Bitcoin addresses are cumbersome

to type, as they comprise a mix of uppercase and lowercase letters, but should still

include them in the invoice, as it helps provide a paper trail. And the customer

can also prove payment through the Bitcoin Block Explorer®, which keeps a record

of every payment. Using each address just once removes any ambiguity for clients

about who is making the payment.

Paying taxes on Bitcoin income

Tax compliance is a topic of concern for small businesses. But in many respects,

Bitcoin transactions work very much like cash. According to the IRS, taxpayers

who receive bitcoins as payment for goods or services must, “in computing gross

26 “Dell Now Accepts Bitcoin.” Dell.com. Dell, n.d. Web. 28 Oct. 2014.

© 2014 4imprint, Inc. All rights reserved

income, include the fair market value of the virtual currency, measured in U.S.

dollars, as of the date that the virtual currency was received.27”

The downside of bitcoins

There are a number of disadvantages beyond the

deflationary issue and threat of losing all bitcoins in

the way you can lose cash:28

• Deflationary currency—as the number of

bitcoins will max out at 21 million, the value

of coins will rise after the limit is reached. This

creates an incentive for holding on to coins

until they rise in value rather than spending

them today. This can put downward pressure

on product prices to create an incentive to

spend. This is one of the main criticisms of the theory behind Bitcoin: It

encourages people to not spend money.

• The level of acceptance—while more businesses are accepting bitcoins, the

level of market acceptance is low and has to grow to benefit from network

effects.

• Price fluctuations—the small market size of bitcoin means that relatively

small events, trades, or business activities can significantly affect the price.

Bitcoin supporters argue that this volatility will ease when the market grows

and matures.

• Beta status—Bitcoin remains incomplete. Security developments are still in

process and most Bitcoin businesses are so new, they offer no insurance on

transactions carried out using those services. Credit card companies, on the

other hand, do offer insurance on transactions using their financial system.

• Public/private key system security—the key system for transactions is

only secure as long as the private key is kept secret. Web-based apps store

everything on a server. If that server is compromised, all the bitcoins on that

server can be lost. This is what happened with Japanese bitcoin exchange

Mt Gox—almost $500 million worth of bitcoins were taken when hackers

accessed the exchange’s server. There are two ways to store bitcoins. A hot

wallet involves storing public and private keys on a device that’s connected

to the Web, which is like walking around with all your cash in your pocket.

A cold wallet means storing everything offline, on an external drive for

example. However, if you lose your drive or it stops working—you lose your

bitcoins. It is also possible to take a hybrid approach: Storing most of your

27 Irs.gov. IRS, 25 Mar. 2014. Web. 1 Oct. 2014. <http://www.irs.gov/pub/irs-drop/n-14-21.pdf>.28 “Bitcoin: Frequently Asked Questions.” Bitcoin.org. Bitcoin Project, n.d. Web. 3 Oct. 2014. <https://bitcoin.org/en/faq>.

© 2014 4imprint, Inc. All rights reserved

4imprint serves more than 100,000 businesses with innovative promotional items throughout the United States,

Canada, United Kingdom and Ireland. Its product offerings include giveaways, business gifts, personalized gifts,

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and many other promotional items. For additional information, log on to www.4imprint.com.

bitcoins offline but moving coins to your hot wallet as you need them.

• New digital currency—it is possible that a new digital currency could

enter the marketplace and take the place of Bitcoin, reducing its value

significantly. However, Bitcoin may now be too well-established for it to be

easily replaced.

Summary

Bitcoin is a new crypto-currency that holds real benefits for business and

consumers, including more control over their money, low fees and quick transfers,

even internationally. And companies can easily start accepting bitcoins using apps

on their phones or computers or using Bitcoin merchant solutions. There are a

growing number of companies adopting this digital currency, including Subway

and Dell. And there are consumers who want to use it. But the truth is that right

now it is not a major source of new revenue. But Bitcoin may be heralding a new

way for businesses and consumers to think about money. And in the next several

years, it may develop into a niche electronic currency that serves as an alternative

to other electronic payment processing platforms, such as credit cards and PayPal.

It is easy set up, so does not take much effort to give it a try. Accepting bitcoins

may also give a company’s public relations operations a shot in the arm, as there is

a lot of local coverage for companies that adopt Bitcoin.