Bitcoin, Ethereum, Monero—these are just a few names of the more than 1,000 types of cryptocurrencies in existence today. But what is cryptocurrency? Is it just a lot of hype? Or does it really represent the beginning of the end of paper money? As experts in financial planning and accounting we wanted to tell you what cryptocurrency is and where it might be headed in the future.

What is cryptocurrency?

As we mentioned earlier, there are more than 1,000 types of cryptocurrency currently circulating. For the purposes of this blog, and the sake of simplicity, we’ll be talking about bitcoin, by far the most widely-used form of cryptocurrency and the most well-known—due to its surging value making headlines in recent months.

Bitcoin, like all cryptocurrencies, relies on a technology called blockchain (more on that later) that makes financial transactions so secure that experts consider them to be virtually unhackable. Cryptocurrency isn’t managed by a single entity like a government or bank, so it sidesteps a lot of regulations. Rather, individuals called miners act as the engine that makes bitcoin run.

So, what is a miner?

A “miner” is a third-party individual who verifies bitcoin transactions. For example, let’s say Eric buys a TV from Nicole with bitcoin. A miner needs to verify the transaction to ensure the bitcoin is genuine and allow the transaction to go through.

Here’s how that happens. That transaction between Eric and Nicole is grouped with other bitcoin transactions into what is called a “blockchain”. Think of the blockchain as a virtual safe with an impenetrable padlock. In this case the padlock is a complex mathematical equation.

Miners all over the world use special software to try and solve the equation. Once it is solved, the box pops open and all of the transactions inside are verified. It can take up to 2 billion attempts to find a solution.

Why would a miner go through all of that trouble just to verify transactions for other people? Well, that miner gets a reward of 12.5 newly generated bitcoins for every transaction verified. The inventor of bitcoin engineered the software this way to incentivize miners and maintain a steady infusion of bitcoin into the virtual economy.

Will bitcoin be our future?

Bitcoin was created to work outside national currencies, which is attractive to people who don’t trust central banks. However, the technology is so secure and cost effective, that banks and governments are already looking into cryptocurrencies. In fact, bitcoin and other means of exchange have become popular in Zimbabwe and Venezuela because those transactions are more stable than the hyper-inflated national currency.

Some believe that bitcoin is too riddled with problems to be the currency of the future. First, it can only make seven transactions per second. By way of comparison, VISA can handle 65,000 transactions per second. Bitcoin also provides a lot of privacy, which means it’s often used for illegal purposes.

But most experts agree that a national banking system that involves blockchain technology is almost guaranteed. Will it be bitcoin or something else? That remains to be seen.

Here’s one thing we can be sure of—whether it’s virtual currency or physical currency, you’re going to be taxed. This tax season, contact the financial experts at Tobin & Collins. For more than 50 years, Tobin & Collins has provided certified public accounting services to clients in the New Jersey and New York metropolitan area. Our exceptional team of professionals provides personal service and sound financial strategies to put our clients on the path to future success.