When the term ‘currency’ is spoken about, most people tend to only associate it with Australian bank notes and coins. However, currency can actually be classified into two different monetary systems, namely commodity money (these are objects that possess intrinsic value and value in their use as currency such as gold) and fiat money.
All bank notes and coins are normally referred to as fiat money. This means money that does not have intrinsic value and that has been issued and controlled by government and is deemed to be legal tender – in other words recognised as a suitable exchange medium when paying for good or services.
Along with coins and bank notes, information such as records of all types of card purchases and bank balances can also be classified under the definition of fiat money. This means that the method that you use to process a payment for any purchase with fiat money can be with physical cash like bank notes or coins or electronic funds such as those on your debit or credit card.
A crucial aspect with regards to electronic payments is the entire process that is required to complete a single transaction. Below is an example:
- On route to the office, you make a stop at your local café and buy coffee by swiping your debit card through the vendor’s EFTPOS device.
- The payment request is then received and actioned by your bank – provided that you have sufficient funds in your account.
- Your bank then sends a payment file through to the receiving bank, which then processes it and transfers the correct amount of money to the vendor’s bank account.
- The final result is that your purchase request is approved and yours and the vendor’s bank accounts will be adjusted accordingly to reflect the fund transfers, namely a debit in your account and a credit in the vendor’s account.
- The sending and receiving financial institutions will settle the differences in the amounts of credits and debits through the Reserve Bank of Australia at the end of the day.
Over the past few years, there has been much discussion over the options of Bitcoin, Blockchain and cryptocurrency as well. Below is a basic overview of each.
Cryptocurrency
This is an alternative type of currency that many people consider to be a type of hybrid between commodity money and fiat money. It is either digital or virtual currency that is not considered to be legal tender. However, it may be used as an exchange medium if a vendor is willing to accept in exchange for goods or services rendered.
No form of government control or issuing, or assistance from any financial institutions is required when processing any type of cryptocurrency payment. Instead, they make use of dedicated forms of encryption (such as cryptography ) to safeguard data, create and store ‘monetary units’ and verify all transactions that are within a decentralised (for instance, a peer-to-peer network) digital public ledger or blockchain.
There are currently more than 1,000 different types of cryptocurrencies out there, which have a combined market capitalisation (market cap) of more than AUD $177 billion. The term ‘market cap’ refers to the full market value of a company’s outstanding shares or monetary units where cryptocurrencies are concerned and it is calculated by multiplying the existing market price of a single share or monetary unit by the amount of outstanding monetary units or shares. Market cap is also often used to help people understand the relative size of one company compared to another.
Bitcoin
This is the first and most well known out of all the cryptocurrencies. It was created back in 2009 by an unknown group or individual called ‘Satoshi Nakamoto, along with all of the technology that underpins it – namely, blockchain.
At present, Bitcoin’s market cap is more than AUD $132 billion and it has a trading value of AUD $7,940 per monetary unit or Bitcoin. Despite its high trading value, you don’t need to purchase a full Bitcoin at any time because each of them can be divided to a predetermined amount of decimal places. Bitcoin and other cryptocurrencies can be bought and sold through several different cryptocurrency exchanges.
Blockchain
This is the technology that enables cryptocurrencies to exist. Blockchain is a digital and decentralised public ledger of all cryptocurrency transactions that are linked together as ‘blocks’ in a linear sequence. Below is a basic example of the blockchain process that is involved in cryptocurrency transactions:
- You make a request for a transaction that involves the transfer of bitcoins from your account to someone else’s as payment in exchange for goods or services rendered. This request will be initiated by mans of instructions using public keys (similar to a bank account number) and private keys (similar to an ATM PIN code). Owing to the fact that both of these keys are long combinations of letters and numbers, the identity of the initial sender remains completely anonymous.
- The transaction that has been requested is then broadcast as a block to a peer-to-peer network that consists of computers called nodes. Groups or individuals referred to as miners operate each of these nodes. This network of nodes approves the transaction that has been requested and validates it by solving a range of mathematical algorithms.
- Upon verification, the transaction block will then be time stamped and added into the existing blockchain in such a way that it becomes unalterable and permanent. The miners are rewarded for validating and approving a transaction by mans of transaction fees and/or the creation or release of new bitcoins.
- The transaction is now classified as being complete.
It has been suggested that the unalterable and permanent nature of blockchain could see this type of technology being applied in other areas as well, such as voting, property settlements and keeping records in the health care industry.
Crucial Points to Consider
Tax Treatment
Any cryptocurrency that is being held for investment purposes could be subject to capital gains tax upon disposal. However, in the event that cryptocurrency that costs $10,000 or less is used to pay for goods or services that will be for personal use, capital gains tax will not apply.
The Government made an announcement in may 2017 that it would end GST on the purchase of cryptocurrencies as of July 1, 2017. Although legislation amending the GST Act has recently been passed through parliament, further amendments will still be required before this proposal can come into full effect.
Volatility
Until now, short-term trading and speculative investing have taken precedence over the initial use of cryptocurrencies, namely to act as a substitute medium of exchange for purchasing goods or services. Part of the reason for this could be attributed to the fact that the value of all cryprocurrences can often be highly unpredictable.
Possible reasons for this unpredictability could be due to government reactions to cryptocurrencies (for instance, proposed regulations and taxation measures), news relating to possible security issues (such as the hacking of cryptocurrency exchanges, which has occurred) and the different perceptions of its intrinsic value and how to calculate it.
Below is just one example of volatility in Bitcoin’s trading value per monetary unit during September 2017:
Highest noted trading value: AUD $6,393.39
Lowest noted trading value: AUD $3,472.02
Average trading value: AUD $5,096.73
Although every effort has been made to explain Bitcoin, cryptocurrency and blockchain as simply as possible, it can still be quite an in-depth subject. If you intend investing in any type of cryptocurrency, it is crucial to take aspects such as liquidity, risk versus return, diversification, the potential to lose money by means of security hacks and tax treatment into consideration. It is also essential that you carefully consider whether this type of investment will be suitable to your specific financial situation.