Cryptocurrencies Demystified

What are they?

Cryptocurrencies are virtual payment systems that do not rely on a central authority (the Federal Reserve here in the U.S.) to verify, track, and record transactions. Instead, they are created and stored electronically by a decentralized system. At this time, there are approximately 1,500 different CC’s, with Bitcoin being the most widely recognized and represents one-third of the entire market. Cryptocurrencies have attracted a lot of public and regulatory attention.

There is a predefined limit to the creation of bitcoins with a maximum of 21 million to be created, with the final one to be created around the year 2140.

The Bitcoin process uses a digital ledger – the “blockchain” – which records the history of the entire Bitcoin money supply. A digital signature allows certain participants (“miners”) to verify that the payer actually owns the coins being exchanged.

The digital signature is similar to a passcode, enabling the parties in the transaction to remain anonymous.

How are they used when you want to pay for something?

E-Wallets and exchanges are both necessary for payments.

E-Wallets : These do not contain the coins themselves (as the name might imply). Instead, it is a mechanism for storing the public and private keys for identifying the owner.

Exchanges : These are the virtual infrastructure for converting CC’s into US dollars (or other traditional currencies), and vice versa. The exchanges charge trading, deposit and withdrawal fees to generate revenue.

Why do banks not accept cryptocurrency?

1. Anti Money Laundering (AML) / Bank Secrecy Act (BSA)

Money laundering is the act of concealing profits from illegal activities. The BSA is a U.S. law requiring financial institutions to assist U.S. government agencies to detect and prevent money laundering. 

As mentioned in the section above, owners of Bitcoin remain anonymous. Because of this, identifying the customer and the source of their funds is impossible with cryptocurrencies.

2. Security issues
The Bitcoin protocol is considered very secure; however, the exchanges and e-wallets have been subject to fraud. In 2014, a Japanese Bitcoin exchange called Mt. Gox filed for bankruptcy because 7% of its money supply was unaccounted for: the coins had been either lost or stolen.

Where do regulators stand on cryptocurrencies?

Regulators are giving CC’s more attention, especially as retail users desire to utilize CC’s for payments, and because of the collapse of Mt. Gox.

To date, the only stance most countries have taken towards CC’s is in the area of taxation: the US and various other developed nations treat Bitcoin as property and levy capital gains taxes on Bitcoin transactions.

Potential regulations are being formulated to attempt to restrict the use of CC’s by money launderers.

To some people, regulations around bitcoin is a sign that CC’s are moving toward a more accepted status for payments, meaning a possibility for more vendors to accept them as payments. 

What does the future hold?

The future is quite unclear, but the one clear prognostication is that the future will look nothing like the present.

It seems safe to assume that the most important development coming out of CC’s is not the payments themselves, but the blockchain technology behind it. 

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Kimberly Spinks professional photo

Kimberly Spinks  

Senior Vice President and Chief Investment Officer 

Kimberly Spinks has more than 20 years of experience in investment and portfolio management, with much of her career focused on serving the needs of high-net-worth clients. In her role at Texas Bank and Trust, she is responsible for the oversight and management of investment portfolios, as well as asset allocation, research, and setting investment policies and strategies.