Whenever you hold an asset, it can increase or decrease in value. When you trade the bitcoin for fiat currency, then you’re trading an asset for dollars. It works the same way as when you trade gold bullion for dollars. Bartering or exchanging bitcoins for anything is also a taxable event.
There’s a digital gold rush sweeping the globe as investors try to cash in on Bitcoin, the notoriously volatile cryptocurrency. Getting involved yourself is easier—and riskier—than you think.
As with any exchange or speculative market, trading in Bitcoin is a risky venture that could cost you real money—and lots of it. So the most important advice is to proceed with caution. If you’re game, though, here’s what you need to know to get started.
How Bitcoin Works
Bitcoin is a currency much like any other, albeit digital. It can be saved, spent, invested, and even stolen. The rise of Bitcoin, the most widely circulated cryptocurrency, began in 2009 by someone (or someones) using the alias Satoshi Nakamoto. It came to prominence earlier this year when its value suddenly jumped 10-fold from R30 to R3500 between February and April.
How Bitcoin Exchanges Operate
The simple answer is: just like physical currency exchanges. You’re essentially buying one currency with another. The relative value of a nation’s physical currency is a reflection of the country’s economic and financial health, especially since we moved off of the gold standard. The U.S. dollar, for example, is worth more than that of the Mexican peso due to the discrepancies between the two countries’ economies—therefore you can buy lots of pesos for very few dollars (the dollars being relatively more valuable).
The same holds true for Bitcoin, except that its value comes not from an industrial economic base but from the work performed by your computer. That means it can be traded like a commodity, no different than pork bellies or Florida oranges.
That said, exchanges like Mt. Gox act as intermediaries for currency transactions, converting wealth from Bitcoin to US dollars to other national currencies, back to dollars or Bitcoin. And that’s how you make money. By exploiting the constantly shifting relative values of various currencies, savvy investors can make a tidy sum simply from moving money around these markets, in a process known as arbitrage. But they can lose it just as easily.