Infographic: What Are Bitcoins and How Are They Taxed?

You've heard about bitcoins, the digital exchange system, if only because of a recent hack that resulted in tens of thousands of usernames, email addresses and passwords being released. But you should be paying closer attention, argues TurboTax, which recently put together this explainer on the anonymous, decentralized currency.

"In today's economy, the value of the dollar is weaker than ever and the thought of a digital currency is becoming more of a reality with the recent introduction of bitcoins," TurboTax explains in the introduction to this infographic. "Bitcoins can be compared to cash, but cash is limited to physical exchange, where as bitcoins can be sent throughout the Internet. Today there are more than 6.3 million bitcoins in existence and this number continues to grow. So, how are bitcoins used and how have they become a currency that can be used like dollars, but is tax avoidable? Let's explore."

Infographics are always a bit of a hodgepodge of statistics culled from a variety of sources. Here, we sort through the clutter and pull out some of our favorite facts and figures:

  • What are bitcoins? Created in 2009 by a Japanese programmer, bitcoins are the first anonymous decentralized digital currency. They are digital coins that you can send through the Internet.
  • As of May 2011 there are over 6.3 million bitcoins in existence. At current prices, it would cost over $49 million to buy these. The value of a bitcoin drastically changes during the course of a single day; however, they have generally hovered around $14 to $17 per unit.
  • Advantages to bitcoins: Bitcoins are transferred directly from person to person; fees are much lower; they can be used in any country; and accounts cannot be frozen and there are no prerequisites or arbitrary limits.
  • Disadvantages to bitcoins: There are privacy and security issues that arise, since bitcoins are shared publicly online; transactions are difficult and based on scripts contained inside them; bitcoins are the currency for many criminals online.
  • Bitcoins are generated all over the Internet by anybody running a free application called a bitcoin miner. Mining requires a certain amount of work for each coin. This amount if automatically adjusted by the network, such that the bitcoins are always created at a predictable and limited rate.
  • Bitcoins are produced without the involvement of governments or banks, thus avoiding taxes. Instead, they are generated by software and are stored in an online e-wallet, similar to cash.
  • On June 19 of this year, a security breach of the Mt. Gox Bitcoin Exchange caused the leakage of usernames, emails and passwords of over 60,000 users into the public domain. In a separate incident, an unknown criminal allegedly transferred or stole 25,000 BTC, worth approximately $500,000, out of an unsuspecting user's wallet.

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