Near the mom-and-pop convenience store in my west central Toronto neighbourhood, another store has put up a sign: “Bitcoin sold here—6.5% servicing fee.” Next thing I knew, my teen was talking about buying bitcoin. Was he about to blow his part-time paycheque on a fad or become part of a savvy group of investors riding the next wave of disruptive technology?

The Bank of Canada has been looking into e-money, both the centralized type (which goes through a trusted third party, such as PayPal) and the decentralized type (which is stored in and flows through a peer-to-peer computer network that directly links users without a trusted third party, such as bitcoin). But the flaws of bitcoin and other peer-to-peer virtual currencies are so severe that “the Bank of Canada views bitcoin and other cryptocurrencies as investment products rather than money,” said Carolyn Wilkins, senior deputy governor of the Bank of Canada, in a speech at Wilfrid Laurier University in November 2014.

Is bitcoin really bad coin? In December 2013, the European Banking Authority (“EBA”) issued a bitcoin warning that cautioned against unregulated and sometimes fraudulent exchanges, theft via hacked “digital wallets” (where e-money is stored), lack of refund law enforcement, extreme price volatility of e-money, money laundering, and unforeseen tax liabilities. The EBA didn’t even mention the money lost by bitcoin owners who forgot their secret key numbers and therefore forfeited their bitcoin forever.

Potential Disruptor

“Bitcoin lets you bank without a ‘bank’ or remit funds overseas without a currency exchange,” says Christine Duhaime, co-founder and executive director of the Digital Finance Institute. “There is no question that bitcoin is disruptive as a…peer-to-peer way of transferring value to another person instantaneously.”

There’s a risk that existing global banking infrastructure might become redundant and unnecessary. “People will naturally gravitate to transactions that can be completed on their mobile devices and that are frictionless and significantly less expensive,” says Duhaime. She pointed to a June 2014 report by Macquarie Financial that estimated digital disruptive technologies would cost Australian banks AU$27 billion in lost revenues annually unless they adapt to the new digital financial technology.

Is it Money?

“E-money is still a wallflower in developed countries,” Wilkins says. “It is more popular in countries where relatively fewer people have access to banking services,” such as Kenya, where the amount of local e-money, M-Pesa, that is in circulation equals nearly 20 percent of the Kenyan GDP.

Appearing before the Canadian Senate in April 2014, Bank of Canada specialists summarized their objections to calling bitcoin a currency:

First, bitcoin is not widely accepted as a medium of exchange. “Perhaps 100 merchants in Canada… accept bitcoin,” said Lukasz Pomorski, researcher at the Bank of Canada. “Worldwide, online sources estimate that bitcoin can be used to buy about 15,000 goods and services.”

Second, bitcoin does not function as a unit of account; instead, merchants contract with third parties such as BitPay that “exchange the bitcoins into national currencies at the moment of transaction.”

Third, bitcoin should be a store of value that stays stable over time. Pomorski quoted a volatility estimate of 108 percent per year. Bitcoin traded at US$0.003 in 2010, reached a high of US$1,200 in December 2013, and now trades at around US$560.

“It may not technically fit the definition…but it is still used as a currency,” Duhaime says. “It seems to me that if we use bitcoin as a currency, as we have been doing since 2009, that de facto makes it one. As Shakespeare said, ­“A rose by any other name is still a rose.”

Canadian Law

In June 2014, Canada passed Bill C-31, which includes provisions on bitcoin, requiring similar reporting and regulatory standards as those in traditional financial markets. The new law, which also covers bitcoin exchanges and automated teller machines (“ATMs”), views bitcoin as a “money service business” that governs businesses providing traveller’s cheques, money orders, and cheque cashing. Bitcoin exchanges and dealers must register with FINTRAC (Financial Transactions and Reports Analysis Centre of Canada), report transactions, flag suspicious transactions, implement compliance plans, and determine if any of their customers are “politically exposed persons” in the eyes of anti-money-laundering experts. The new law is currently in abeyance.

As of February 2015, Quebec requires bitcoin ATMs and exchanges to be licensed by the Autorité des marchés financiers (“AMF”), as part of the Loi sur les entreprises de services monétaires (Money-Services Businesses Act). The AMF website emphasizes that it will not regulate bitcoin or protect consumers from “risks associated with virtual currency, in particular, volatility and liquidity risks.”

Canada Revenue Agency said it has two rules that apply to bitcoin. First is the barter rule: When bitcoins are used to purchase goods, then whatever has been received in exchange for $1 worth of bitcoin must be documented as a taxable gain of $1. Second is the commodity rule: If bitcoin is bought or sold like a commodity, the resulting gains or losses must be declared as income or capital for the taxpayer, depending on the specifics.

The number of merchants accepting bitcoin continues to climb. Time magazine, Microsoft, Expedia, and even Victoria’s Secret all accept bitcoin. In 2013, the first-ever bitcoin ATM appeared in Vancouver. A year later, Simon Fraser University became the first university to install a bitcoin ATM.

Lost Opportunity?

“Canadians…were early adopters [of bitcoin] and inventors [of its] applications,” says Duhaime. However, much of that talent left because of “the lack of investment in this country in financial technology and the lack of government support for financial technology start-ups that were already here.”

This is a lost opportunity, says Duhaime. Like it or not, disruption of the financial sector “is going to happen, and my hope is that we are wise enough to invest in financial technology now in Canada to maintain our leadership role,” she says. “Toronto is a leader in banking and finance, and as the world of finance changes, we should be doing whatever we can to keep up with it or another city will take our leadership position.”

Hmm…lost opportunity? Start of a new wave? No wonder this attracts notice from my teen. All the same, he’s not keen on a servicing fee, which seems to counter the bitcoin cut-out-the-middle-man ethos. For now, he’ll just stay tuned.

Bit by Bit

Supporters of bitcoin say, “Bitcoin is to value transfer what Napster was to music.” Proponents of bitcoin say the time is ripe for disintermediation of the financial services sector (i.e., taking out the fee-charging middleman). A bitcoin system would replace the centralized model of payments with a decentralized, or distributed, network of payments.

There is no formal issuer (i.e., central bank or central computer server) of bitcoin. As for transferring value electronically, decentralized e-money had a theoretical barrier that many technology experts considered insurmountable because of the issue of double-spending, the electronic equivalent of photocopying one dollar bill to spend it twice.

There are two problems that must be solved:

First, the recipient of bitcoin needs to verify the authenticity of the electronic bitcoin record that the payer is sending. There are well-established IT techniques using cryptographic software to validate each transaction, similar to checking whether a bank note is counterfeit. (This is why “cryptocurrency” is often used to refer to bitcoin and similar electronic currencies.)

Second, how does the recipient know the bitcoin has not already been sent to someone else? The solution to this problem relies on the “block chain,” a public ledger that functions like a distributed database and records all bitcoin transactions to date. The block chain is maintained by a network of nodes, which communicate constantly with one another and run bitcoin software. Transaction details are broadcast to this network. The nodes validate transactions, add them to their copy of the ledger, and then broadcast new ledger additions to the other nodes. Each network node must store its own copy of the block chain in order to independently verify the chain of ownership of every bitcoin. Approximately every 10 minutes, a new group of accepted transactions, a “block,” is created, added to the block chain, and published to all nodes. In this way, the bitcoin software prevents double-spending —by making every node contain an up-to-date public ledger.

Sources: 2014 Senate hearings, Bank of Canada submission; Brian Kelly, The Bitcoin Big Bang; and Andreas M. Antonopoulos, Mastering Bitcoin: Unlocking Digital Cryptocurrencies.