Iceholes: How The ALSA May Win The Battle But Lose The War

You know what we do to bad ice on a pedestal?

The biggest surprise hit of the summer is not Guardians of the Galaxy but rather the megaviral smash Ice Bucket Challenge benefiting the ALS Association. Rather than be thankful for this windfall the ALSA has recently decided that they should own this challenge and prevent any other cause or organization from using it. What do you think they are, a charity?

Oh yeah, they are.  Then maybe they should start acting like it and not a bunch of selfish iceholes.

First, some background. The ALSA did not create the ice bucket challenge. The gimmick has been around for a long time. In fact, when this latest round started over the summer it began as a challenge to dump a bucket of ice water on your head or donate $100 to a charity of your choice.  It was only when the challenge first passed to professional golfer Chris Kennedy that the donation was flagged for the ALSA and the individuals he tagged kept the charity when they made their videos.  Later, there was a significant wave of ice bucket activity in Boston due to native ALS sufferer Pete Frates and concerted actions by the Red Sox organization.  Facebook’s data team’s analysis shows that Boston does appear to be the epicenter of the challenge going truly viral.

Nobody is exactly sure why the challenge has reached its current level of popularity, but that’s true for most viral hits in the social media age.  Sure, the videos are funny. And having one person tag several others to participate makes for an exponential reach. And having the challenge somehow associated with charity so we all think we can have fun while helping out a worthy cause makes it seem nice too. There are even a scattering of super serious videos in the mix depicting a bit of what the disease means to its victims and their families. We can identify all the elements but we still don’t know what made this challenge go viral like it did.  Heck, even I did one.  Although I’m not linking it after the reasons behind this post.

That doesn’t really matter though. It doesn’t matter that we can’t explain why it went viral; it went viral. It doesn’t matter that perhaps the amount of money we give to charities is out of proportion to the impact of the disease as IFLScience linked in a Vox article infographic; there is no doubt this is a horrific disease and increased attention to it is a good thing. It doesn’t matter that ALSA only spends a small percentage of its budget on research; it performs several other valuable services and all charities have to spend a lot of money to ultimately make more money in the end.

Here’s what does matter: the ALSA was given the greatest gift of their life in terms of this ice bucket challenge.  Donations are through the roof.  Yesterday they reported making over $94.3 million in donations in just the last month.  Last year, in the same time period, they received around $2.7 million.  Rather than just say thanks or give the tearful Sally Field “You like me, you really like me!” Oscar acceptance speech they decided to go another direction. They decided to take that warm fuzzy feeling we’ve had from watching or making these videos and donating to a worthy cause and pour a giant bucket of ice water on our flames of altruism.

As first reported on the Erik M Pelton & Associates blog, the ALSA filed an application with the US Patent and Trademark Office to be granted a trademark for the term ICE BUCKET CHALLENGE as used for any charitable fundraising.  They also filed an application for ALS ICE BUCKET CHALLENGE but it’s the main application that should make people furious.  Heck, it made me enough to write a blog post on a Thursday night and I never do that.

Filing a trademark for the term “Ice Bucket Challenge” would allow them to prevent any other charity from promoting a campaign that the ALSA had fall into their lap.  The ALSA did not create this concept.  They did not market this campaign until it already went viral.  They have no responsibility whatsoever for this going viral.  If the ice bucket challenge had found a connection to the American Heart Association or the American Cancer Society then it could have gone just as viral.

What on earth could make the ALSA think they should have any right whatsoever to prevent someone else from using this challenge?

I can’t think of a good reason.  I can think of reasons, mind you.  They just aren’t good.  Fortune was able to get a statement from ALSA spokesperson Carrie Munk:

The ALS Association took steps to trademark Ice Bucket Challenge after securing the blessings of the families who initiated the challenge this summer. We did this as a good faith effort after hearing that for-profit businesses were creating confusion by marketing ALS products in order to capitalize on this grassroots charitable effort.

Sorry, ALSA, but that excuse doesn’t hold water.

First, obtaining the blessings of the families who created this challenge is nonsense.  Even if you got permission from everyone who ever did an ice bucket challenge–SO WHAT?  This was a charity drive.  You think the first charity to earn a million dollars from a bake sale should get to stop all other bake sales?  Because that’s what filing a trademark on the challenge is an attempt to do–you’re trying to stop any other charity from using the term for fundraising.

Second, you heard some shady companies were making money off the Ice Bucket Challenge?  Wow, that must be weird.  To think there are these companies just sitting around making money off something they didn’t create.  JUST LIKE YOU.  Who cares if someone makes an Ice Bucket Challenge shirt and sells it?  If it says ALSA on it or has your logo you can already go after them without this new trademark application.

The ALSA’s actions are atrocious and reprehensible.  They may have raised a ton of money this summer but it could all backfire over a move like this.

But here, ALSA, I’m going to be nicer than you appear to be.  Here’s a way for you to cover your cold, soaked behinds and spin this in a favorable way.  What you should have done is post on your website the day you filed the application, saying that you are only doing so to protect all charities from shady profiteers but that all charities would be free to use the mark forever for no charge if you received the trademark.  The fact that you didn’t tell anyone about the application and only commented when it was called out on social media (by the way, you’ve heard about this social media thing and how a lot of people use it, right?) you can just blame on being so busy counting all your money.  It’s a bad excuse, but maybe it can save some face.

Because right now you look like a bunch of iceholes and I resent every penny I gave you.  Not for the good work you’ve done, which is a lot, or the families you’ve helped, which are numerous, but for being greedy instead of generous, selfish instead of, you know, charitable.

Update Aug 29: The ALSA has withdrawn their trademark application. Good.

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Filed under Celebrities, Crowdfunding, Facebook, Social Content, Social Tracking

Wish I Was Legal

It’s a movie.

I’m a social media law geek.  I have long accepted this fact and it shouldn’t be a revelation to you since you’re, you know, reading a blog about social media law.  So nobody should be surprised that when I attended a movie premiere for Wish I Was Here last week and everyone took out their smartphones to take pictures of Zach Braff and Donald Faison I, instead, took pictures of the disclosure form and privacy warning.  Because I’m geek like that.

I was a backer of Mr Braff’s Kickstarter campaign and paid to get two tickets to the Austin premiere and Q&A session.  I am not a superfan of Mr. Braff–I thought Garden State was okay and I only watched a season or two of Scrubs–but I do think he’s a talented actor and saw him perform in Twelfth Night at Shakespeare in the Park.  I was also intrigued by the Kickstarter project, being the first high publicity original movie to be funded after Veronica Mars.  I sent my money, read the updates, and watched the backlash roll in with curiousity.

There were four items of interest that struck me regarding social media law at the movie premiere.  I’m going to tell you three of them.  Just kidding, here’s all four.

photo 11. The release form

I’ve enclosed a picture of the consent and release form that all attendees were required to sign prior to entering the theater.  Much of it is standard for a movie screening where filming will take place if they may use the footage for behind the scenes featurettes.  But the item that jumped out to me is the item IN BOLD ALL CAPS.  Because, you know, that’s what bold all caps is supposed to do.

That text reads

I agree that to the extent I make any statements about the content including via social media or other public forums (e.g. Facebook, Twitter, Blogs, etc.) that such statements (“Statements”)…IF THE STATEMENT IS MADE ON SOCIAL MEDIA OR ANOTHER PUBLIC ON-LINE FORUM, I WILL DISCLOSE NEXT TO MY STATEMENT(S) THE MATERIAL CONNECTION BETWEEN MYSELF AND FOCUS FEATURES (I.E. I SAW THE PICTURE FOR FREE AT AN ADVANCE SCREENING

This statement is for participants to comply with the FTC Endorsement Guidelines.  They’re even explicitly called out in the next sentence of the release but they aren’t IN BOLD ALL CAPS so you might have missed it.

That’s a great call-out for such a long release form.  It may be the only sentence you actually read if you’re handed this page and given a minute to sign before getting out of the hot Texas sun into the air conditioned theater.  Although I may quibble with some technicalities (I paid for the tickets via Kickstarter so it wasn’t free, and I paid Zach Braff’s group not Focus) I’m a professional quibbler so I’m willing to focus on the positive.  A good call-out for a venture they know will get mentioned on social media.

photo 22. The consent sign

This sign was posted inside the theater before you could get to the orchestra seating and visible from the stairs leading to the balcony.  While I understand the need for something like this, heck I’ve drafted a few in my career, I also think this sign goes a bit overboard.  First, the release was already in the signed form that everyone had to fill out before they got inside so this is duplicative at best–but as a lawyer I can appreciate having multiple points where consent was gained just in case a lawsuit comes up (especially after DVDs have been produced).

I take less issue with the repetition than I do with the scope–while the signed form seems more targeted in the consent, this poster goes a bit overboard.  Sure, it’s easier to print a sign with less language like YOU GIVE ME ALL THE RIGHTS! RAWR! it also goes beyond the scope of the event.  According to this sign, Focus Features can now use my photograph to publicize an entirely different movie or event and that doesn’t help anyone.

I don’t think Focus would use my photo to publicize a different movie, mostly because I thoroughly enjoyed Reign of Fire and therefore have horrible taste in movies, but also because this is more likely just a defensive consent.  If someone were to sue for being on the DVD then the company has a signed release form and this poster to use in their defense.

Still, even though I may be the only person who read this sign (and definitely the only one to take a picture of it), I have to wonder what would happen if someone took issue with the consent.  I paid for the tickets to the premiere–that’s what the Kickstarter event promised me.  There is some general language in the Kickstarter campaign that if a reward conflicts with laws they’ll work to give you a substitute, but it isn’t a conflict of law for me to attend without giving consent to filming.  Just a small thought–perhaps they had a special area reserved for non-consenting audience members or they figured the odds were so low of this being an issue it wasn’t worth developing a plan.  I just find that kind of thing interesting.

3. The backlash

During the Q&A session after the film, one man asked Mr. Braff if he experienced any backlash over the funding.  The response was along the lines of “Where have you been?  Did you contribute and then go off-line for a year?  Did you just land from the space station and thought, ‘Hey, I can still make the premiere!'”  It was funny and the audience’s reaction showed they were all aware of the backlash as well.

The answer was interesting as well.  Mr. Braff explained how his world is all about getting films financed and when something is your world you unrealistically expect that other people will know something about that world.  So when the backlash started rolling in about the Kickstarter project he suddenly realized that people didn’t really understand how films are financed and why Kickstarter could help him.  So that was a lesson learned, but ultimately something he wasn’t concerned about since his fans and other interested parties did back him and that mattered more.

Mr. Braff did express some concern over the backlash regarding Kickstarter itself–specifically that people attacked him for taking money away from other Kickstarter projects that could use the money more.  He said that Kickstarter was quiet at first but later spoke up saying that high publicity projects like this do draw attention to the platform and ultimately bring in new users who end up funding more projects–the net being more money shared with more projects.  I can’t find a link to Kickstarter’s statement but that makes sense and is also probably a lesson learned for future high publicity projects.

4. Reflecting on the social world

At the end of the Q&A session, Mr. Braff and Mr. Faison sang “Guy Love” as a special treat to the audience.  They said it had been a while since they performed it and don’t get a lot of opportunities to sing it together so everyone should record it.  And so they did.  This was my view of the song:

photo

Working in social media I often take for granted the world of information and connections we have at our fingertips.  But every once in a while it strikes home.  When I looked at the event before my eyes I wasn’t watching the stage, I was looking at all those phones.  Yes, in my head I realized everyone probably has one, but it takes events like these for that to sink in sometime.  Seeing everyone recording the event, having their own perspective and building their own memories and being able to share it with all of their friends as well.

That’s awesome.  That’s social media.

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Filed under Celebrities, Copyright, Crowdfunding, FTC Endorsement Guidelines, Social Investment, Social Platforms, Terms and Conditions

Here’s Why Killing Net Neutrality Makes You Pay Twice

This matters. A lot.

I’m not going to recap the wealth of discussion and debate over Net Neutrality.  You know how to use Google, so use that to find more information.  Or for the most basic of primers check out this great video from the New York Times on How Net Neutrality Works.  It explains the concept well and has some great points from David Carr (who, according to this video, has a head so huge I’m afraid it might snap his neck any second) about controlling content as well as access.

But even if the debate over Internet innovation doesn’t motivate you to take action then perhaps this will.  Killing Net Neutrality will make you pay more money not once but twice.  Here’s how.

First, for the large bandwidth services like Netflix and Hulu and Amazon Instant Video, paying for access will be an absolute must.  Take a look at Netflix’ blog post about why Net Neutrality is important, specifically the second chart which shows what happened when Netflix started paying Comcast for priority access:

Netflix was forced to do this because average Netflix access speed was decreasing to unacceptable levels for Comcast customers.  (This was not happening to customers on other carriers…isn’t that an odd coincidence?)  If they hadn’t paid then customers would be upset.

But where do you think this extra money is going to come from?  Netflix customers, that’s who.  It will either come from their customers in the form of increased monthly rates over time or it will come in the form of less content that Netflix now develops because part of that money is routed to paying ISP tolls.  Either way, this is the first time you’ll pay without Net Neutrality as all the major bandwidth services are forced to incur this expense.

The second way you’ll pay is in the form of reduced access to everyone who isn’t willing to pay.  Maybe the site isn’t large enough to pay the tolls but you really enjoy it–be prepared to have their access de-prioritized in exchange for all the major players.  Or maybe the site simply can’t afford the tolls even if lots of people use it.  Think Wikipedia.

This problem gets worse the more high-bandwidth content is forced to pay for tolls and get priority access.  Of the big three streaming services, you may subscribe to one or none of them–but that won’t stop their content from delaying everything else heading your way.

So you’ll have the privilege of paying a second time for no Net Neutrality.  Maybe you’ll pay to try and get more bandwidth to your house, a method which may not work if the major networks are still crammed with the high-bandwidth priority content.  Or maybe you’ll just pay with your time, waiting longer periods for content that used to be treated equally.  And yes, to paraphrase, time is a form of payment.

If you honestly don’t have an opinion on Net Neutrality, maybe that will connect with you.  Paying twice for a rule change is a pretty bad option compared to everyone participating equally in a single network and everyone having a vested interest in making the entire network run better.  The proposed rules by the FCC kill net neutrality–they hide behind this nomenclature of Open Internet but that is not a Neutral Internet.

All the major technology, content, and social media companies support Net Neutrality.  The big companies like Netflix and Facebook know that a neutral Internet let them become the giants they now are.  The smaller companies know that a neutral Internet is the only way they can compete against their larger competitors.  And technology innovators everywhere know that having equal access is the best way to develop new platforms and software.

Do you know who supports killing Net Neutrality?  The carriers.  That’s it.

If you feel compelled to take action, here’s a great article on how you can submit comments to the FCC while they are still considering their proposed rule changes.

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Social Media Law Final (You Know You’re Curious)

Because triumph.

While I enjoy many aspects of being a social media lawyer one of my absolute favorites is teaching a class I developed at the University of Texas School of Law.  This spring I taught the class for a second time to an even larger class and had many entertaining classes and conversations throughout the year.  We even had to deal with actual ice cancellations and fake ice cancellations and held one class virtually over Adobe Connect.  All in all, a fun semester.

Since my class covers a variety of legal subjects impacted by social media, the final also covers a number of different topics.  And just like last year when I posted the first law school exam I gave, below is an embed of this year’s final.  Now you can play along and imagine what you would respond if you had to take this final.  I omitted the first page which was just directions–just know it was open book and students had three hours to take the exam.  Each question was weighed equally.

Oh, and there’s a social media easter egg hidden in the final.  Let me know if you find it.

Update: Jason Ross found the easter egg first, so congrats to him!  Yes, I rickrolled my students, they just didn’t realize it.  Read the first letter of each line of the final.

 

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Filed under Celebrities, Consumer Protection, CopyFUD, Copyright, Employment, Fair Use, FTC Endorsement Guidelines, Identity, Instagram, Privacy, Social Content, Social Marketing, Social Media and the Law, Social Media Lawyers, Social Media Policies, Social Media Risks, Social Platforms, Terms and Conditions

Learning From Social Media Mistakes

 

Wait. I did that?

A few weeks ago USAirways tweeted out an offensive image in response to a customer.  I’m not going to link it.  You either know the story already or you don’t need to see the image (and it’s easy enough to google it yourself).  Mistakes will always happen on the job and sometimes they happen in a public venue like a Twitter account.

I thought the response issued by the internal US Airways newsletter (which is available publicly) was so outstanding that I’m just pasting a picture of their newsletter article.  I wish they hadn’t buried it at the end of the newsletter but I applaud how it was handled and addressed.  Other companies could learn a lot by how this embarrassing mistake was handled.

USAirways

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Filed under Informal Tone, Quick Updates, Social Content, Social Media Risks, Twitter

Everything You Wanted To Know About Bitcoin But Were Too Afraid To Ask, Part 3: Bitcoin Risks, Chuck Norris, and Pork Loin

Now that we’ve learned the basics of money in part 1 of this primer and how bitcoins and Bitcoin work in part 2 it’s finally time to talk about the problems and legal risks facing bitcoin adoption.

Which are significantly more serious than issues surrounding Cabbage Patch Kids adoption.

The Downside Of Bitcoin As Currency

There are plenty of potential downsides to using bitcoins as a virtual currency and these could be insurmountable obstacles in terms of its future.  Here are some of the big ones.

Fluctuating Value

While speculators may love the idea of buying bitcoins today and reaping a huge profit tomorrow, that isn’t the kind of thing you look for in currency.  For example, this primer took a while to write (longer than it’s taken you to read this far and man, hasn’t that felt like forever?).  When I wrote the section about bitcoins being worth around $515 that was true when I was writing it (March 28, 2014).  Today, as I write this section (March 31) the value is around $460.  That kind of huge fluctuation isn’t what people look for in terms of a currency–they may look for huge swings for other types of investments but that won’t make bitcoins succeed as a currency.  You don’t want both sides of a transaction trying to figure out how much the money will be worth by the time the transaction is done–then it turns into a complicated bartering system.

To some extent, this is a hurdle that any new currency will face.  As long as the currency doesn’t have widespread adoption then it will be valued mostly by its conversion to other forms of currency.  But without some kind of longer-term stability, it will be difficult for a true bitcoin economy to emerge as the amounts charged for goods and services will fluctuate too wildly.

The 51% Attack

One of the greatest strengths of the Bitcoin network is also its greatest weakness.  Bitcoin was created to replace those trusted, proprietary third parties that verify transactions.  To do so, the Bitcoin network was created with a complicated transaction ledger (the Block Chain we discussed in part 2) and mining system.  For those transactions to be verified, the majority of Bitcoin miners have to agree that the latest batch of verified transactions are correct–this process not only verifies the Block Chain but also sets to reward the miner that first solved the mathematical problem.

Verifying the solution requires agreement by at least 51% of Bitcoin miners.  That distribution built into the Bitcoin network is designed to make it so that no single party is taking over verification and leading to them increasing transaction costs (leading them to increase transaction costs closer to the 2.9% being charged by most third parties today).  But that distribution comes with a significant disadvantage: at any time someone can come up with enough hardware to make themselves 51% of the Bitcoin mining network and suddenly they can rewrite all the rules.  They could move bitcoins to their own accounts or issue all remaining bitcoins to themselves.  It’s possible that these changes could be undone, but that could be difficult.

It’s also an attack unique to Bitcoin–51% of the world’s nations could decide the US dollar is worthless and that wouldn’t impact our ability to use the dollar here in the US.  The 51% attack on Bitcoin could completely destroy the system.

Like this almost killed Superman.

While the deeds that could be accomplished by someone in the 51% position are hypothetical, the actual ability is not.  In January of 2014, one network of Bitcoin miners accounted for more than 42% of the network.  A deliberate push by that network could have easily tipped it over the 51% number–fear of that takeover made many miners leave the network but it does reveal an actual, serious threat.

Current Third Party Protections

We discussed earlier how US retailers could save $11.7 billion a year if they moved to bitcoins given the reduced transaction fees.  But one thing that should be considered is how credit card companies and others provide valuable services in exchange for those higher transaction costs.  In addition to your losses being capped for fraudulent charges with credit cards, most third parties will also have reward programs and dispute resolution processes that could make the extra transaction fees worthwhile.

Forget all the bonus miles and extra hotel nights for now–those dispute resolution processes are very important.  If you have a fraudulent charge on your credit card today you can contact the credit card and dispute it.  They will have their own process for deciding the issue but you have a good chance of getting the issue correctly resolved.  (I’ve had to do this maybe a dozen times over the past decade, every one resolved in my favor.  That’s not to brag but to highlight an actual need.)

Bitcoin has no dispute resolution process.  A completed bitcoin transaction, once verified into the Block Chain, cannot be undone.  A reverse transaction could be completed if both parties agree to transfer the money back, but that is a new transaction and not removing an earlier one and is completely subject to the whims of the new bitcoin owner.

Private Keys Lost

Earlier we learned that having money in the Bitcoin network really means you have two things: the public address of that money (which anyone could have) and the private key that allows you to control where that money can be moved.  If you lose that private key then you have lost the money.

This is true for currency as well.  If you stand at the top of a mountain and wave a $20 bill around and the wind rips the bill out of your hand, you don’t have that $20.  If someone walks up to you with a gun and demands the $20, same thing.

Unless you’re Chuck Norris. Chuck Norris makes money when he gets mugged.

The concern here is that private keys are not designed to be remembered by human brains.  So you need some kind of storage method to intervene.  Wallet programs or websites are the easiest place to store them, both for their ability to remember long strings of numbers and because they can be utilized to complete bitcoin transactions in the future.  But programs and websites can be hacked.  Or a virus on your hard drive can detect wallet programs, deduce that you have bitcoins, encrypt all of your files, and demand a bitcoin ransom or it will delete the key and you lose everything.  That’s not a hypothetical risk, that’s a real virus.

As an additional method of security, some people place private keys in what is called cold storage. This means the files are removed from an Internet-connected device. They may be printed to paper and deleted from online records or they are placed on a USB drive that is placed in a secure location like a bank safety deposit box. This certainly makes the keys less susceptible to an online attack but they are still subject to the same limitations as physical currency (loss, theft, damage). If you wanted to have a physical stockpile of currency, there are easier ways. But security around private keys is vitally important since if you lose the keys you lose your money.

The problems with losing a private key, losing your money, are not unique to the bitcoin economy. The same thing could happen to your bank accounts if they were hacked.  But there are a lot more safeguards in place and laws to help you in that event.  The bitcoin economy has not matured enough to address these risks, giving you virtually no recourse if you lose your keys.

Other Technical Issues

The 51% attack is the easiest technical issue to understand but there are several other that can impact bitcoin transactions.  One which has gained some attention is called transaction malleability (very technical article on how it works can be found here).  Understanding this attack is a bit difficult–just know that an attacker can modify transactions before they are entered into the Block Chain.  The modified transaction is seemingly innocent–it doesn’t change where the bitcoins were transferred.  But it does modify the final verification hash and since there is no standard way for wallet programs to operate, some wallet programs would see the modified hash as proof that the first transaction failed and the wallet needed to send bitcoins again.  The result is that a nefarious seller could trick a wallet into spending twice as many bitcoins as it should–and like we discussed before, there’s no recourse.

When one of the larger bitcoin exchanges, Mt Gox, announced it had lost several hundred thousand bitcoins it claimed this was due to transaction malleability.  While that cause has been questioned, it is also true that in the days following Mt Gox’ announcement this attack was found to be responsible for double charging over 300,000 BTC’s worth of transactions.

Plus we were really, really sure we knew the Ace was in the middle.

There are several other potential weaknesses and attacks with the Bitcoin network and to some extent that should be expected with a new technology.  It’s also true that our current third party verification systems have also been subject to attacks and data breaches.  We just have a lot more experience dealing with the technology that has been around for decades.

Bitcoin Legal Issues

Beyond facing technical issues and obstacles to having bitcoins adopted as officially recognize currency, the Bitcoin network and bitcoin transactions also face significant legal challenges in the near future.  Here are some of the most important.

Currency Or Commodity?

The IRS recently issued guidance that bitcoins will be treated as commodities rather than currency under US law.  Brazil has just done the same and other countries will determine their own treatment.  This triggers certain legal treatments that differ from currency–if someone pays you in bitcoins then it is like you were paid with gold bars rather than Euros.  This not only requires you to figure the amount you were paid in terms of how much those bitcoins were worth when you received them, but if the value of those bitcoins change by the time you use them then you also need to record that amount.  And if the new amount is higher than you can be taxed under capital gains.

Tax treatment depends on your overall income situation and I’m not a tax expert, so take this all with a grain of salt.  But short-term capital gains (for commodities or investments held for under a year) you will be taxed 35% of the gain.  If you held that commodity for over a year then that falls to 15%.  Let’s see that in action.

Say I agree to pay you $25 in bitcoins (BTC, if you recall) if you hold my place in line at Franklin BBQ on one dreary day in January.  Leave aside the ethics and propriety of such a transaction.  In June, Franklin BBQ adds pork loin to the menu.  You are eager to try the latest BBQ awesomeness, especially because Franklin is now taking BTC as payment.  Pork loin is being sold for $12.50 a pound, quite a deal, and you decide to order 4 pounds.

This shall now be called your bitcoin pork loin.

Lucky for you, BTCs have doubled in their US dollar conversion since January so you are able to use the exact amount of bitcoins I paid you to purchase your $50 of sweet, smoky BBQ.  Because you received $25 in a commodity (BTC) and were able to turn it in for $50 in goods you have now realized a gain of $25.  Since this was based on something you held for under a year you now owe 35% of the gain, or $8.75.  If you had been able to hold on until January, and assuming BTCs are still worth double compared to when you received them, then you would only pay 15% of the gain, or $3.75.  But, really, who can wait that long?

The good news is that technically you still made out pretty well–you were able to get $50 in goods for the equivalent of $33.75.  But the bad news is that you have to keep track of all your transactions, when you got BTC, how much they were worth, how much you got for them when you exchanged them for something else, or else the IRS may take issue with your filings.  And that’s never a good thing.

It’s also bad news when you compare to a standard currency exchange.  People make investments in foreign currency just like they can buy stocks and bonds or gold or collectible Elvis plates.

Fact: the Fat Elvis plate can hold six full-size pork loins.

When you make money off a currency investment you are typically taxed 23% of the gain (they use a 60/40 rule to determine the amount, 60% taxed at long term 15% rate, 40% taxed as short term at the 35% rate).  Just the fact that the IRS is treating BTC like stocks or other commodities puts it into a category different from, and less advantageous than, other forms of foreign currency.

Legally Used?

Although the US has determined that BTC can be used for transactions and just has a specific way of dealing with the tax implications, other countries have declared bitcoin transactions to be illegal or placed restrictions on their use.  Bitcoins cannot be used in Iceland and their use has also been restricted in Taiwan, India, Japan, and China, among others.  This is still an emerging technology so it would be in your best interest to look into bitcoins’ legal standing in a country before you embark on transactions with them.

Anonymity And Money Laundering

Anonymity and Bitcoin is a fascinating issue.  On the one hand you have people claiming that bitcoin transactions are completely anonymous and this makes it attractive to criminal elements.  On the other hand you have people claiming that bitcoin transactions are publicly trackable and that you can follow every bitcoin from person to person which is something you can’t do with cash currency today, making it even more secure than cash.

Who’s right?  They both are.

Although every bitcoin transaction is public knowledge, what is known is the amount that was transferred and the address to which the amount was transferred.  If you can determine who owns or controls that bitcoin address then you know how much they received.  But there is nothing that compels bitcoin addresses to be identified, unlike many countries which have laws that require bank accounts to be registered in people’s/companies’ names.

If a bitcoin is ever stolen (through a technical attack or someone stealing the password) then you can absolutely know where the bitcoins were transferred–but that may not help you.  Especially if the destination was some large bitcoin transaction site that you then lose in the shuffle.  Perhaps the thief takes 5,000 BTC from your account and then start sending out batches of 100 BTC now and then.  It would be impossible to say that those were your BTC and not someone else’s.

The identification of bitcoin transactions doesn’t necessarily make it more secure, but it also could make it easier to follow.  Like a double-edged sword, it cuts both ways.

Double edged swords: as awesome to look at as they are to use in analogies.

Another way bitcoin transactions are like a double-edged sword is that the person handling it may face the most risk.  We’ve already seen one example of an entrepreneur arrested on money laundering charges for providing a service to convert bitcoins to cash faster than the Bitcoin network allows and we could see more actions like this in the future.  Even though bitcoins are treated as commodities, money has its own set of regulations and new companies rising to meet the gaps in the Bitcoin economy could run up against this highly regulated space.

The Future Of Bitcoin(s)

Where does this leave bitcoins and Bitcoin moving forward?  While there are significant challenges to bitcoins being adopted as an actual currency there is a degree of interest in the technology that could keep it alive long enough to be accepted.  This could change in an instant if the Bitcoin network is compromised or a few large countries declare it completely illegal, but for now it has a chance to be adopted if it can deliver on the promise of reduced transaction fees.

Of far more interest, I think, is the Bitcoin network itself and the idea that you can securely transfer unique codes from person to person.  If the Bitcoin network becomes more refined and then modified to use more than bitcoins, it’s entirely possible that other, actual forms of currency could be exchanged on the network.  That could be an interesting application of the technology and its promise of cheap, efficient transfers without the downside of a new, unregulated (by a traditional authority) currency.

Whatever happens with bitcoins and Bitcoin, hopefully by reading this primer you’ll understand what’s at issue.  But if you do have suggestions for refining the primer, please contact me and let me know.

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Everything You Wanted To Know About Bitcoin But Were Too Afraid To Ask, Part 2: bitcoins, Bitcoin, and Ishtar

In part 1 of this primer on bitcoins we first took a step back and took a look at money.

Okay, I see it. Now I want it.

Now we’re going to dive into the world of bitcoins so we can understand what they are and how they work before we return with part 3 of the primer on some of the downsides and legal risks of bitcoins.  If you are interested in reading more about bitcoins there are plenty of resources available online but I highly recommend this 25-page research paper by Goldman Sachs that approaches bitcoins from a variety of angles and where I obtained many of the data points for this section of the primer.

The Two Bitcoins

Before we delve into the fun world of bitcoins we need to clear something up.  Bitcoin can actually refer to two different things.  One uses the capital B and is called Bitcoin.  The other one has a lower case b and is called a bitcoin.  This gets super confusing when the word starts a sentence so the capital letter doesn’t tell you anything.  But they are two very different things.

bitcoins, the lower case version, are a form of virtual currency in that they were created to be used as online money.  How they are treated legally is a very different matter that we’ll discuss later, but for the most part when you read about people buying a villa in Bali with bitcoins, or an ATM for bitcoins here in Austin, or how a site was hacked so members lost all their bitcoins you are reading about the lower case bitcoin.

The capital letter Bitcoin is the technology that makes bitcoins a potential currency.  And it’s actually the more important of the two.  But we’ll talk about that later.  For now, let’s discuss how bitcoins could be used as virtual currency.

Bitcoins as Currency

First, let’s clear up one thing about bitcoins as a potential currency: they were not created to buy illegal things.  This is a common misconception about bitcoins–that the mob or criminals are using bitcoins to buy drugs, weapons, and DVDs of Ishtar.

Technically still legal. For now.

So Why Make Bitcoins?

Bitcoins were created like so many other internet services: to make things cheaper.  The paper that launched it all starts innocently enough:

A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.

When you buy something on the Internet you almost always use a credit card.  Sometimes you might use a direct bank transfers, other times you could use another trusted third party like Paypal.  But all of those transactions involve a third party not directly involved in the transaction.  Those third parties get paid for ensuring the transaction goes smoothly.  On average, those third parties will take just under 3% of the total transaction (they take around 2.5% for physical retail transactions due to the increased risk of fraud in the e-commerce market).  In 2013 an estimated $609 billion in goods and services was purchased online.  Meaning $17.8 billion was given to banks and credit card companies and Paypal and others.

The hope is that using bitcoins could reduce those transaction costs to only 1%.  That would be $6.1 billion in total fees and would save the industry $11.7 billion.  Of course, whether the saved money would result in lower prices to consumers or just higher profits to the companies would remain to be seen, but the hope is that the money eventually flows to the consumer.

But how do you create a brand new form of currency without having the same kind of third party involvement?  The purpose of using bitcoins to buy things was to be cheaper, after all–it wasn’t just to create a new form of currency with the same transaction costs (although some people really liked that idea too).  So the system of bitcoins and Bitcoin was created to try and create a new form of currency: the bitcoin.

Okay, I’m ready.  What’s a bitcoin?

Glad you asked and that you’ve stuck around this long.  The short answer is that a bitcoin is like any other digital file, a series of 1s and 0s that can be used by certain programs.  In this case, those programs are wallets that both hold your bitcoins and allow you to transfer them to other wallets so you can pay for things.  In this way, bitcoins acts like currency.

Anyone who has worked with computers knows about two essential digital functions: copy and paste.  So if the bitcoin is just a digital file, what’s to stop people from hitting a few buttons and becoming virtual billionaires or turning the bitcoin economy into hyperinflation 1946 Hungary like we discussed in part 1?  And how do you ensure the reliable transfer of these bitcoins without using a trusted third party that will want it’s 2.9%?

“I want my 2.9%!”

The answer to those questions is what makes bitcoins look and act like a virtual currency (also called cryptocurrency) in meeting those five essential elements we discussed in part 1.  How these bitcoins can be used also forms the basis of Bitcoin, the network.

1. Bitcoins have fixed units of measurement

The standard unit for a bitcoin is the BTC just like the standard unit in the United States is the dollar.  However, unlike the dollar which can be divided into 100 cents, a bitcoin can be divided into 1 million pieces.  The smallest trackable unit of a bitcoin is currently 0.00000001 BTC.  What that is worth, in terms of buying power, will be discussed later.  But just like fixed money had an advantage over a barter system because everyone agreed on how much of the currency was being traded, bitcoins have a common and precise measurement.

2. Bitcoins don’t disappear

By virtue of being digital and on a shared network, bitcoins don’t disappear.  They may, however be stolen just like gold jewelry.  Or you may forget your password to the wallet that holds your bitcoins, just like you could bury a jar of gold coins and forget where they are.  But the bitcoins themselves don’t disappear.

3. Bitcoins are controlled and scarce

Rather than having a government or central bank issue new bitcoins, the Bitcoin system is responsible for creating new bitcoins.  We’ll discuss how that happens later when we talk about Bitcoin mining, but know that there is an algorithm for adding new bitcoins to the BTC economy.  And there is a fixed number of bitcoins in the BTC economy.  If you want to see the current amount you can check this graph and see how there are a bit over 12.1 million BTC as of March 24.  The rate at which BTC are added is based on the number of BTC transactions rather than a fixed time.  That’s why the line on the BTC supply isn’t straight–it fluctuates based on activity.

Adding currency is done by issuing authorities all the time, lest you think BTCs are going the way of the pengo.  The US mint produces new money every day–about 95% is used to replace older, damaged notes while the rest can be held in reserve or issued as new currency.  One potential concern that comes up with bitcoins is that the current method for creating and verifying bitcoins has a cap of 21 million BTC (this will be reached by around 2140).  However, bear in mind that there is currently only $1.2 trillion dollars in the world economy (this is the M0 money supply, or actual money in the forms of notes and coins) and there is a grand total of around $10.5 trillion dollars in total when you count other money supplies (this fact and a nice breakdown of the difference between money supplies can be found over at HowStuffWorks).

$10.5 trillion dollars counted down to the last cent looks like this: $10,500,000,000,000.00  (16 digits)

21 million BTC counted down to the last decimal place looks like this: 21,000,000.00000000 (16 digits)

Meaning that even with a finite supply of BTC, it seems like there would be enough for a BTC economy to function.

4. Bitcoins are transferable

Bitcoins can be transferred between indviduals using their wallet programs and the Bitcoin network.  Several online vendors have also started taking BTC directly, such as Overstock and WordPress.  And those are just the directly transferable BTC transactions–there are bitcoin ATMs that are starting to pop up and there are multiple BTC exchanges that let you convert BTC into other forms of currency for indirect BTC transactions.  Directly or indirectly, BTCs are transferable.

5. Bitcoins have value

Now this is where things start to get tricky.  First, there is no denying that bitcoins have value.  While I write this the price for 1 BTC is somewhere between $515 and $520.  People using BTC agree that there is value to them, but the value fluctuates wildly.  Bitcoins could be purchased back in April, 2013 for around $100.  At the end of November, 2013, bitcoins were being sold for $1,000 or $1,100.  There have been huge spikes up and down throughout the year.

Compare that to how many Euros could be bought for one dollar over the last year (if you follow the link you’ll need to click the 1Y button to show the year).  At the lowest point of the year it cost $1.27 to purchase 1 Euro.  At the highest point it cost $1.39.  That is what happens with generally stable currencies.

The unstable value of bitcoins is also a large criticism for its use as a currency.  If a currency can’t be relied upon for its value then people will stop using it.  Hungary had to give up the pengo and replace it with something completely new.  The majority of BTC value spikes are due to speculators trying to make money–they aren’t using BTC to buy things but rather hoping the value will go up so they can make money off it.  Whether they do or not, there is no denying the volatility they’ve created.  And that can be a bad thing for bitcoins.

Consider this: in 2010, a programmer convinced someone to buy him two pizzas in exchange for 10,000 BTC.  At the time, bitcoins had no value since very few people had them or used them.  Those same bitcoins would be worth millions.  There is no way that programmer could have known this, but everyone today who participates in the BTC economy knows the value fluctuates wildly.  This makes both sides less likely to use them for transactions.

The Big B Bitcoin

But now we have to talk about Bitcoin, the network that made a new virtual currency possible.  Remember that in order for bitcoins to be a viable currency not only did they need to meet the five essential elements (which they more or less do, with some warnings) but they also needed to have a method of transferring those bitcoins without involving a third party taking it’s 2.5%.

The solution to the problem of avoiding the dreaded 2.5% transaction fee while still being a trusted method of transfer is the capital B Bitcoin system.  Here’s how it works.

Wallets

To understand Bitcoin, we start with wallets.  In order to conduct business transactions involving bitcoins you need to have a wallet.

That velcro ripping sound every time you open it? Money. So money.

In this case, a wallet is a collection of two essential things paired with optional items:

Essential thing #1: A public address

Think of this like the address that people send money to, much like your physical address is where the Amazon drone can drop off your copy of Ishtar.  For bitcoin transactions, an address is typically a random string of 34 characters such as

1CC3X2gu58d6wXUWMffpuzN9JAfTUWu4Kj

Essential thing #2: A private key

This is like your mailbox key that keeps other people from getting their slimy hands on your copy of Ishtar.  You go to your mailbox and unlock the door to pull out the sweet, sweet desert comedy stylings of Beatty and Hoffman.  (I know, it doesn’t exactly work with the drone–let’s just imagine that the drone can wirelessly open the door to toss in the DVD, mmkay?)

For bitcoin transactions, a private key is a 256 bit number that can be reduced down to a 51 key string such as

5Kb8kLf9zgWQnogidDA76MzPL6TsZZY36hWXMssSzNydYXYB9KF

So unless you’re really good at memorizing pairs of 34 and 51 character strings you will probably use wallet software to store your public address and private key for you.

Optional thing #3: Money

Just like with a regular wallet, it’s nice but not necessary to put money in it.  But if you want to send money, you need to have money.

Now, here’s where the wallet starts to get a bit tricky because unlike physical currency this is all virtual.  So instead of having money you have an address that Bitcoin, the network, agrees has a positive balance of bitcoins.  Think of that address as a pocket within your wallet.  And each of those pockets has the two essential elements–the public key and private key.  If the Bitcoin network says that pocket has bitcoins in it, then you have money to spend.

The Bitcoin Block Chain

When it’s time for you to conduct a bitcoin transaction, your wallet and the wallet of the other side in the transaction uses the Bitcoin network to add the transaction to the Block Chain.  This is a giant database that is a complete ledger of every transaction involving a bitcoin.

Say you are buying my copy of Ishtar because I have grown weary of all that sand.  We have agreed to complete the sale using bitcoins.   I have my wallet create a new address for you to send me money.  (This isn’t required but highly encouraged to keep all transactions secure.)  I send you the public key for this new address and await payment.

You instruct your wallet to deposit the agreed upon amount of bitcoins into my new address.  The instruction you give your wallet will include the address where the money is going as well as where the money is coming from (because your wallet probably has multiple addresses/pockets of money from different transactions).

The instruction sent from your wallet will be signed using your private key.  Your wallet then transmits this instruction to the Bitcoin network where miners race to verify the transaction.  Mining can technically be done by anyone with a computer and special software but doing so quickly requires specialized hardware and software.  Speed matters because transactions are lumped together in batches (typically the last ten minutes’ worth) and the first miner to verify the batch is rewarded with 25 bitcoins.

The reward for being the second miner to verify a transaction block? Nothing. Because bitcoins are for winners.

Verifying the transaction is a very technical mathematical operation that looks at the old bitcoin address (where the money came from), the new bitcoin address (where it’s going), and the signed transaction (which factors in your private key but doesn’t disclose it to anyone).  The process allows all the pieces of information to be checked without also revealing your private key.  It also ensures that the same bitcoins aren’t used in multiple transactions–the double spending problem associated with digital cash.  Regular currency avoids double spending because you hand over a physical item like a ten dollar bill–you don’t have that same bill to be used again.  Electronic transactions utilize a third party to ensure that the purchasing party doesn’t spend the same money twice (typically by establishing limits and then ensuring the purchasing party pays their bills).  For bitcoin transactions each transfer is based on the old address and the new address–the same money cannot be used twice.

Once the transaction is verified it is added to the Block Chain, the giant ledger of every bitcoin transaction ever made.  It is possible to follow a bitcoin transaction backwards from address to address all the way back to when the bitcoin was first created (as a reward for mining).  If you’re into that kind of thing.

Mining and Transaction Costs

Mining is the replacement for the current system which uses a trusted third party as the go-between with today’s transactions.  Today, if you wanted to buy my copy of Ishtar I would wait for a message from a trusted third party (American Express, Paypal, etc.) before handing it over.  With a bitcoin transaction I am waiting for confirmation from the Bitcoin miners before I hand over the DVD.  The good news (for me) is that it’s far less expensive to complete our bitcoin transaction since I am not paying the 2.5% of the total to the third party verifier.  The bad news (for you) is that the verification doesn’t come instantly.  And if you were ever using your credit card at a store and had to wait 10-15 minutes for verification of the payment you’d be pretty frustrated.  As it is, those extra 15 minutes of waiting for Ishtar could seem like forever.

Of course, the real forever is when you watch the movie. Because this is the most exciting thing in the film. Oh, sorry, spoiler alert.

For most online transactions this 10-15 minute delay doesn’t matter much–whether the Ishtar DVD is put into an envelope and sent immediately or 15 minutes later shouldn’t matter much.  But this does prevent a limitation for bitcoin transactions in the real world where speed matters.  There are already some bitcoin payment providers that are attempting to bridge this timing gap by providing instantly accessible transactions, but those come with a higher transaction cost and might not be as desirable.

Speaking of transaction costs, we discussed earlier how bitcoin transactions were aiming for 1% transaction fees instead of today’s trusted third parties taking 2.5%.  But we also just learned that miners are being paid with newly minted bitcoins–money not attributed to either the buyer or the seller.  So where is the 1% coming from?  Mostly from the wallet providers as a cost for converting bitcoins into currency.  In the future, however, all the bitcoins will be issued so miners can’t be paid with new money–instead the Bitcoin network allows for transaction fees to be built into the transactions.  Miners then will function similar to third parties today, taking a portion of the transaction to ensure the transaction is completed and the hope is that they take 1% or less.  Because otherwise that would be a lot of work for nothing.

Now I’m Going To Blow Your Mind A Little Bit

Because you’ve come a long way in understanding this new form of virtual currency and the system that makes it work, here’s a fun little bit of information to blow your mind.  Feel free to just skip this section if it confuses you too much but otherwise it’s a fun thing to think about at this point.

There’s no such thing as a bitcoin.

We’ve been talking about virtual currency this whole time trying to make the equivalent connections between these small b bitcoins and actual money because that’s how our minds work.  We’re used to money and we’re accustomed to electronic transactions with money because we’ve used credit cards and those are backed by real money.  But there aren’t any bitcoins.

There is no this.

All there is in this bitcoin economy is Bitcoin–the network that verifies the Block Chain.  A positive number, divisible into a million pieces, is created and passed from address to address.  But that’s all it is–an address of a number where we first imagined something of value existed and then we moved it to the next place.  Nothing was ever there in the first place.

In this case, bitcoins are really like fiat money.  It only has value so long as everyone agrees it has value.  And that is the start of some of the risks facing Bitcoin.  Risks that we will cover in part 3 of our primer next week.

Ready to read part 3?  Then here you go.

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