The R&D Tax Credit Aspects of Bitcoin and Blockchain Technology
Cryptocurrency is a digital or virtual currency that
uses cryptography for security. Bitcoin technology, a type of
cryptocurrency, is "a purely peer-to-peer version of electronic
cash." It allows payments to be sent between parties without
involving a third party, such as a bank. Bitcoin requires components
such as digital signatures to function properly. It also employs the
blockchain, which is a public ledger for all Bitcoin transactions.
Increasingly, more attention is focused on future development of
blockchain technology. Companies developing innovative software for
online crypto-currency may be eligible for R&D tax credits.
The Research &
Development Tax Credit
Enacted in 1981, the federal Research and
Development (R&D) Tax Credit allows a credit of up to 13% of
eligible spending for new and improved products and processes.
Qualified research must meet the following four criteria:
- New or improved
products, processes, or software
- Technological in nature
- Elimination of
- Process of Elimination
Eligible costs include employee wages, cost of
supplies, cost of testing, contract research expenses, and costs
associated with developing a patent. On December 18, 2015,
President Obama signed the bill making the R&D Tax Credit
permanent. Beginning in 2016, the R&D credit can be used to offset
Alternative Minimum tax and startup businesses can utilize the credit
against payroll taxes.
Bitcoin is a cryptocurrency that relies on the
blockchain ledger. Through a Bitcoin address, currency is securely
exchanged between users. First, the Bitcoin wallet is downloaded on a
computer or mobile device. Using QR codes or public key access, the
Bitcoins are transferred to another wallet. Transactions will be
confirmed before they are added to the blockchain.
In order to confirm a transaction, it
must be in a block that meets the cryptographic rules verified by the network. The rules will help
prevent previous blocks from changing. After all, once one block is
changed, all the blocks before it become invalid. Whereas Bitcoin is
experiencing obstacles in overcoming privacy issues, blockchain
technology is beginning to prosper within the financial industry.
How the Bitcoin Process
Links with Blockchain:
Hashes and Timestamp
Bitcoins are stored in addresses that consist of a
private and public key. The hashes (signatures) used for Bitcoin
are SHA-256 (for transaction verification) and RIPEMD-160 (used after
SHA-256 for digital signatures). The process of a hash and
timestamp solution is indicated below:
- Takes hash of a block of items.
- The hash must be time stamped & widely published.
- Timestamp proves the data existed at that time.
- In order to get into the hash, the data must be proven to be
there at that time.
Each timestamp is composed of the previous timestamp
in its hash. This forms a chain in which each additional timestamp
reinforces the one before it. Bitcoin uses a proof-of-work system
defined as mining to scan for a value after it is hashed. The
chart below illustrates the process of Bitcoin transactions:
A proof-of-work system (POW) is an economic measure
intended to eliminate denial of service attacks (DoS) and spam on a
network. It requires some work from the service requester, typically in
the form of processing time by a computer. While this piece of data is
costly and time-consuming to produce, it is easy for people to verify.
Producing a proof-of-work can be a random process with low probability.
As a result, a great deal of trial and error is required on average
before a valid proof-of-work is generated.
Bitcoin uses the Hashcash proof-of-work function as
its mining core. Hashcash can be used as a method to prevent email
spam. It will require a proof-of-work on the content on every
email. Mass spam emailers will have difficulty generating the
required proofs. Similarly, hashcash proofs-of-work are used in Bitcoin
for block generation. Miners must complete a proof-of-work for a block
to be accepted by network participants. This encompasses all data in a
single block. New blocks can be generated every 1 to 10 minutes. It is
unpredictable which work computer in the network will generate the next
block because of the low probability of successful generation.
A block is valid when it hashes to a value less than
the current target. In other words, each block indicates that work has
been done to generate it. Each block has the hash of the preceding
block so that each block has a chain of blocks. To alter one, a block
requires regenerating all successors and redoing the work they contain.
Because this is such an arduous process, changing a block is highly
unlikely. Furthermore, this protects the blockchain from being tampered
with and therefore increases its security.
This most widely used proof-of-work scheme is based
on SHA-256. The SHA-256 function hashes a block from the miner and
checks for matching patterns to build it onto the existing block.
Bitcoin uses the same SHA-256 function for each block using the
previous block to generate a hash. When the new block is created, the
previous block's work becomes irrelevant. In order to
modify a previous block, "an attacker would have to redo the
proof-of-work of the block and all blocks after it, then catch up with
and surpass the work of the honest nodes." As mentioned
previously, this function is configured to provide minimum risk of
Bitcoin is a developing digital currency that cannot
confirm authenticity of a transaction. For example, double-spending
arises as an issue because a user may send funds to another and then
instantly send those funds to a second person during the processing
time (usually 10 minutes). The problem is the ability to copy digital
assets. For example, digital cash (which can be an image attached
to an email) can be copied countless times. Because it is a
decentralized currency, Bitcoin should find solutions to the privacy
issues that may arise.
I. The Big Picture: Blockchain is a
network that all users can access. Using unique 64-character hash
functions, a "winning" block will be added to the blockchain. Usually a
block that makes it to the chain will correspond with a certain number
of zeros in the beginning that match the previous block on the chain,
followed by different ending numbers.
Blockchain made significant developments throughout
the years since creation of Bitcoin in 2009. Its intended goal is to
produce a reliable network for unrelated people to undergo
transactions. An obstacle in this development is that some people who
cannot be trusted may try to corrupt the network. Fortunately, they
came to the solution of using majority rule to overrule disagreements
in the blockchain.
II. Payment Verification: Blockchains
have "block headers" which appear on every block. If the user keeps a
copy of the header, then going back in hashes is simpler. Using the
longest proof-of-work chain and block header, it can be proven that the
block with a payment exists. Once found in the network, it is
confirmed. It is difficult to copy a long chain, so those chains are
usually considered the "honest nodes." If there is any suspicion that
an attacker has presence within the network, a precaution is to accept
notifications about when the network suspects fraudulent activity or
run them independently to have quicker responses.
In recent years, banks and other financial
institutions found blockchains to be disruptive. Blockchain represents
a digital ledger in a shared database where all participants can access
each transaction that gets bolted to the next. Banks see
blockchain as a threat because without a uniform system among their
closed and existing networks, banks will see incoming competitors as a
Threats that blockchain impose on present "financial
playing fields" are becoming more evident as blockchain develops.
Participants can see previous transactions and what others paid to one
another which may leave hedge funds falling behind in recognizing
ordinary trader transactions.
Blockchain has advantages but also disadvantages.
Disbeliefs concerning blockchain exist in terms of security. Blockchain
relies on "consensus and collective memory" to filter out forged and
erroneous transactions that lead to fraudulent transactions with
on the Banking Industry: Banks offer closed ledger systems and
recognize that if they do not develop a common system, competitors will
gain an advantage and work towards eliminating their power via the
blockchain. Over 30 banks, including Goldman Sachs, are involved in a
blockchain network development project called R3 CEV. This project
plans to create a uniform system for banking institutions. If
banks can work together, this may eliminate threatening competition as
well as form a more efficient system to operate normal banking
IV. Blockchain vs. Credit Card Companies:
"an open source software program that is shared on the
Internet, and has the potential to remove multiple layers of processes
and intermediaries in the sequence of steps that ‘settle’ or ‘clear’
payments from one party to another." Concerns of credit card
providers, such as Visa, MasterCard, and American Express, are rising
due to the rapid growth of blockchain technology and the threat it
imposes. Bitcoin is a unique visual currency that has potential to grow
but the disbelief of "fantasy money" to consumers is too high. As
Bitcoin came into play, blockchain technology was able to step in and
grow off the concept of internet-based banking. Blockchain is
decentralized and separate from Bitcoin. It is projected to have a much
larger impact than Bitcoin on various industries.
Blockchain uses a chain of computer codes and debits
and credits in the online ledger. The ledger can provide information
about any currency (Bitcoin, dollars, etc.). The reason
blockchain technology can surpass the success of Bitcoin is because of
the trust it provides. Blockchain instills a unique concept that is
appealing in the financial world because no one owns it.
There is no way for an individual or private organization to gain on
blockchain technology profits. This leaves no issue of parties trying
to dominate in the ledger.
Credit card companies fear the risk of being
replaced by blockchain. According to Barrons.com, blockchain is an
"internet technology," not a "financial industry technology, therefore
[it] will still require the use of banks in their activities. In the
future, banks will ‘play a role as underwriters for blockchain risk,
guaranteeing deposits in local currencies around the
world.’" Cryptocurrency advancements and blockchain
developments are very similar to the changes occurring in the payment
industry. As new entrants continue to expand, it is important to adapt
to the emerging changes. Without competition, new technology
innovations will wipe out banks as long as payment technologies and
blockchain developments. New market entrants impose a threat to
established organizations. With growing markets in payment technology,
cryptocurrency, and blockchain, new entrants have the ability to
attract substantial capital investment.
The payment industry is undergoing change that
credit card companies ought to adapt to. There are several threats that
can substantially reduce or remove credit card companies. For example,
banks and credit card companies must adapt to:
- Mobile payments,
eCommerce, tokenization, crypto-currency, and blockchain technology
- Bank’s role: Banks issue
credit cards, plug your phone into blockchain, and all bank accounts
will be reflected
is one company that has hopes for blockchain technology.
The investment bank filed a patent for an e-currency called "SETLcoin"
that will be the virtual currency providing "nearly instantaneous
execution and settlement." The technology shows an efficient and
fair way to execute transactions, which Goldman Sachs is anticipating
for the success of blockchain technology.
To start off 2015, Bitcoin had a decrease in value, which created
doubts about future success for investors. For example, a Bitcoin
exchange start-up called Bitstamp (UK and Slovenia) had its system
hacked, where more than 19,000 Bitcoins were in possession.
Security concerns with the currency arise from events like this, and it
proves the technology has potential with further innovation.
Many developers and miners who keep a close eye on
emerging Bitcoin trends show high interest in the applications that can
be built on Bitcoin's blockchain. According to Fortune Magazine,
blockchain is "the currency's foundational backbone" that allows the
secure exchange of any form of value between two users. In 2014,
Bitcoin was adopted by many companies including Microsoft, PayPal, Dell
and Dish Network, Target, Overstock.com, and WordPress. It is
anticipated to continue being adopted by more companies.
Holdings LLC: According to Bloomberg
Business Journal, Blythe Masters is seeking a new investment in
blockchain technology. Being involved in the financial industry for
many years, Masters takes this developing technology very seriously
because it can evolve the way financial transactions are executed with
the right innovation. She supports that blockchain technology does not
rely on Bitcoin or require third party approval or control of
transactions. Masters say that costs will decrease from using
blockchain technology. As a result, revenues will increase.
America: On September 17th, 2015, Bank of America (BoA)
released its patent-published app using cryptocurrency to protect wire
transfers between customers. This technology will be supported by
BoA's wire transfer process
- Funds transferred to a cryptocurrency exchange
- Conversion to a cryptocurrency (such as Bitcoin)
- Sent to another exchange
- Converted into another currency for the recipient
As BoA is moving towards a digital currency, it is
predicted that many other financial institutions will make the same
change in coming years. Finally, there have been many investments in
blockchain start-ups including: Blythe Masters Digital Asset Holdings
LLC and Boost VC. In fact, blockchain investments increased more in the
first quarter of 2015 than in 2014. It is expected to
R&D in Blockchain
Blockchain requires innovative updates to
continuously improve its technology. Improvements include security,
accessibility, easily usable, and more. There are custom blockchains
that companies are building to perform internal tasks more efficiently,
along with pre-built blockchains that are ready to use. These
blockchains require people with backgrounds in "math, cryptography,
statistics and computer science." With research and studies in
blockchain technology, there is potential for R&D tax credits.
Bitcoin is a new, unique form of virtual currency
that is continuously improving. New developments continue to emerge
with both Bitcoin and blockchain technology. Players in the financial
and banking industries are seeing growth for blockchain technology in
the near future and are planning to adapt to such changes. Blockchain
requires uniformity among the banking institutions that exist today in
order to gain an advantage against competitors. Although Bitcoin shows
the potential to innovate and increase its presence, blockchain
technology shows more of a capability to succeed in future years.
Innovation related to Bitcoin and blockchain technology development
provides an opportunity to receive federal and state R&D tax