Bitcoin has stormed onto the main stage in the past year. Although this cyber currency originated more than five years ago, its value rose dramatically in 2013 from US $13.56 per coin at the beginning of the year to US $750 at year-end. In fact, on Nov. 29, one bitcoin was worth US $1,159.02--not far from the closing price of an ounce of gold (US $1,252.10) that day.
The modern-day gold rush has waned from such heights this year. In February, Mt. Gox--the exchange that handled about 70 percent of all bitcoin transactions--closed after falling victim to the theft of more than 740,000 bitcoins and filed for bankruptcy that same month. Despite this collapse, bitcoins currently trade in the US $450 to $500 range and more than 1,000 businesses accept them as payment.
As bitcoins become more commonplace, internal auditors need to understand the ramifications of this cyber currency to organizations. By having a basic understanding of bitcoin, auditors can better assess the possible risks and impacts to their organizations.
A Bitcoin Primer
Bitcoins are based on the concept that money can be any object used to accept payment for goods and services. The original idea was proposed as a peer-to-peer version of electronic cash, in which the individual nodes (peers) in the network are both suppliers and consumers. Members of the network create bitcoins in a process known as "mining," in which users devote computing resources to solve a complex mathematical problem. When users find a solution to the math problem, new "blocks" are created and attached to the existing "blockchain," which is a complete public record of all bitcoin transactions and is the foundation for the security and integrity of the currency. Users are rewarded with bitcoins when the math problem is solved. At present, users receive 25 bitcoins for each block, with an average of six blocks created every hour. There currently are more than 12.6 million bitcoins in circulation.
This process also facilitates, secures, and validates transactions in the currency. To transfer the currency, users must have a bitcoin wallet that provides ownership of a bitcoin balance and a unique address, which is saved with each transaction. For security, the transactions are based on public key cryptography in which a user has both a public key and a private key. When a user spends the bitcoin, the new owners public key is attached to the coin, and the previous owners private key is used to validate the...