Chances are, you have been around someone who was talking about trading digital currency or checking their phone every day to see how their Bitcoin or Ethereum was trending in the global market. Here is the reason why … Since 2011, the cryptocurrency market went from being worth a modest $10 million to being worth roughly $3 trillion dollars, as of November 2021. In 2011, there were only a few cryptocurrencies on the market, and now, there are over 15,000 on the market. It’s growing in popularity by the day, so let’s take a few minutes to look at what you should know before getting involved with these digital dollars.
What is Cryptocurrency?
In its most basic form, cryptocurrency (or “crypto”) is a type of payment that can be exchanged online for goods and services. Some companies have issued their own form of currency, often known as tokens, to be used for company-specific goods and services. You can use these tokens like you would at an any arcade or casino, just in an online capacity. Cryptocurrency is paid for by real currency, as you would at any in-person store, to access the good or service.
Digital assets like cryptocurrencies utilize unique coding and blockchain technology to operate autonomously, without need of a central party such as a government, person, bank, or company to manage the system.
Much of the popularity around crypto—and perhaps why you hear about it on social media or around your family this past holiday season—is because these digital currencies can also be traded for profit, in addition to being traded for goods and services. Bitcoin was the first cryptocurrency created in 2009 and currently sits as the number one most profitable cryptocurrency today with a price of $46,446.01 USD per coin (as of December 20, 2021). From January 2009 to March 2010, the bitcoin really had no value. And in May 2010, the price of a bitcoin was less than $0.01.
Types of Crypto
Crypto assets are categorized by how they are used. Although many terms in the space are used interchangeably, which can make it confusing for someone attempting to learn how to invest or purchase something online, there are three basic categories that digital assets can be organized into.
Crypto Assets or Digital Assets
This all-encompassing phrase is a catchall term in the crypto space and will cover all the unique assets that have evolved from the blockchain revolution since 2009, when bitcoin was first created, and that use cryptography. Cryptography is how the digital assets are sent securely through encoded message. This is a category that both cryptocurrencies and crypto tokens will fall into.
Crypto assets are also called crypto coins and are those native to blockchain. Ether (ETH) and bitcoin (BTC) are examples of crypto assets known as crypto coins and are native to blockchains. For example, the bitcoin is the native cryptocurrency to the Bitcoin blockchain, and ether is the native digital currency of the Ethereum blockchain. These coins are used to pay transaction fees and compensate miners, also known as users, who verify the transactions on the digital ledger for a blockchain using machines with extensive hardware and software resources.
Unlike coins like ether and bitcoin, tokens don’t have their own blockchain and instead run on top of an existing blockchain. Tether (USDT) is an example of a token that operates as a “second-layer token on other cryptocurrencies’ blockchains such as Bitcoin, Ethereum, Tron, and a few others. Decentralized Finance (DeFi) tokens are also organized in this category.
Of the thousands of crypto assets that have been created since 2009 when bitcoin first entered the market, they will all fall into these 3 categories. We know that they will be a digital asset by being a crypto asset. Many get confused when “crypto asset” is shortened to simply “crypto” and mistakenly think they all have blockchains of their own or may not know the real difference between coin and token.
Benefits and Risks of Virtual Currency Trading
Like most everything in life, there are pros and cons of getting involved with digital currency. What draws people to crypto assets are they are faster than traditional banks with 24/7 accessibility to accounts, simpler international payments, and direct payment handling between two parties, without the need for any middleman, usually at a lower cost. Banks often reduce the value of money via inflation, and digital currency offers an alternative, autonomous solution. By using cryptography and secret keys between users, transactions are also made more secure.
However, even with the most popular form of currency such as Bitcoin, users are being exposed to great risk with potential for great reward. The golden rule of investing in a volatile market such as digital currency is never invest more than you are willing to lose. This means that any cryptocurrency account, by definition, can’t have Federal Deposit Insurance Corporation deposit insurance because as it isn’t through an FDIC-insured bank. As we discussed earlier, digital assets like cryptocurrencies utilize unique coding and blockchain technology to operate autonomously, without need of a central party such as a government, person, bank, company, to manage the system.
More regulations and recommendations on how to make the system equitable are potentially making their way to the traders of digital assets. The government is currently passing a bill known as HR 1602 Eliminate Barriers to Innovation Act of 2021. The bipartisan bill was passed by the House on April 20, 2021. It is to establish a working group to better understand the framework around the rapidly growing digital currency market to provide recommendations around fairness, cybersecurity, and reduction of fraud and manipulation. While crypto has sparked a lot of financial innovation and development, it has also brought about new opportunities for hackers and scam artists. For example, over $7.7 billion was stolen in crypto scams in 2021 as the digital currency becomes more and more popular in the U.S.
How is Crypto Taxed?
Crypto taxes are based on a 2014 IRS ruling that determined digital assets like crypto should be treated like a capital asset such as stocks or bonds, instead of a currency. This opens owners of crypto for more complicated taxes.
What determines how much a person owes in cryptocurrency taxes depends on the following information:
- Annual Income
- How long you’ve held your cryptocurrency
If you’ve owned your coins for less than one year before spending or selling them, any profits would be short-term capital gains, taxed at your normal tax rate. If you’ve held your crypto for one year or more, any profit would be long-term capital gains, taxed at a lower rate, determined by your annual income.
If you earn cryptocurrency by mining it, or receive it as a promotion or as payment for goods and services, it counts as regular taxable income.
You’re Not Alone in Navigating Your Crypto Taxes: Hire Lawhorn CPAs!
Crypto has evolved greatly in the last 10 years, and it’s exciting to want to get involved on the ground level of it as an investor. Don’t let tax implications hold you back from exploring a possible opportunity with a reputable company after the appropriate amount of research and exploration. At Lawhorn, we pride ourselves on continuing education and staying in tune with the latest virtual currency tax law and trends so we can help you avoid tax consequences where possible and save money every year. While crypto may not be for everyone, we know that we have the tax advisors equipped for the people that do own cryptocurrency and trade in virtual currency no matter what changes come down the road with regulations or taxes.
Contact us today to learn more about how we can assist you today with your unique cryptocurrency wallet.