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What are Cryptocurrencies and Why do I need to know about them?

One of the newest and most talked-about financial trends of the modern era is the rise of cryptocurrency and how it has impacted the market.  

For a while now, cryptocurrencies such as Bitcoin have been in the limelight for several reasons, particularly around their volatile valuation and constantly fluctuating value. In addition, there has been a recent interest in the taxation of cryptocurrencies. This has made cryptocurrency a global talking point.  

But what exactly is a cryptocurrency and what is there to know about it, especially for an accountant? 

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Cryptocurrencies have a extremely volatile nature!

What Is a Cryptocurrency? 

Let’s start with the basics. You’ve probably heard of Bitcoin, and if so, then you also likely have a rough idea of what cryptocurrency is. A cryptocurrency is a digital asset that exists in binary form, primarily meant to work as a medium of exchange.  

Unlike paper money, cryptocurrency makes use of cryptographic (a sophisticated encryption system) to secure transactions. Cryptocurrency revolves around a decentralised control system, and the cryptocurrencies are independent of any institution or nation. Because of this, they are also not under the regulation of a central authority or government, attributing to their constant fluidity of valuation. 

Currently, there are many cryptocurrency coins in the world. Bitcoin is considered the pioneer and the most well-known, which is the reason why it is cemented in mainstream knowledge.  

The latest statistics from Investopedia show there were over 18 million Bitcoins in circulation with a total market value of around $165 billion. Other forms of cryptocurrency include Ethereum (ETH), Ripple (XPR), Litecoin (LTC), and Monero (XMR).  

Today the coins have a combined market cap of over $196 billion. However, as cryptocurrency price valuations are volatile – due to their decentralised control system – only estimate figures are used in their analysis.

Creation Of Cryptocurrencies

Creating new cryptocurrencies is a little complex. It involves modification of the existing process to generate a fork and build an entirely new blockchain. This blockchain is the means through which cryptocurrencies are traded. 

For instance, most of the altcoins are forks that were modified from Bitcoin. The mining process is used to generate more coins of an already existing crypto. Cryptocurrencies like Bitcoin are finite whereas others are not capped and thus have no maximum limit. Instead, they artificially limit the quantity of coins that can be created yearly, driving up demand. 

Although cryptocurrency has been accepted as a medium of exchange as well as investment, some countries have restrictions on it. China, Saudi Arabia, and Zambia have restrictions. Whilst, in Mexico, cryptocurrency or its transaction is illegal. In Bolivia, Nepal, and Bangladesh, there are jail sentences for those who use or transact crypto. 

Cryptocurrency Taxation 

Cryptocurrency is typically considered one of three things: a personal, business or investment property. Yet despite those labels, up until recently there has not been any debate on the taxation of cryptocurrencies.  

In the United States a notice (Notice 2014-21) was given back in 2014 that implied cryptocurrency should be taxed as it was treated like property. Nonetheless, holding the cryptocurrency without using it to accomplish a purchase or selling it doesn’t incur you a tax as of yet. However, the trading of cryptocurrency can generate losses or rewards in the form of gains, which as a result is taxable. 

Cryptocurrency Accounting 

As complexities keep piling around the taxation topic, there’s no better time to get acquainted with cryptocurrency accounting basics. This new form of currency is important to understand as an accountant because it will enable you to handle your responsibilities and duties to a cryptocurrency client efficiently, widening your scope of potential customers.  

Below are seven tips you should always keep in mind while working for cryptocurrency clients:  

1) Cryptocurrency is a virtual currency 

It is vital to remember that cryptocurrency is a digital virtual currency that is internet-based. Thus, it is not considered a real currency (a legal tender), albeit it can be transacted and used to purchase commodities. Similarly, cryptocurrency can be traded to make profits; hence, it is also an investment. It should, therefore, be managed in a similar manner as stocks and funds. 

2) All cryptocurrency transactions are subject to tax 

The trading of cryptocurrency can generate losses or rewards in the form of gains. These gains or losses are taxable. 

3) The more coins involved, the harder the accounting level  

When a person transacts more than one coin type, a lot of events are involved such as cost base calculation and fair market values. This makes the process of accounting onerous and demands a high-level of accounting expertise. 

4) Calculation of gain and losses must be based on the adjusted cost base  

The adjusted cost base represents the average cost of the cryptocurrency, including the first and last acquired by an individual. In the case the client makes use of more than one crypto, the adjusted cost base is independently calculated for each coin. 

5) Cryptocurrency transactions do not get audited  

Although currently organisations such as the IRS in the United States doesn’t audit crypto, this may not be the case in the future and in other countries. Therefore, to keep your client safe, you should record and consequently give an account of profits as well as losses. 

6) Transaction value hinges on FMV  

Regardless of the transaction, the value of the cryptocurrency is determined by the Fair Market Value (FMV) on that day. 

7) Tax associated with hobby and business  

For cryptocurrency transactions carried out as hobbies, only half of the gains will be subject to taxation. For cryptocurrency transactions carried out as business, all the gains will be subject to taxation.

Mistakes Cryptocurrency Clients Make 

There are three main issues that may occur should you decide to deal with cryptocurrency clients:  

1) Most clients don’t fully disclose their assets and transactions for tax reporting 

2) The majority of the clients give falsified or omitted data 

3) Miscalculations mostly centred around profits and losses 

Make sure that you take into consideration these potential problems when auditing your clients. Due to the relative infancy of cryptocurrency, many don’t fully understand the difference between it and traditional forms of currency, and it is your job to inform both yourself and them.

Final Thoughts  

It is undeniable that cryptocurrency is creating waves in the financial world. Before long, it could be a permanent feature of modern banking – it’s complimentary nature to the current digital age makes it an ideal form of currency. 

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If you need help managing your taxable income, perhaps as a result of gains made through cryptocurrency, contact one of our experts today to see where we can help! 

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