Cryptocurrency: The Digital Gold Rush
Cryptocurrency is a form of digital money that is created from code and encrypted. The original cryptocurrency, Bitcoin, was introduced in 2009 by pseudonymous developer Satoshi Nakamoto as “A Peer-to-Peer Electronic Cash System.”1
In traditional centralized banking systems such as the Federal Reserve, the government controls the supply of currency. Cryptocurrencies are decentralized, with no single party having control or oversight. Instead, the system is maintained by “miners” who are members of the general public that use their computers to authenticate and record transactions to the cryptocurrency’s ledger. Confirmed transactions are irreversible, unalterable, and permanent, therefore making the system extremely secure.
Most cryptocurrencies define the maximum number of “coins” that can be produced, thus limiting the total supply that can be in circulation. For example, there will only ever be 21M bitcoins.2 The mathematically limited maximum is analogous to the limited supply of precious metals that are used as (or as the basis for) currency.
According to a recent court case against Coinbase, a popular cryptocurrency service, only 802 people declared their gains from the sale or exchange of cryptocurrency to the IRS in 2015. The number of taxpayers reporting income from the sale of cryptocurrency has largely remained flat.3 Cryptocurrency has tremendous value globally, with a $95B market cap4, of which Bitcoin accounts for nearly half. The IRS has been looking for ways to ensure that transactions denominated in cryptocurrencies are properly reported and any tax owed is paid. At the moment, the IRS has published guidance only once – Notice 2014-21.5 Per Notice 2014-21, virtual currency is treated as property for federal tax purposes. For non-dealer taxpayers selling or exchanging cryptocurrency, gains or losses on such transactions that are capital in nature are reported on Form 8949, much like a similar transaction involving precious metals or currency would be. For other transactions involving cryptocurrency, the value of the cryptocurrency received or paid must be determined in U.S. dollars at the time of the transaction. Once converted into U.S. dollars, the transaction would be treated as any other transaction and the facts of said transaction would determine its treatment for tax purposes.
As the world moves towards paperless payments, the increase in cryptocurrencies is a natural part of the world’s economic evolution. Marcum will continue to monitor new developments with the IRS and other taxing authorities related to this new frontier.