Cryptocurrencies have taken the world by storm. You can’t turn on CNBC, open the Wall Street Journal, read the Financial Times, or access social media without seeing something about them daily. What is the big deal with crypto? Is it here to stay and how does it work? These are great questions many of our investors are pondering and wondering how to position themselves for the future. The first cryptocurrency created was Bitcoin; therefore, we will use Bitcoin as our example in this article.
Bitcoin was created as a digital store of value that uses an open network referred to as the blockchain to secure transactions. Today, when you pay for a good or service you pay with a fiat currency (dollar, Euro, etc.), processed on a closed network, typically either through Visa’s or Mastercard’s networks. The blockchain creates a digital ledger that secures and verifies transactions on its platform. Think about the blockchain as a continuously updated checkbook ledger that is universally accessible to all. Bitcoin itself is the coin created to move across this blockchain platform. It is assigned a value by how much people are willing to pay for a coin, and that transaction happens on the blockchain when you go to purchase your coin(s).
The decentralized component and the blockchain technology are what has attracted investors into the crypto space. However, since there is no governing body regulating this industry as of today, it is sometimes used for more nefarious reasons. It has garnered much attention as hackers will often hold companies “hostage” until they are paid in the form of cryptocurrency. Hackers will often ask to be paid a “ransom” in cryptocurrency. They do this because at present you cannot easily trace transactions on the blockchain. This is one reason why investors may be hesitant to invest in the space.
Despite the nefarious uses of cryptocurrencies, the investment world is becoming more open to the adoption of this technology and identifies it as a store of value. While incredibly volatile, Bitcoin and other cryptos have seen huge gains in the last year. Part of this is driven by pure demand, but also by the fact that businesses and governments are becoming more open to its adoption. For example, El Salvador made Bitcoin its official currency! However, headwinds still exist for investors in this space. The Chinese government has made transactions involving cryptocurrency illegal. The SEC (Securities & Exchange Commission) is looking into possible regulation related to the industry. Another headwind for the crypto industry is how it is taxed when sold or used as payment.
Understanding how Bitcoin and other cryptos are taxed is also incredibly important. Though Bitcoin and others trade as coins that are held in digital wallets, they are not currency. The IRS views these as property owned, the same as the stocks you may own in your portfolio. Therefore, if you were an early adopter in Bitcoin, you may be sitting on significant capital gains. These are taxed either as ordinary income if it is a short-term gain, (a gain you realize within 365 days of your original purchase date) or as long-term capital gain, (a gain realized after holding for more than 365 days) either at 15% or 20%. Make sure to account for that when selling or using crypto to make any purchases or sales.
Cryptocurrency isn’t going anywhere anytime soon. It is important to understand how it works, how it is utilized in real life applications, and how to handle it as an investor. Blockchain technology has the potential to change the financial industry; however, we are still far from that. It doesn’t have the power or the speed to handle the current bandwidth of financial transactions. Nevertheless, expect it to be reported on a lot and become more mainstream. If you have questions about cryptocurrencies give us a call at 904-346-3460. We would love to discuss more with you!
By: Scott Wohlers, VP Riverplace Capital