Bitcoin is "the grandfather" of cryptocurrency, as well as the first official application of blockchain technology. Given this, it is an inherently disruptive technology. Just as blockchain technology has disrupted traditional ledger technologies, Bitcoin has made waves in the fintech and currency spaces by successfully sustaining a decentralized, yet secure digital currency solution.
Bitcoin does not need centralized institutions—like banks—to be its backbone. Instead, a cryptographic encryption system acts as the mathematical authority required to organize and verify transactions. Bitcoin miners task their PCs with solving pieces of an open-source algorithm, which helps to organize and verify transactions. In return for their hard work, this mathematical authority compensates miners in Bitcoin in proportion to their efforts.
Miners can then exchange Bitcoin for fiat money like USD, or use them to buy goods and services directly.
Bitcoin and the US government have an interesting relationship. Between Bitcoin's trademark volatility, and its superficial associations with the nefarious, not to mention the anxieties officials must have about ceding monetary control and fiscal policy to what is essentially an algorithm and those that verify the transactions (if it would ever come to that), it makes sense that the government would be uneasy about mainstream acceptance of the currency.
First, cryptocurrency exchanges started pairing Bitcoin to fiat counter-currencies such as the dollar. These platforms, like Binance and even Coinbase remain popular today. The increasing presence of Bitcoin in finance is also evidenced in Bitcoin futures contracts, which are traded on major institutional exchanges like the Chicago Mercantile Exchange and the Chicago Board Options Exchange.
Given this acceptance, and Bitcoin's gradual inroads into the established market, it only makes sense that Bitcoin has become subject to some institutional pressures. And indeed, regulators watching over this latest entry to their ecosystem have also exerted their own influence on Bitcoin.
The Internal Revenue Service (IRS) recently said it is in the process of mailing 10,000 educational letters to taxpayers it suspects owe the government taxes on virtual currency transactions. It is entirely possible that the federal agency has based its list of recipients on customer data it acquired from cryptocurrency exchange Coinbase. Those who do not report income correctly can face penalties, interest or even criminal prosecution, warned the IRS.
Bitcoin and Taxes
While originally proclaimed anonymous, the lion's share of Bitcoin transactions today are transparent. Governments have observed surges of black-market trading using Bitcoin in the past. Exchanges now impose anti-money laundering requirements on Bitcoin traders to avoid drawing the ire of regulators.
The biggest change for Bitcoin traders, though, has been taxes.
While regulators, central bankers, and federal judges all have different opinions on how to categorize Bitcoin, whether a currency or commodity, they all seem to agree it should be taxed. Most major countries tax cryptocurrencies similarly, too.
So, what does that mean for traders?
The Specifics
The first thing to know is that nothing matters until it’s put into law. There's always speculation about what will happen based on what some financial regulator says, but no individual has the ability to redefine an asset or unilaterally alter tax code, and little has changed since the IRS first addressed cryptocurrencies in 2014.
In the United States, IRS Notice 2014-21 defines virtual currencies as property. This means anything purchased using a digital currency is liable to be taxed as a capital gain whether short or long term depending on how long the asset was held.
For instance, if you buy a cup of coffee using Bitcoin that you purchased when it was worth $1,000, you must also account for the price of Bitcoin at the time of the coffee purchase. If Bitcoin is trading at $1,200 when you buy the coffee, you’ve purchased a dollar-denominated good with another asset that is now worth more in dollars than it used to be. That means the amount of Bitcoin you spent on the coffee will be taxed according to capital gains rules.
While cryptocurrency brokers aren’t required to issue 1099 forms to clients, traders are supposed to disclose everything to the IRS or face tax evasion charges. Taxable transactions include:
Exchanging cryptocurrency for fiat money, or “cashing out”
Paying for goods or services, such as using Bitcoin to buy a cup of coffee
Exchanging one cryptocurrency for another cryptocurrency
Receiving mined or forked cryptocurrencies
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