It is hard to miss a cryptocurrency-related headline when you tune into the business news. For a while now, cryptocurrencies such as Bitcoin have been in the limelight for several reasons, particularly around their volatile valuation.
In addition, there has been a recent interest in the taxation of cryptocurrencies. This has made cryptocurrency a trending subject all around the world.
But what exactly is a cryptocurrency and what’s there to know about it, especially for an accountant?
What is a cryptocurrency?
You’ve probably heard of bitcoin. 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 which is 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 uses a decentralised control system, and the cryptocurrencies are independent of any institution. By the same token, they are also not under the regulation of a central authority.
Currently, there are many cryptocurrency coins in the world. Bitcoin is considered the pioneer which is the reason you have heard the most about it.
Latest stats show there were over 18 million Bitcoins in circulation with a total market value of around $165 billion. Others 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 estimate figures are used in their analysis.
A blockchain acts as a database enabling the secure transaction of cryptocurrencies.
Creation of cryptocurrencies
Modification of the existing process to generate a fork and build an entirely new blockchain is how to create a new crypto. 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, i.e. have no maximum limit. Instead, they have a limit on the coins that can be created yearly.
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 while in Mexico, cryptocurrency or its transaction is illegal. In Bolivia, Nepal, and Bangladesh, there are jail sentences for those who use or transact crypto.
Up until recently, there hasn’t been any debate on the taxation of cryptocurrencies. Lately, however, this has been an area of debate as there has been little guidance on this topic.
In the US, 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.
Cryptocurrency can be viewed as personal, business or investment property. If you have an interest in cryptocurrency, you should follow on this discourse, should there be future guidance from the involved organisations and bodies.
As complexities keep piling around the taxation topic, there’s no better time to get acquainted with cryptocurrency accounting basics.
It’s also important as an accountant to understand cryptocurrency as it will enable you to handle your responsibilities and duties to a cryptocurrency client efficiently.
Below are 7 things you should have in mind while keeping books for cryptocurrency clients. You can also learn more by taking our short free course on cryptocurrency.
1. Cryptocurrency is a virtual currency
As mentioned earlier, cryptocurrency is a digital virtual currency that is internet-based. It’s 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 also an investment. It can, therefore, be managed just as investment forms such 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.
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 the IRS in the United States doesn’t audit crypto, this may not be the case in the future. 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.
As said before, this is far from all to know about crypto. Make a point of going further and learning more.
Mistakes cryptocurrency clients make
As an accountant, it is important to be aware of the mistakes most clients make when it comes to cryptocurrency.
- Most clients don’t fully disclose their assets and transactions for tax reporting
- The majority of the clients give falsified or omitted data
- Miscalculations mostly centred around profits and losses
It is undeniable that cryptocurrency is the new wave in the financial world. It doesn’t seem like fading any time soon especially as it conforms to the digital world we live in currently.
Understanding cryptocurrency would be a great addition to your portfolio as an accountant.