A lot of new interest is likely linked to the news stories about larger institutional investors getting involved in Bitcoin (Phase 2).
Phase 1- Consisted of a small number of rogue individuals and institutions that took a chance on Bitcoin, and what it could do for them (i.e. tech geeks and Silk Road users).
Phase 2- Larger number of institutional investors see the returns and decide to participate (i.e. hedge funds, big Wall Street money).
Phase 3- Everyone else who doesn’t want to miss out.
Que the bubble pop…
Phase 4?- Might be able to minimize the bubble issue if more governments adopt and endorse Bitcoin (or another crypto) as a national currency.
Major retailers are starting to accept Bitcoin as a payment method.
Microsoft- allows users to purchase games, movies and apps using BTC, in the Xbox store and Wondows store; not necessarily for in-app or in-game purchases.
More Than Your Grandfather’s Payment Systems
At its humblest, Bitcoin is a new type of payment system. But, trying to compare Bitcoin to USD, Visa or PayPal is like trying to compare apples to crackers, cheese or cucumbers. Although they serve a common purpose, they go about it in extremely differing ways.
This is a huge tenet of the cryptocurrency mission.
The blockchain creates a relatively secure, peer-to-peer network for carrying out the transactions.
Users (nodes) employ software that follows identical mathematical rules, to verify transaction blocks.
Although its network design is open-source and public (accessible to anyone with internet and an allowing government), Bitcoin still has some developers andinvestors who have gained considerable influence over the community.
When there is divergence among developers and investors as to how the network should be run, a fork can happen (i.e. Bitcoin Cash).
First To Market, Digital “Money”?
There is no doubt that Bitcoin maintains a considerable advantage as the first mover and trend setter in the market of digital currency, but does it do a good job at matching up with the principles that define what we know currency to be?
Definition of money and how Bitcoin compares:
Medium of exchange-
Allows participants to easily transact goods and services, without having to barter over swaps of actual physical like-value goods, or like-value services. You can use currency to pay for your foot massage, instead of having to give a back massage, in order to get one. As long as participants in the given economy accept the form of money, it allows for a much simpler way to trade goods and services.
Bitcoin is setup to be a great medium of exchange, once more retailers accept it as a payment method, and buyers choose to use it to pay with.
You don’t even have to worry about exchange rates and practices, in order to use BTC.
Store of value-
In order to function as a reliable medium of exchange, the value of the currency should not experience large fluctuations. Certain assets like USD, gold, and real estate are classic examples of stores of value.
In the long run, if you stored your money in either gold or real estate, the value of your money would likely appreciate at a rate that allows you to keep up with inflation. Your purchasing power remains strong, even as prices rise in the economy.
In the short run, gold and real estate might fluctuate a lot, but they have proven to stay relevant as stores of value throughout history (when ownership is allowed).
Liquidity is also an important feature of money if it is to be a store of value and a medium of exchange.
Although precious metals and real estate have proven themselves as a store of value, they are not a good form of currency because it takes extra effort to make them liquid; readily transferable.
This is where the US Dollar has an advantage.
Although digital currency is a relatively liquid asset, there has not been enough experience and history to elapse for us to consider it a reliable medium of exchange. And in the relatively short amount of time digital currency has existed, it's fluctuations have made for an extremely volatile store of value.
For example, people would be much less likely to use the USD if they were not able to store it at a relatively similar value. Otherwise, the same energy it took you to earn $20 might be able to buy you a few cups of coffee in January, but might be able to buy you a Lamborghini in September (or vice-versa). Predicting the directions of such movements is too risky and unreliable for the average hard-working consumer to trust and rely on.
This is indicative of why so many governments around the world are not trusted by their citizens to reasonably control inflation; maintain purchasing power and reliable value for their citizens' hard work.
Large value fluctuations in an asset are more likely to have it defined as a speculative investment, not a form of reliable currency to use for buying goods and services.
Bitcoin is NOT proving to be a good store of value, because the price fluctuates a LOT. Bitcoin has proven to fluctuate in value by over $1,000 USD in only a couple weeks.
Unit of account-
Provides a common measure of the value of goods and services. Allows buyers and sellers to easily communicate the value being exchanged, for any particular good or service.
Bitcoin is facing a psychological roadblock when it comes to its economy’s participants, because most consumers and investors are not accustomed to thinking about the value of their money, in terms of such small fractions of whole numbers.
It is extra difficult for buyers and sellers to communicate the value of a good or service, when the value of the currency used to trade it is fluctuating so much, like with Bitcoin. See “Store of value” section, above.
For example, if a restaurant uses BTC as its primary form of currency, it would have to update menus constantly to communicate accurate prices to customers. The restaurant would also have a ton of extra administrative work in constantly updating wages for employees, in order to give them a relatively consistent amount of value for their work performed.
Further explained- only someone with a gambler's mentality would work for and hold only bitcoin, in order to cover relatively consistent daily/monthly/weekly expenses.
The bottom line: Cryptocurrencies with higher circulating supplies (i.e. Ripple) do a better job at being a medium of exchange, store of value, and unit of account. More liquid, less price volatility, and measurements that are easier to relate to.
All this being stated, the US tax code currently treats digital currency just like the USD, when it is being used in the same way (to exchange goods and services, compensate employees, make investments). Read below for the gritty:
My Convo with a H&R Block Rep on How Bitcoin is Classified and Taxed, by the US Government:
Kristin B: Hi, my name is Kristin B. How may I help you? Me: Hi Kristin. I have some investments in cryptocurrency, and I have questions about how taxes apply to them. Kristin B: What are your questions? Me:I called the IRS, but can't get through to a rep. I also googled the info, but what I came up with isn't as reliable, or understandable, so I'm hoping you guys can help clear it up a bit: Me:How is cryptocurrency defined in the tax code? What type of assets are considered “property” and why? How is crypto taxed for retailers that accept it as payment for goods and services? How is crypto taxed if I use it as a medium of exchange; to make purchases? How is crypto taxed if I use it as an investment, held long or short term? What are the main differences in how cryptocurrency is taxed, vs investments in fiat currency?
Kristin B: Virtual currency is treated as property for U.S. federal tax purposes. The general principles that apply to property transactions apply to transactions using virtual currency. Me:What are those general principals? Kristin B: For example, wages paid to employees using virtual currency are taxable to the employee, must be reported by an empoyer on a Form W-2, and are subject to federal income tax withholding and payroll taxes. Kristin B: Payments to independent contractors by virtual currency are similar. Kristin B: The self-employment tax rules apply and payers must issue form 1099. Me:So are wages in fiat currency usually considered "property" as well? What else is usually considered "property"? Kristin B: Yes, it is. Kristin B: There is a Notice 2014-21 provided by the IRS that has frequently asked questions and answers. You may want to take a look at it. I think this notice will answer your questions. It is found at https://www.irs.gov/pub/irs-drop/n-14-21.pdf Me:That is very helpful, thank you! I'm still trying to get a frame of reference as to what else is usually considered property? Kristin B: Re your last three questions, Q-7 and A-7 discusses the character of the gain when you use the virtual currency to buy and sell goods. For example, things like stocks, bonds, and other investment property are capital assets, so if you receive virtual currency from selling these items, you will be taxed on the capital gains/loss. Kristin B: The normal gain or loss recognition rules apply to the virtual currency. Kristin B: The IRS sites their Publication 544 to determine the character of the gain or sale based on the type of property (capital asset/ non-capital asset). These are the normal rules that you would apply to the virtual currency. Kristin B: https://www.irs.gov/pub/irs-pdf/p544.pdf Kristin B: The virtual currency is considered property as wells as what you buy and sell with it. Me:Ahhh. Also helpful. So in your example, are stocks, bonds also considered property? Is there a list of what all is considered "property" in the US tax code? I believe this is where a lot of my hang-up is. That word is starting to sound like it encompasses any taxable asset- wages, stocks, bonds, real estate. Is the USD considered property, as well? There is a huge debate in the crypto community as to whether or not it is considered a valid currency, so I think the best way to clear that up is to find out how its treatment differs from how the USD is treated, in US tax code. Kristin B: Right. Kristin B: I will do some research Me:Should I stay in the chat, or would you prefer to email the response? Kristin B: Please stay as I think this will be quick. In the tax code property is defined as any matter or thing capable of private ownership. Kristin B: The IRS determines how a sale or exchange or property is taxed based on its character. Me:WOW! That gives a lot of wiggle room for Uncle Sam. Kristin B: That is true. Pretty much everything is property. Kristin B: On a sale or exchange you will have either ordinary gains/losses or capital gains/losses. Me:Lol. Well ok then. Any insights on major differences in how digital currencies are handled differently than USD, in US tax code? If any. Kristin B: And then you must classify your capital gains or losses as either short-term or long-term. The Irs Pub 544 defines capital asses on page 22. Kristin B: Almost everything you own and use for personal purposes, pleasure, or investment is a capital asset. Kristin B: You will have a short-term capital gain or loss if you hold the property 1 year or less. Kristin B: You will have a long-term capital gain or loss if you hold the property more than 1 year. Kristin B: That Irs notice reads that the IRS treats the virtual currency as property. Kristin B: Does this answer your questions? Kristin B: What is property for the normal tax rules is property when you involve virtual currency. Me:Sorry for the delay, my Chihuahua had to go outside to potty. Kristin B: No worries Me:It's all getting MUCH clearer. Kristin B: Great. Me:Lastly, I'm still curious as to how digital currencies are handled differently than USD, in US tax code? If any. Kristin B: They are handled the same as far as the Tax Code goes. Kristin B: Virtual currency is considered property, just like the USD. Me:Well. You are officially my Tax Angel Genius! Thanks Kristin B. I'll be sure to use this chat when preparing my 2017 return, and share the resources with some of my crypto friends. Kristin B: Terrific, thank you. It has been a pleasure assisting you today and thanks for choosing H&R Block. Goodbye Me:Bye :) Kristin B has disconnected.
In-Depth Info on Bitcoin's Consensus Protocol:
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BA in Economics. BS in Finance. Hostess of the Crypt Keepers’ Club. Passionate about research, and processing data. I don’t fold sheets, I spread them!
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