Cryptocurrency has become a buzzword in recent years, with everyone from teenagers to seasoned investors looking to get a piece of the pie. But what exactly is it, and should you be investing in it? As a hard-working taxpayer, you want to make the most out of your money and invest wisely. Explore what cryptocurrency is, how it works, and whether you should invest in it.
Cryptocurrency investments can be confusing but they are a great way to diversify your portfolio.
What is Crypto?
To start, it is important to understand cryptocurrencies are digital currencies or virtual currencies that use cryptography for security purposes. There are thousands of cryptocurrencies available today, with the most popular being Bitcoin and Ethereum. Unlike fiat currencies, digital or virtual currency is currency monopoly free, and they are generally available on decentralized networks and not tied to a bank or government. This means they operate on a peer-to-peer system, making transactions directly between the parties involved without trust in a central authority.
What is Blockchain?
Cryptocurrency transactions are stored in a digital ledger called a blockchain. The blockchain is the underlying technology that allows cryptocurrencies to be decentralized and secure. Transactions are verified by a network of users called nodes, and these transactions are then added to the blockchain permanently. This means, unlike ordinary electronic transactions, once a transaction is added to the blockchain, it cannot be altered or deleted.
What are the Different Kinds of Cryptocurrency?
There are various types of cryptocurrencies in the market, but two of the most popular are Bitcoin and Ethereum.
Bitcoin
Bitcoin is the oldest and the most popular cryptocurrency in the market. It was invented by Satoshi Nakamoto in 2009. Bitcoin works on a peer-to-peer network where all transactions are recorded in a blockchain public ledger. The blockchain is managed by miners who verify transactions, and in return, they receive Bitcoins. Bitcoin has a fixed supply of 21 million tokens, which is scarce due to the fixed supply. The value of Bitcoin has been volatile since it was launched, but it is still considered a safe option for investors.
Ethereum
Ethereum is an open-source blockchain-based cryptocurrency that was launched in 2015. Ethereum’s primary use is to facilitate smart contracts and decentralized applications. Its programming language allows developers to build and execute smart contracts. Ethereum’s cryptocurrency is called Ether, used to fuel the network. Ether is created through a decentralized process known as mining. Another feature of Ethereum is that it allows developers to create their own cryptocurrencies through its platform.
Legality of Cryptocurrency
Although crypto has been around for over a decade, there is still an amount of ambiguity about its legality. Regulators continue to take a closer look at crypto as a threat to financial institutions and a method for bad actors to scam people out of their money. In the United States, the legality of cryptocurrency is not clear-cut, as the government imposes restrictions and regulations on currencies and currency exchanges without outright banning cryptocurrencies. In 2019, the Internal Revenue Service (IRS) released guidance on virtual currencies, stating they should be treated as property and subject to taxes. Therefore, if you make a profit in cryptocurrency, you must report it on your tax return.
The laws for cryptocurrency vary depending on where you are trading, but generally speaking, buying and selling cryptocurrency is legal. However, any illegal activities carried out using cryptocurrency are not. This refers to illegal activities explicitly forbidden by law, such as money laundering, buying and selling drugs, and other activities considered nefarious.
Crypto and Taxes
When it comes to taxes, the IRS has classified crypto assets as property, meaning they are subject to capital gains taxes. If you sell or convert your cryptocurrency into another currency, you will need to report any capital gains or losses on your tax return. Additionally, those who receive cryptocurrencies as payment are required to report the fair market value at the time of receipt. This makes it crucial to maintain accurate records of all cryptocurrency transactions, including the date of acquisition, the cost basis, the fair market value at the time of transaction, and any capital gains or losses.
Trading cryptocurrency still requires taxes be paid.
The Pros and Cons of Crypto
Like any other investment opportunity, investing comes with its own set of pros and cons, advantages and disadvantages of cryptocurrency.
What are the Pros of Investing in Crypto?
High potential for returns – One of the primary reasons why investors are drawn to cryptocurrencies is their potential for high returns. Bitcoin, for example, saw a staggering increase in value from $1,000 in 2017 to nearly $20,000 by the end of that year. Although cryptocurrencies are volatile and their values can fluctuate widely, they still offer the possibility of significant returns.
Decentralization and anonymity – Cryptocurrencies are decentralized, meaning they are not subject to government or central bank control, and transactions are recorded on a public ledger that is transparent and secure. This can give users greater privacy and anonymity, which can be useful in certain situations.
Global accessibility – Crypto markets and the currency traded on them are accessible to anyone with an internet connection, regardless of geographic location or socioeconomic status. This means individuals who may not have access to traditional banking systems can still participate in financial transactions and investments.
What are the Cons of Investing in Crypto?
Lack of regulation and security – One of the biggest challenges facing the cryptocurrency industry is the lack of regulation and security. Cryptocurrency exchanges have been known to be hacked, resulting in the loss of users’ digital assets. Additionally, the lack of government regulation means investors may not have the same protections as they do with traditional investments.
Volatility – Cryptocurrencies can be extremely volatile, with prices fluctuating wildly in a short period of time. This can be a double-edged sword. While it can create high returns, it can also lead to significant losses. Cryptowinter, a term you may have heard, can also contribute to the volatility of the market.
Limited acceptance – While the popularity of cryptocurrencies is growing, they are still not widely accepted as a form of payment by businesses and merchants. This means investors may have to convert their cryptocurrency into traditional currency to make purchases, which can result in additional transaction fees paid and potentially lower returns.
How to Buy Cryptocurrency
If you’re interested in investing but unsure of how to enter the market, we have a few steps to not only explain the cryptocurrency markets but the steps to trade digital currency.
Step 1: Choose a Cryptocurrency Exchange
The first step in buying cryptocurrency is to find one of the reputable cryptocurrency exchanges available that supports the type of cryptocurrency you want to buy. Many exchanges are available in the market, so do your research and compare factors such as minimal transaction fees, security, and user experience. It’s important to note not all exchanges support all types of cryptocurrencies, so if there’s a particular type of currency you’re interested in, make sure to confirm this before choosing a platform.
Step 2: Complete the Know-Your-Customer (KYC) Process
Once you’ve chosen an exchange, you will be given a private key to access your account, and you may be required to complete a KYC process. This legal requirement helps prevent money laundering and other illegal activities. The process typically involves submitting identification documents such as a government-issued ID or passport.
Step 3: Fund Your Account
Once you’ve completed the KYC process, you can fund your account with fiat currency. Most exchanges accept methods such as credit/debit cards, bank transfers, and PayPal. Remember, there may be fees associated with depositing funds into your account. Make sure to check the fees before proceeding.
Step 4: Buy Cryptocurrency
After you’ve funded your account, you can buy the type of cryptocurrency you’re interested in. This process typically involves entering the amount of cryptocurrency you want to buy and confirming the purchase. Keep in mind cryptocurrency prices can be extremely volatile, so it’s important to do research and invest only what you can afford to lose.
Investing in crypto can be high-risk, high-reward.
Summary
Investing in cryptocurrencies can be a high-risk, high-reward proposition. As a taxpayer, it’s essential to understand the technology behind cryptocurrencies, market trends, and the legal framework surrounding them before investing. Ultimately, investors should evaluate the risks and rewards of investing in cryptocurrencies and decide whether it’s the right investment for their portfolio.