Bitcoin 101: A cryptocurrency primer

You have probably heard the media buzz about Bitcoin but you may not understand the clamor. Supporters of Bitcoin, particularly millennials, will tell you it’s a different, some say better, type of currency. It’s unique in that it has no physical form.

Bitcoin was developed in 2009 by a programmer using the alias Satoshi Nakamoto. Bitcoin is produced virtually through what is called a “mining” process in which computer users solve intricate math problems and are rewarded with Bitcoin. Under the Bitcoin cryptocurrency system, only 21 million Bitcoin are available to be mined, with more than 15 million Bitcoin already in circulation.

Once mined, Bitcoin can be used like any accepted currency. Its primary function is for online transactions. According to the IRS, cryptocurrencies such as Bitcoin are classified as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” At this point in time, cryptocurrencies, including Bitcoin, have legal tender status in extremely few governmental jurisdictions. The United States is not one of them. Bitcoin falls into the category of “convertible virtual currency,” a form of virtual currency that can be purchased in or exchanged into U.S. dollars.

Because there is no central banking system for cryptocurrencies, the digital footprint for these virtual currencies is recorded in a virtual digital wallet. Entities were formed to act much like banks, but without the regulations and oversight, to assist in the one-on-one cryptocurrency transactions and to create historical records of those transactions. Most times the exchanges worked, but other times they did not; some were forced out of the marketplace.

The IRS says that Bitcoin is to be treated as property for federal tax purposes. The same tax principles that apply to property transactions apply to any transaction involving cryptocurrencies. Taxpayers receiving Bitcoin in exchange for providing goods or services will recognize income equal to the fair market value of the Bitcoin on the date of receipt. With the recent volatility of Bitcoin, particularly the last few months, this could indicate a wide range of values.

Bitcoin is still a fairly new technology, which means tax treatment is still being developed. With the increase in use and established values, Bitcoin is likely to gain more interest from the IRS.

 

Ross Manson is chief innovation officer at Eide Bailly. You can reach him at 701-239-8634 or [email protected]