Understanding Cryptocurrency

Cryptocurrency is a digital asset that is created and traded online. Computer operators called miners establish new units of the digital currency and record them on a blockchain, which is a string of verified, public transaction records. While the records are public, the identity of the cryptocurrency holder is private. Virtual money is traded on exchanges like Coinbase and Gemini. A cryptocurrency transaction involves the exchange of wallet numbers, not names.

Bitcoin is the most popular and valuable of the thousands of cryptocurrencies on the market. Satoshi Nakamoto invented Bitcoin in 2009, after the global financial crisis (although, Australian computer developer Craig Wright claimed in a recent court case that he was the inventor of Bitcoin, using the pseudonym Nakamoto). One of the reasons Bitcoin is valuable is because, like gold, there is a limited supply. Only 21 million Bitcoins will ever be produced. Other cryptocurrencies include No. 2 brand Ethereum; dog meme-based Dogecoin; and Tether, a “stablecoin” that is tied to the US dollar. The value of cryptocurrency can be volatile, but it enjoyed a good year in 2021: Bitcoin’s value increased by 70 percent, while Etherium’s Ether currency grew by over 400 percent.

Cryptocurrency is property, not currency

The Internal Revenue Service (IRS) looks at Bitcoin and other digital cash as property rather than as currency. Therefore, on the sale of cryptocurrency purchased for personal or investment purposes, the profits are subject to capital gains tax. The length of time cryptocurrency is held determines whether the capital gains are short-term or long-term. Twelve months is the threshold for getting long term treatment.  A taxable event occurs when cryptocurrency is exchanged for other property such as fiat currency or a different brand of cryptocurrency.  If a crypto trader is in the business of selling or mining virtual assets, ordinary income tax rates apply.  Further, cryptocurrency gains cannot be avoided using like-kind exchange rules.

How is cryptocurrency stored

The digital wallet for cryptocurrency can be a physical item or a place on the internet. The cryptocurrency can only be accessed by public and private keys, which are complex and long. That means that the key must be stored safely and address in estate planning.  Further, a password cannot be “reset” . One investor accidentally threw away the key to half a billion dollars, while others have lost millions from misplacing their passwords. If a cryptocurrency holder dies without revealing his key to his heirs, the funds may be lost forever. Additionally, estate planning documents need to authorize a fiduciary to access digital assets.  Lawyers thinking about this current issue are drafting comprehensive provisions authorizing fiduciaries to access, control, and manage digital assets.

Nonfungible Tokens

Cryptocurrency has now given rise to digital assets known as nonfungible tokens (NFTs). These are digital assets that are unique and cannot be divided, like a work of art.  They are traded on marketplaces like OpenSea. With sales totaling $23 billion in 2021, these digital collectibles can include any of the following:

• Digital art (with a top price of $69 million)
• Sports collectibles (including animated NBA basketball cards)
• Gaming collectibles and characters
• Music
• Video clips
• Social media posts
• Digital real estate

In one example, “digital real estate” resulted from someone dividing all of the locations on earth into digital hexagons;  thus,  you could become the virtual owner of the Eiffel Tower or the Taj Mahal. While the value of these assets seems questionable, investors hope these NFTs, like cryptocurrency, will eventually grow in value like rare postage stamps, coins, or baseball cards. An NFT of the first Tweet of Twitter’s founder, Jack Dorsey, sold for over $2 million, so the eventual value of an NFT is impossible to predict.

NFTs also offer a connection to a community. If you own a CryptoPunk, for example, you have something in common with Serena Williams, Jay-Z, and Logan Paul. So while you not to spend $172,000 on a digital kitten or trade their Tesla for a picture of a porcupine, it is possible such a risk could eventually become a sound investment.