What Is Cryptocurrency?

Bitcoin has certainly captured the attention of international finance headlines. Along with the Bitcoin discussion comes a series of questions that cause investors to scratch their heads.

Is this a real form of currency?

Can I collect USD in return for my cryptocurrency investments?

Are my investments protected by any regulatory organizations?

These questions and more have come our way regarding the growing cryptocurrency topic. In this four-part series, we will attempt to explain the current standing of cryptocurrencies in the eyes of the IRS.

Cryptocurrency Definition

Investopedia defines cryptocurrency as the following:

A cryptocurrency is a digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of this security feature. A defining feature of a cryptocurrency, and arguably its most endearing allure, is its organic nature; it is not issued by any central authority, rendering it theoretically immune to government interference or manipulation.

The key concern circling the realm of cryptocurrencies is the heavy leaning towards anonymity. The ability to purchase and exchange via anonymous means opens the door to crimes such as money laundering, hacking, and even theft.

Before ditching traditional investment methods, it’s important to consider cryptocurrency as a tool for diversification opposed to an all-or-nothing payout.

Deciding to Invest

This currency-of-the-future does not exist without its own dose of barriers. The first is actually getting your hands on Bitcoin, Litecoin or any other currency on your radar. There are two primary methods:

Mining – In the world of Bitcoin, specifically, there is a rough total of 16 million coins in circulation. Based on a complex formula established by the mysterious inventor(s) Satoshi Nakamoto, there’s a hypothetical maximum of 21 million Bitcoin.

Mining is great for those who have spare time and aren’t interested in day trading or purchasing out-of-pocket. There are “blocks” which unlock 50 new bitcoins into the “ecosystem.” These blocks are composed of the data from hundreds of currency transactions. These data collections exist within a block chain. Each block can be released through complex computation puzzles.

In short, solve a puzzle, place a block, get paid—repeat. But be forewarned, you’ll want to have a decent grasp of data processing, hashing, and other tech know-how. We will discuss how this freelance income method is taxed later on in our series.

Day Trading – Industry-leading trade entities are now gladly exchanging Bitcoin. APMEX for example, offers a 4.0% cash discount to lure the new currency. Once publicly traded, Bitcoin can be exchanged for gold, silver, and vice-versa. Because Bitcoin is a decentralized currency, it can pretty much be exchanged with anything that’s up for a fair trade.

At this time, there is no central regulatory board for cryptocurrency.

Discussing Bitcoin With Your Tax Pro

As this topic continues to swirl in the headlines, H&R Block will remain a trusted source for understanding exactly what is cryptocurrency.

Up next in our series will be dissection of the cryptocurrency definition according to the IRS. It’s important to know how this new form of investment could directly affect your tax dollars.

For immediate questions, you can chat with a tax pro in our Community or visit your local H&R Block office.