What Clients Need to Know about Bitcoin

By: Barry J. Friedman, CPA | Sep 28, 2018

Bitcoin, the digital currency, has been in the news a lot recently. What’s it all about and how does it work? Is it something you or your clients should invest in?

Bitcoin is a decentralized digital currency — a cryptocurrency. It’s essentially a form of money that exists only as computer code and is not overseen by any central bank. It was created in 2009 and is maturing as a recognized asset class on Wall Street. Already, Bitcoin futures trade on major markets — allowing investors to bet on Bitcoin’s price without holding the coin itself. Although it is not the only cryptocurrency, it has become the most famous.

This virtual currency surged to new highs as a frenzy of investors wanted to get in on the action. In fact, the price of all cryptocurrencies soared — and then crashed back down.

Prices of What Clients Need to Know about BitcoinBitcoin approached $20,000 by the end of 2017 and then plunged to below $11,000 — a correction, some said.

The plummet took some of the shine off what had been an incredible year for bitcoin. In December, two major U.S. financial exchanges launched trading in bitcoin futures, giving it more clout. The question today: Is this only the beginning of cryptocurrency madness?

Another major consideration is extreme volatility, with scammers capitalizing on the booms and preying on victims of the busts. The hustles are diverse, including many different types of phishing, spamming and the notorious development of bogus initial coin offerings. It appears that social media impersonation has a role in many of the scams, where so much discussion, speculation and misinformation about cryptocurrency take place.

Because no government or central bank is regulating the market, it’s not surprising that the reliability of digital currency is questioned. In fact, many doubters still can’t believe things have come this far. There are cryptocurrency exchanges — Coinbase is probably the best known, although there are others. (At least one was shut down due to accusations about money laundering.)

Still, bitcoin is a difficult currency to use in the real world: The network is slow and too expensive for small transactions. The mined block is broadcast to the network to receive confirmations, which takes an hour or so, though occasionally much longer, to process. Depending on the kind of traffic the network is receiving, bitcoin’s protocol will require a longer or shorter string.

But Bitcoin can be exchanged for other currencies, products or services. By 2015, there were already more than 100,000 merchants and vendors who accepted Bitcoin as payment. And because Bitcoin is not tied to any country or subject to regulations, international payments are easy and cheap. And there are no credit card fees for small businesses to pay.

In 2017, research produced by Cambridge University had estimated that there were 2.9 to 5.8 million people using a cryptocurrency wallet, most of them using bitcoin. Wallets exist in the cloud or on a user’s computer. They’re not insured by the FDIC, and the names of buyers and sellers are never revealed; only their wallet IDs are made public.

Unfortunately, this has made it the currency of choice for buying drugs or taking part in other illicit activities — buying and selling is not easily traceable to those responsible.

But for all the secrecy surrounding these currencies, to the IRS, Bitcoin is a real thing, and that means you pay real taxes. If you buy Bitcoin and sell it at a profit, it’s a capital gain, pure and simple. The bottom line? Be very careful regarding the largely unregulated world of digital currencies, and keep in mind that even though you’ll hear that these currencies are beyond government control, the IRS will still want its cut.

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