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October 22, 2020

Crypto Tax Events Professionals Ought To Know - CryptoMining

What is CryptoMining

Binance, one of the world’s largest crypto exchanges defines cryptocurrency mining as “the process in which transactions between users are verified and added into the blockchain public ledger… Mining is also responsible for introducing new coins into the existing circulating supply and is one of the key elements that allow cryptocurrencies to work as a peer-to-peer decentralized network, without the need for a third party central authority .”

Bitcoin, the first and most established mineable cryptocurrency, states this in its founding whitepaper, “... the first transaction in a block is a special transaction that starts a new coin owned by the creator of the block.” 

This first transaction in a new block that has been successfully mined is known as the “coinbase” transaction. It is the transaction that rewards the miner for solving a complex mathematical problem. At the time of this writing, a miner will receive 6.25 bitcoin for a block and a block is mined and added to the bitcoin blockchain approximately every 10 minutes.

The whitepaper goes on to say, “This adds an incentive for nodes to support the network and provides a way to initially distribute coins into circulation since there is no central authority to issue them. The steady addition of a constant amount of new coins is analogous to gold miners expending resources to add gold to circulation. In our case, it is CPU time and electricity that is expended.”

So, Like Mining Virtual Gold?

I think most of us can relate to the analogy of gold mining referred to in the bitcoin whitepaper. 

Just like gold miners need to expend resources to dig for new gold which is added to the circulating supply, so bitcoin miners need to expend electricity and computational resources in solving complex mathematical problems to earn new bitcoin. 

Those who participate in cryptomining get rewarded in bitcoin and transaction fees. Interestingly, the bitcoin protocol only allows for a maximum of 21 million bitcoin to ever be created which is currently estimated to be reached during the year 2140. 

Clearly mining cryptocurrency plays a critical role in both keeping the network secure and serving as the cryptocurrency supply mechanism

CryptoMining My Own Business

The first block of the first-ever blockchain was mined by the pseudonymous creator of bitcoin, Satoshi Nakamoto on January 3, 2009. As of this writing, more than 600,000 blocks have been mined on the bitcoin blockchain.

In the (very) early days, you could use your home computer to mine bitcoin. That is, if you could figure it out.

As competition increased and computers became more powerful the bitcoin protocol has made provision to adjust the difficulty of the math puzzle to be solved, to produce the next block, and receive the reward.

As competition increased and intensified miners had to eventually pool their computing resources and share in the spoil to remain competitive.

These days it takes an incredible amount of electricity and computing resources to run a profitable bitcoin mining operation. Thus, most brave new souls wanting to enter the bitcoin mining business will typically join an existing mining pool to stand a chance of earning a sliver of the bitcoin pie. 

Taxable Event: CryptoMining Income

Mining income will be treated as taxable ordinary income.

According to IRS Notice 2014-21, when the taxpayer successfully mines virtual currency (bitcoin is classified as convertible virtual currency), the fair market value of the virtual currency as of the date of receipt is includible in gross income.

If a taxpayer's crypto mining of virtual currency constitutes a trade or business and not undertaken as an employee, the net earnings from self-employment resulting from those activities constitute self-employment income and are subject to the self-employment tax. You can also deduct your business expenses incurred to produce mining income.

With Ledgible Tax, you can tag coins or tokens received as "mining income” to identify and classify these items as ordinary income separately from your capital gains, and you can start with a free trial. 

If you have questions about hardforks or airdrops, we recommend you back up a tad and check out part 5 of this series. Otherwise, onward we go to Part 7 (coming soon!)


Disclaimer: This post is informational only and is not intended as tax or investment advice. For tax or investment advice, please consult a professional.

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