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January 12, 2022

What are Cryptocurrencies and How are they Taxed?

Cryptocurrencies have taken over the world of consumer and professional finance over the last several years, but how do they actually work? It's probably best to think of cryptocurrencies as digital assets that are secured by cryptography. These transactions are verified through a decentralized network which ensures accurate counting and tracking of the amounts spent. While various cryptocurrencies have unique features, they all use centralized ledgers to track their transactions and maintain security; this is referred to as a blockchain.

Common cryptocurrencies to know

Common cryptocurrencies that you'll hear about are Bitcoin and Ethereum. The main differences between these two cryptocurrencies are the purposes for which they were created. Bitcoin, created by Satoshi Nakamoto was designed to be a peer-to-peer electronic cash system that allows people to make secure payments without having to go through a financial institution. In other words, it's the digital equivalent of the U.S. dollar in many ways but intrinsically linked to blockchain technology.

On the other hand, Ethereum was created by Vitalik Buterin in 2015 with the idea of building decentralized applications (dApps) to be run on top of the blockchain. This cryptocurrency also functions as a digital currency, but one that can be used to purchase specific computational power while running apps .

These are only two examples of what cryptocurrencies are and how they operate; there are tens to thousands of different cryptocurrencies out there.

Since cryptocurrencies are still emerging technology in the financial sector, the way that these digital assets are taxed and accounted for requires some extra understanding.

How Tax & Accounting fits in

Cryptocurrency tax and accounting has been a hot topic in the U.S., with most taxpayers not knowing how to treat it, let alone keep track of what they owe from their transactions. For tax professionals, understanding the new market of cryptocurrency can be daunting. Understanding how to calculate clients' cryptocurrency taxes, and more requires either a powerful tool or a greater understanding of how crypto works in the first place. When accounting for cryptocurrency transactions, you have to keep in mind that the transactions are all virtual, which is what might have most taxpayers confused.

With cryptocurrency being treated as property instead of currency, the sales of that property will be taxed at capital gains rates resulting in possible significant savings or added liability to the client.

Understandably, it's easy for these virtual transactions to become missed since they can exist outside of traditional ledgers and banking systems. This makes tracking down every transaction necessary so that you know how much tax someone owes on their cryptocurrency transactions.

To help accountants understand how to handle cryptocurrencies, Ledgible has created a wealth of helpful learning content. If you're interested in learning more about tracking cryptocurrency for your clients, check out our news and knowledge page here.

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