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Cryptocurrency Basics

Digital Currency vs Virtual Currency 1.3

Editor’s Note
The following transcript was taken from one of Kelly’s live classes for tax professionals.

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In this chapter we’re going to talk about real currency, digital currency, virtual currency, and convertible virtual currency.

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Digital currency as defined by FinCEN (Financial Crimes Enforcement Network:

“Digital currency is also called digital money, electronic money, or electronic currency. It is distinct from physical currency, such as paper notes and coins. It has similar properties to physical currencies, but it allows for instantaneous transactions and borderless transfer of ownership. It is “Real” and Legal Tender, similar to using Western Union or PayPal.”

Although, you can also think about your own bank accounts as just ones and zeros on a computer screen.

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Earlier this year I was so grateful that FinCEN came out with new guidance, which was a summary of all their other guidance, and it’s only 30 pages. I highly recommend it. https://bit.ly/2oem0xe

They define virtual currency this way: the term “virtual currency” refers to a medium of exchange that can operate like currency, but does not have all the attributes of real currency as defined in 31 CFR § 1010.100(m), including legal tender status.

In my notes I say that they’re telling me, it looks like a duck and quacks like a duck, but it’s not a duck. In other words, it looks like money, acts like money, but the government says it’s not money, because they decided it’s not legal tender.

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This page says: convertible virtual currency is virtual currency that can be bought with and sold back to real currency. Earlier we talked about “inconvertible” paper money. This is convertible virtual currency. So convertible virtual currency can be bought with and sold back to real currency, like US dollars, or traded for other virtual currencies. Virtual currency and convertible virtual currencies are not legal tender in any jurisdiction. This is an important concept.

Real currency is paper notes, coins or the ones and zeros on your computer screen that the government says is legal tender. Real currency just means you can use it, the government says you can use it as a currency, and you don’t have to pay taxes on it if you sell it or trade it to somebody or give it to somebody. Although, you wouldn’t have any taxes if you just gave it to somebody. Real just means it is legal tender. You can use it to pay your taxes, you can use it to pay your bills; it’s just money. The ones and zeros in your bank account is digital, but it’s legal tender also known as real currency.

https://coincenter.org/entry/fincen-snew-cryptocurrency-guidance-matches-coin-center-recommendations

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Here is my summary of what I just said. Real currency is paper money and coins. My definition of real currencies is paper money and coins. Technically, digital currency is a subset of real currency, which makes it real, meaning, it’s just currencies, just money, fiat money. Virtual currency is a subset of digital currency that is not real, meaning it’s not legal tender, but you can still use it to buy stuff.

Proposed infographic:

$USD ⬄ bitcoin ⬄ Monero (I’d also add symbols for LTE, ETH and other coinbase coins)
Convertible Virtual
Virtual Currency
Currency

Convertible virtual currency is a subset of virtual currency. Convertible means you can sell bitcoin back into cash. You can’t do that with all cryptocurrencies.

I can use bitcoin and go buy some other cryptocurrency and I can sell that other one (let’s call it ether) and if I sell the ether, it goes back into being bitcoin, which is what I originally bought it with. Bitcoin I buy with US dollars. When I sell bitcoin it’s gonna go back into being US dollars. That makes bitcoin a convertible virtual currency. Now to confuse you even more, ether is also one of those cryptocurrencies that can be converted back into US dollars. A better example would be if I used bitcoin and I bought Monero. Monero is one of the big privacy coins. If I buy Monero and then later on I sell Monero, it’s going to get converted back into bitcoin. That makes it a virtual currency but not a convertible virtual currency.

What’s interesting is that lots more cryptocurrencies are becoming convertible virtual currencies because a lot of the exchanges are making it possible to buy cryptocurrency with fiat money. The overarching definition of legal tender is real, and real means it’s legal tender.

Audience: Bitcoin is much like a barter system.
Speaker: I won’t disagree with that, but let me ask you a question: if I trade you my used laptop for something, say your services, that’s a barter, would you agree? So, in that exchange, is there a taxable event? What kind of a taxable event is it? It’s income. it’s not capital gains.

In that way, I say that bitcoin is not exactly a barter system, because if I do a trade with bitcoin and I trade bitcoin for something else, what type of income that is created depends on what that something is that I received for my bitcoin. So, depending on what I received, the value I received could be income, it could be a capital gain, or it could be something else. We’re going to get into that more in depth as we go along.

Audience: Is bitcoin fungible? I think it’s difficult to understand.
Speaker: Bitcoin is fungible. It is fungible with itself. You can trade bitcoin with another bitcoin. You can sell bitcoin back into US dollars. That’s different than fungibility. I think it’s not difficult at all, so maybe it’s just getting comfortable with the technology, which to be honest, the user interface part of cryptocurrencies is still being developed. It is not the easiest thing for people to use, but it puts the power of your money back into your control, and not in the control of the bank.

Audience: What about a laptop having capital gains or losses?
Speaker: You’re giving away my thunder later! What he just identified, which we will talk about in part three, is that there seems to be a little double taxation going on with cryptocurrencies. We’ll get into more into what that means in a little bit.

Audience: Someone made a comment that the graph for the summary of digital currency didn’t make sense.
Speaker: I may have confused people who really know how to read sets and subsets, but I was trying to illustrate as best I could, technically what I just said. Convertible virtual currency is NOT real currency, don’t read it like that. It’s a very difficult concept to get people to visualize and this is the best that I could come up with.

Audience: Someone made a suggestion about the graph.
Speaker: I like that I’ll redo my slide for the next training that’s a very good point, thank you. (See new power point slide for the graph)

Audience: Why would you develop a virtual currency instead of a convertible virtual currency?
Speaker: Does anybody know what ICO’s are? Initial Coin Offering. How many know what an IPO is? Initial Public Offering. Initial Public Offering is how a company raises money to get their company off the ground, and an ICO was a way that people figured out how to create their own coin using the Ethereum blockchain using smart contracts. When you create your own coin, you can now go sell that coin for money and use that to run your business. If we were in a world where cryptocurrencies had more value in and of themselves, people could have done that and not sold them for cash. But they created cryptocurrency and sold them for cash, so they’d get money to run their businesses. Tokens created through smart contracts are non-convertible virtual currencies.

There’s over 3,000 cryptocoins out there right now and not all of those can you trade back into US dollars. Because we now have new central authorities going on, which is a bit of an issue for me, in the blockchain world. Some of the exchanges have gotten so big, they’re becoming the new banks. And they are the ones that take your cryptocurrency and convert it back into US dollars. They’re the ones with the relationship with the regulators, probably with Federal Reserve banks. These ICO’s creating non-convertible virtual currencies is a way to create money without having to go through any authority, without having to go through the government, without having to follow regulations. And it’s starting to catch up to people because the government is catching up and the regulators are catching up and saying: no, sorry you can’t do that. They are in the process of defining what this means and how does it fit into existing regulations and law.

From what I can see, there has not been one new law written governing cryptocurrency. They’ve just been dragging their feet, taking their time telling us how it fits into current law. They finally said if you do these things, your cryptocurrency fits in the category of being an ICO, so you’ve got to follow the same rules of the SEC that an IPO has to follow.