Is cryptocurrency legal according to central authorities? Governments across the world view cryptocurrencies in different ways. In the U.S., according to the IRS, cryptocurrencies are legal, but it is considered property, not a currency. Individual investors will have to pay capital gains tax when reporting profits and expenses related to cryptocurrencies.
Since cryptocurrencies are legal, let's understand how investors are exposed to cryptocurrency trading risks.
What Are The Risks Associated With Trading Cryptocurrency?
Since crypto is a fairly new technology as a whole, one must understand the risks associated with its dealings before investing a big amount. Here are some of the most commonly spoken of risks associated with cryptocurrency-
- Decentralized Status
A central authority or the government does not govern the value of these digital currencies. Its value depends entirely on cryptocurrency owners, the demand for it, and the value of competing cryptocurrencies. Unlike traditional paper currency, the production of cryptocurrencies is limited. When people invest in them, they merely claim ownership by transferring it from one person to another.
- Fraudulent Claims
Cryptocurrency, being digital, exists on a non-regulated 24-hour market. Central authorities do not insure the transactions. Its decentralized nature paves the way for the danger of cryptocurrency. It increases fraudulent activities that will not have the same legal resolution as traditional fraud victims. It happens because the decentralized structure eliminates middlemen like the banks, financial institutions, and regulatory authorities that would otherwise be responsible for securing your investment.
- High Volatility
Cryptocurrencies are highly volatile. In the past year alone, Bitcoin has fluctuated from $28,000 to $69,000, with other coins/tokens showing even more variation in price. There are often announcements, China's ban on cryptocurrencies for example, that can lead to a major market crash. People who can't assume high risks don't invest in crypto because of its high volatile rates.
- Limited production
Unlike paper currency, the production of cryptocurrencies is limited. For example, there are 21 billion bitcoins that can be mined, and out of that, only 18 billion are in circulation. The rate at which a cryptocurrency can be exchanged for money depends on demand and supply of cryptocurrencies in the market. The market price is highly reliant on supply and demand.
What Are The Dangers of Cryptocurrencies?
- Irreversible Transactions
Cryptocurrencies don't involve intermediaries (banks and financial institutions). The sender and the receiver directly transact and remain anonymous. Due to anonymity, the sender must input the right numbers while transacting. If the amount is sent to the wrong person, it can never be retrieved, unless the person on the receiving end sends it back. With traditional currency, the bank not only acts as a regulatory authority but is also responsible for retrieving your funds in case of fraudulent activity/ misdirection of funds. With cryptocurrency, the intermediary is absent, and thus, your investment cannot be reversed.
- Money Laundering
Cryptocurrencies like Bitcoin pave the way for criminals to exploit this technology and evade scrutiny from government agencies. A specific type of money laundering called Smurfing is common with cryptocurrencies. Smurfing is breaking up larger transactions into smaller transactions that are below the threshold. As a result, they are not reported. The digital format of crypto makes it easier for criminals to transfer money abroad instantly. Since online transactions have no borders and no intermediaries in the crypto market, it eliminates the need to move money physically from place to place.
Further, the anonymity surrounding these transactions makes it harder for people to track the name and addresses of cybercriminals. Even though the transactions are publicly stored on the blockchain, only the individuals involved can make sense of it. It is how cryptocurrency risks an increase in money laundering.
- Fake Investment Scams like Initial Coin Offerings (ICOs)
Some common cryptocurrency risks like fake investment scams claiming to provide ICOs attract less skeptical investors when newer opportunities are provided. It is common when a specific investment suddenly increases in price and people who invested in them gain sudden wealth. Some other investors get riled up due to the fear of missing out (FOMO). Other people who regret not investing in these digital assets desperately fall prey to fake investment scams.
What Does The IRS Mean by Cryptocurrency is a Property, Not a Currency?
The IRS does not control cryptocurrency like it controls the paper currency. The IRS is not involved in buying or selling crypto but instead controls the tax levied on it. Investors need to pay capital gain tax when reporting expenses or profits on their annual tax returns, irrespective of where they purchased digital coins.
How Do You Buy and Sell Cryptocurrencies?
Cryptocurrencies are bought and sold using crypto-wallets. Over the years, certain companies have emerged as reliable crypto trading companies. As per your comfort, you can invest in a fraction of a single cryptocurrency. At the moment, cryptocurrencies like Bitcoin range around $68,000/ bitcoin. It's not feasible for everyone to buy a whole coin, and hence, buying these infractions proves to be more lucrative.
What is The Future of Cryptocurrencies?
Crypto critics are worried that governments worldwide will follow China in banning cryptocurrencies. The reason is that the government would not appreciate losing monopoly over the power of money and the ability to control the economy and inflation rates.
However, the majority believes that they won't completely ban cryptocurrencies. Jerome Powell, the chair of the Federal Reserve, said that they have no intention of banning cryptocurrencies altogether. On the other hand, Gary Gensler stated that investors would get hurt if stricter regulations were not imposed.
In its 2022 budget proposal, the Biden administration could lead to new crypto reporting requirements for people transacting in digital coins. In May 2021, the U.S. Treasury Department released "Greenbook," which demands a more comprehensive reporting requirement because, unlike cash, it's difficult to spend digital currency without getting reported. One speculation is that Biden proposed to raise the tax rate on long-term capital gains from 23.8% to 43.4%.
The Bottom Line
Is cryptocurrency legal? Yes, it is absolutely legal to trade all kinds of cryptocurrencies. But, like stocks, cryptocurrencies cannot be used as paper currency to directly buy goods and services. The crypto market is risky, speculative, and volatile. It's important to read, learn, and assess the risks involved before investing. At the same time, cryptocurrency offers potentially high returns, quick transfer of funds, and immediate international transfer.