From taxes to NFTs to the latest IRL events, cryptocurrency is all over the news! And why shouldn’t it be? Even though there may be skeptics, there are crypto supporters, enthusiasts, investors, traders, and miners all over the world. But why is there a craze for this non-tangible, volatile asset class?
Let’s brush up on our basics on what cryptocurrency is and how cryptocurrency works. Additionally, let’s take a look at why you should and shouldn’t invest in it, and if at all you’re interested, how you can buy crypto, and what are the tax implications.
Cryptocurrency: The Basics
A cryptocurrency is a digital asset and digital payment mechanism that may be exchanged without having to rely on banks for transaction verification. Cryptocurrency payments exist solely as digital entries to an online public ledger identifying specific transactions, rather than as tangible fiat money carried around and exchanged in the real world.
For Example
According to CoinMarketCap, a leading crypto price-tracking platform, there are 15,000+ cryptocurrencies as of December 2021, and more are getting added to the list every day. Here are some of the most popular cryptocurrencies:
- Bitcoin (BTC)
- Bitcoin Cash (BCH)
- Binance Coin (BNB)
- Cardano (ADA)
- Dogecoin (DOGE)
- Ethereum (ETH)
- Litecoin (LTC)
- Polkadot (DOT)
- Monero (XMR)
- Stellar (XLM)
- Tether (USDT)
Pros & Cons of Cryptocurrency
Across the globe, investors have strong opinions about whether or not to invest in cryptocurrency. Here are a few grounds why some people think it’s a revolutionary breakthrough and others think it’s a passing trend.
Pros of Cryptocurrency
- Advocates consider virtual coins as the money of the future. A number of authorities are supporting and regulating cryptocurrency, which is giving hope to a lot of investors.
- Crypto transactions have the benefit of being able to be performed in a couple of minutes. When the blockchain confirms the block containing your transaction, it is fully established, and the money is accessible to spend.
- Staking allows users to receive passive income. Staking carries risks, but it can let you build your cryptocurrency assets without having to acquire more.
- Transactions involving bitcoin are generally less costly. Still, you should be aware that as the blockchain becomes more popular, transaction prices may rise. Despite this, even on the busiest blockchains, median transaction fees are lower than wire transfer prices.
- The architecture of the blockchain technology, as well as the dispersed computer network that validate transactions, ensures that transactions are safe. The network grows more reliable as more processing power is added to it.
- Any effort to change the blockchain through a network hack would need enough processing power to validate numerous blocks before the entire system could verify the ledger’s correctness.
Cons of Cryptocurrency
- Many crypto initiatives have yet to be thoroughly vetted, and blockchain technology as a whole has yet to acquire widespread usage. Long-term investors might not ever realize the rewards they expected if the core premise for cryptocurrencies does not attain its full potential.
- Another risk exists for short-term cryptocurrency investors: the volatility of crypto. Its values fluctuate swiftly, and although this has resulted in many individuals making quick money by buying in at the right moment, it has also resulted in many others losing money by doing so shortly before a crypto crash.
- Those dramatic price swings may also run counter to the underlying concepts behind the initiatives that cryptocurrencies were designed to assist.
- Regulatory agencies all around the globe are still figuring out how to deal with bitcoin, so proposed amendments and restrictions might have an unanticipated effect on the market.
- Bitcoin and other ventures that employ proof of work mining techniques have a serious impact on the environment. According to a study conducted by the University of Cambridge, global Bitcoin mining consumes more than twice as much energy as all household lights in the United States. Some cryptocurrencies make use of less energy-intensive technologies.
How does Cryptocurrency Work?
Cryptocurrencies are based on the blockchain, which is a distributed public database that keeps track of all transactions and is updated by currency validators that secure the network. This allows computers to collaborate to retain a distributed, tamper-proof record of transactions.
In a blockchain network, all members must agree on the right copy of the historical transaction record. The technique of adding new bitcoins into circulation is known as bitcoin mining. It’s also how the system certifies new transactions, and it’s an important part of the blockchain’s upkeep and advancement.
On a blockchain network, there are various techniques to establish consensus, but the two most often utilized are:
Users may also purchase the currencies from traders, which they can then hold and transact using encrypted wallets. You, however, don’t possess anything physical if you hold bitcoin. You only possess a key that enables you to transact without the involvement of any third party.
Buying Cryptocurrency
Now that we’ve answered the questions: what is a cryptocurrency and how does it work, you must’ve set your mind on whether or not you’ll buy cryptocurrency. If yes, here’s a step-by-step guide to how to buy cryptocurrency.
- Select a Crypto Exchange or a Broker
To buy crypto, you must first choose a broker or a crypto exchange. While both let you acquire crypto, there are a number of differences to be aware of.
- Crypto Brokers: Online brokers allow you to purchase and sell cryptocurrencies as well as other financial assets such as stocks, bonds, and exchange-traded funds (ETFs). Many brokers provide an online trading tool that allows you to duplicate the transactions of other crypto traders into your own account. Others may provide the opportunity to do transactions in a wider range of cryptocurrencies.
- Crypto Exchanges: A cryptocurrency exchange is a platform where you may buy and sell cryptocurrencies. These platforms function similarly to other trading platforms you might be acquainted with. They set up accounts for you where you may generate various order types to buy, sell, and predict in the cryptocurrency market.
Some of the most popular cryptocurrency exchanges are Binance, Coinbase, Crypto.com, Gemini, and Kraken, whereas Robinhood and SoFi are the two most well-known crypto brokers.
- Create New Account and Verify
You may create an account with either a crypto broker or exchange. You must prove your identity depending on the platform and the sum you intend to purchase. This is a necessary step in preventing fraud and being on the same lines as federal regulations.
You cannot buy or trade cryptos until your verification is accepted. You may be required to produce a copy of your passport or driver’s license, as well as a picture of yourself to confirm that your face matches the verification documents that you submit.
- Funding your Account
You have to add funds to your account before buying any crypto. But it totally depends on which method you wish to pay. Many exchanges allow bank transfers and debit cards. Some even allow you pay with your credit card, however, with the volatility of crypto, using a credit card may be a risky decision because the rates of interest can compound and you can lose a lot of money.
If you already have bitcoin, you may deposit it to your broking or exchange account via a crypto wallet or another platform, and then trade it.
- Place your Order
It’s time to place your first cryptocurrency order after you have money in your account. There are hundreds of cryptocurrencies to select from, including well-known names like Bitcoin and Ethereum as well as lesser-known coins like IOTA, Filecoin, and Cardano.
You can use the online or mobile application of your broker or exchange to make an order. If you wish to acquire coins, go to “buy,” pick the order type, enter the number of coins you want to buy, and complete the order. Orders to sell follow the same procedure.
Securing Cryptocurrency
You know what is a cryptocurrency and how does it work, and you also know how to buy cryptocurrency, but your job doesn’t end there. Once you’ve acquired bitcoin, you’ll need to keep it safe to avoid being hacked or stolen. Crypto wallets will come in handy when you want to securely store your
So, how does a cryptocurrency wallet work?
Crypto wallets, unlike traditional wallets, do not store your crypto assets. Your assets are recorded on the blockchain, but you can only access them using a private key.
If you lose your private keys, you lose your crypto assets. If someone gets hold your private keys, they can do whatever they want with your cryptocurrency.
Some exchanges, like Coinbase, offer wallet services, allowing you to store your funds directly on the platform. Additionally, there are also some pretty amazing hardware wallets, such as Trezor and Ledger that support a lot of cryptocurrencies, have offline storage, and many other features. Learn more about crypto security best practices here.
Taxability of Cryptocurrency
Just knowing how does cryptocurrency work, isn’t enough. If you’re interested in buying, selling, trading, or mining cryptocurrency, you have to be knowledgeable of the taxability of cryptocurrency.
Taxes in themselves are a complicated subject matter, and when added with cryptocurrency it may seem even more tricky. However, the Internal Revenue Services had issued a Notice 2014-21 which stated that cryptocurrency, in the USA, will not be treated as currency, but as property.
In simpler words, cryptocurrency is classified as a digital asset in the United States, and the IRS handles it similarly to bonds, real estate, stocks, and other capital assets. Cryptocurrency profits are taxed differently than other assets, either as capital gains or as income, based on how you received your crypto and how long you kept it.
The Bottom Line
That was all about what is crypto and how does cryptocurrency work.
However, if you’ve already dealt with crypto in the past year, you must note is that the date for filing crypto taxes in 2022 is on 18th of April.
Even though most individuals only pay taxes once a year, there are methods to save all year. You may use ZenLedger to figure out how to avoid paying crypto taxes by spotting tax-loss harvesting opportunities all year long, minimizing your tax burden, and paying your taxes before the 2022 crypto tax deadline.
ZenLedger can help you easily calculate your crypto taxes, and also find opportunities for you to save money and trade smarter. Get started for free now or learn more about our tax professional prepared plans!
Disclaimer: This material has been prepared for informational purposes only, and is not intended to provide, tax, legal or financial advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.
