What You Need to Know About Virtual Currency

Virtual and cryptocurrencies have been at the forefront of our financial consciousness lately. Whether it’s through coverage on tech sites, or even a casual reference on futuristic and tech-geared TV shows, Bitcoin has become a buzzword. But what exactly are Bitcoins, or virtual currencies? We spoke with a couple of experts to break it down.

What is Bitcoin?

William Kehl, co-founder of Coinigy.com, explains, “Bitcoin is a method of transacting online. It should be thought of as a protocol first, and a currency second. Think of Bitcoin as a transport method, almost like an ‘email for money.’ When you send or receive a Bitcoin, you’re not going through any central institution. You’re sending it directly to the other party in the same way you would hand physical cash to someone.”

Is there any transparency in the world of virtual currency?

“Cryptocurrencies like Bitcoin and Litecoin are peer-to-peer,” Kehl explains. “This means that anyone connecting to the Bitcoin network can download the ‘blockchain,’ which is a complete ledger of all transactions that have ever occurred. This allows for complete transaction transparency, and relies on social proof rather than trust in financial institutions.”

What is the difference between virtual currencies like Bitcoin and services like PayPal?

In many ways, Bitcoin acts like digital cash. As Kehl explains, “When someone owns Bitcoin, they actually physically hold it. If you have a Bitcoin wallet installed on your phone, for example, that wallet will physically contain your Bitcoin address’ private keys. As opposed to traditional banking systems or PayPal, which show a representation of a dollar amount that they hold on your behalf, Bitcoin and cryptocurrencies are different in that you physically hold the currency, in data form, on your device. It can be thought of as ‘digital cash’ — which does have some caveats. If you lose your private keys, you’ve lost your Bitcoin, which is comparable to losing some cash.”

Is Bitcoin tax-free?

Yes and no. “You are expected to pay taxes on Bitcoin capital gains just as you would any fiat investment,” Kehl notes. In recent years, employees have been paid with Bitcoin and more than a few retailers accept Bitcoin as payment, while other hold it as a capital asset. The IRS classifies Bitcoin as “convertible virtual currency” and addressed its tax treatment via Notice 2014-21. In short, Bitcoin taxation depends on how it is held and used. Read more about it from TurboTax.

Are virtual and cryptocurrencies regulated?

Kehl explains, “Cryptocurrencies at the present time are completely unregulated (at least in the U.S.). It’s quite literally the Wild West out there. If you’re interested in using a cryptocurrency as an investment medium, do your due diligence before putting money in any exchange.”

Jeffery Born, Professor of Finance at D’Amore-McKim School of Business, Northeastern University, explains further, “At the moment, virtual currencies are all ‘private’ monies — they are not issued by a sovereign government. Thus, they are not legal tender. If you do accept one of these items you do so at your own risk as its value may change. This is true any time you accept barter for a good or service that you provide. The problem with ‘private’ monies is that their ability to serve as a store of value and to facilitate transactions is uncertain.”