Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. Virtual currencies are often used to make purchases online and in certain physical locations. In the United States, the IRS treats virtual currency as property for tax purposes. This means that any profits from purchasing or trading virtual currencies are subject to capital gains taxes.
What is virtual currency?
Virtual currency, or cryptocurrency, is a digital asset that can be used to exchange for goods or services. It is a form of digital money that is not issued by any government or central bank and has no physical form. Cryptocurrencies use cryptography to secure transactions and control the creation of new units of a particular cryptocurrency.
While it can be used to purchase physical items such as gold or silver, it’s most commonly used in transactions on the internet. Virtual currency is not legal tender and has no material form. It exists only in the digital realm. Virtual currency may be centralized or decentralized, depending on how it was created and which entity issues the currency.
Virtual currencies are not issued by central banks or backed by any national government or other legal entity. Instead, they are issued by private companies who create them electronically through mathematical computations performed with powerful computers.
In the United States, the IRS treats virtual currencies as property for tax purposes. The IRS treats virtual currencies as property.
This means that the following rules apply:
- You must report the fair market value of your virtual currency on your tax return.
- If you receive income from mining cryptocurrency or from trading in a cryptocurrency, you must pay tax either as wages or self-employment income 24 hours after the transaction occurs.
- If you mine cryptocurrency then you must report your income as self-employment income. You must also pay self-employment tax.
- If you trade cryptocurrency as a business, then you must report your income as wages on Form W2 and withhold taxes from each employee’s paycheck.
- If you sell cryptocurrency as a hobby, then you must report your income as capital gains and pay taxes on it.
Virtual currencies can be centralized or decentralized. Centralized virtual currencies are controlled by one organization or individual, while decentralized ones are not.
Virtual currencies have been around for decades but have gained popularity in recent years due to their ability to facilitate anonymous transactions across borders without the need for traditional financial institutions — all while transacting at lower costs compared to traditional payment methods such as credit cards or PayPal.
Types of virtual currency
Virtual currency is not a legal tender, it is not backed by any government and it is not backed by gold or silver. Virtual currencies are not backed by physical assets as they do not represent any tangible asset like a commodity or currency.
Virtual currency may be centralized or decentralized.
Centralized virtual currencies are controlled by a single entity, while decentralized virtual currencies are controlled by a network of users. The latter type is more difficult to regulate and control, which can make it more attractive for illicit activities like money laundering and tax evasion. Decentralized virtual currencies like Bitcoin and Ethereum follow the same rules as their traditional counterparts. They exist only on digital networks and not in physical space. In other words, virtual currencies are only backed by their value on the market and nothing else.
Virtual currencies may be centralized or decentralized and have their own rules for how they can be used.
Decentralized virtual currencies
- Decentralized virtual currencies include Bitcoin, Litecoin, and Darkcoin. These are all peer-to-peer payment networks that use cryptography to ensure transactions are secure. Unlike centralized virtual currencies like PayPal or Venmo where a central authority (the company) controls the money supply and transaction processing, decentralized virtual currencies have no central authority. The blockchain technology that powers these cryptocurrencies is open source and cannot be controlled by any one person or entity. The supply of each cryptocurrency is limited by a cryptographic algorithm designed into their codebase.
Centralized virtual currencies
- Centralized virtual currencies are controlled by a central authority. For example, Facebook Credits and Blizzard’s Battle.net Balance are both centralized virtual currencies that are used to purchase items in Facebook games, such as Farmville and Candy Crush Saga. Similarly, Rixty Minutes and World of Warcraft Gold can be used to make purchases on specific websites (Rixty Minutes) or platforms (World of Warcraft). While these types of coins are not as decentralized as decentralized coins, they do offer consumers some protection because they carry the backing of well-known companies like Silicon Valley’s PayPal.
Virtual currencies are an important part of the future of online payments. They offer fast and secure transactions, low transaction fees, and are not subject to government interference. With these benefits on offer, it’s easy to see why more people than ever before are turning towards them as their preferred method of payment.
Advantages of virtual currency
Virtual currency can be used for online transactions through internet-enabled devices like mobile phones or computers. It can also be used for offline transactions in brick-and-mortar businesses by exchanging the cash with the shop owner via mobile phone or hard cash.
Virtual currency has several advantages over traditional currencies and other investments.
Secure and anonymous: All transactions are encrypted and sent directly from the payer to the payee. The transaction cannot be reversed by anyone including the owner of the Bitcoins. This provides a high level of security for people who want to make payments without disclosing their identity or location.
Transactions are fast: Once you confirm your payment, it is sent to the network and then verified by miners before being added to the blockchain (public ledger). The time taken for this process depends on how many people are using Bitcoin at any particular time in any given region, but it usually takes around 10 minutes or less.
Low transaction fees: There are no third party charges or hidden fees when you purchase goods or services from merchants who accept Bitcoins as payment method
No exchange rates: When you send some money abroad, there might be a foreign exchange rate fee that is charged by your bank or credit card company which can add up quickly if you send large amounts of money back home frequently or purchase products online with overseas merchants regularly
No limits: When you use your credit card, there might be a limit to how much money you can spend. This is especially true when traveling abroad and trying to purchase goods or services from merchants who accept only cash. Bitcoin transactions do not have any limits; as long as you have some bitcoins in your wallet, you can make purchases up to the amount of those coins
Disadvantages of virtual currency
Virtual currencies such as Bitcoin, Ethereum and Ripple have experienced a surge in popularity in recent years. However, there are also several drawbacks to these cryptocurrencies. The value of a virtual currency can fluctuate widely over time, which makes it difficult to predict how much you will be able to buy or sell it for at any given point in the future.
The disadvantages of virtual currency include:
Virtual currency has no intrinsic value: They are not backed by any physical asset, such as gold or silver, and are not legal tender. As a result, their value is entirely dependent on the market’s perception of their worth at any given time.
Virtual currency is volatile: The value of virtual currencies can fluctuate significantly, which means they may not be a good investment. They are also susceptible to cyberattacks and theft, which can cause significant losses.
They have no physical form: Virtual currencies cannot be touched or seen in the same way as traditional currencies, such as dollars and euros, which makes them difficult to use in everyday life.
Virtual currency is not legal tender in most jurisdictions: Virtual currencies are not legal tender. This means that the government does not accept them as payment for taxes and other debts.
Virtual currency is a high-risk investment: Virtual currencies are speculative investments, so you should be prepared to lose some or all of your money if you decide to invest in them.
In conclusion, it is important to be aware of the benefits and drawbacks of virtual currency before making a decision about whether to invest in it. A cryptocurrency such as Bitcoin has been described as a high-risk asset because of its volatility. It is certainly an intriguing investment opportunity, but you should never risk more than you can afford to lose.
With the benefits of mass adoption and its ability to make payments more affordable, it’s only a matter of time before governments start to recognize virtual currency as a necessity in today’s global economy. If you would like to learn more about how Cryptocurrencies and their potential, feel free to check out our course catalog, where you will find a variety of course offerings to help your institution stay up to date on the latest banking developments.
