Understanding cryptocurrency and Bitcoin

Over the past few years there has been an increase in the popularity of virtual and cryptocurrencies. The most popular of these is Bitcoin. Bitcoin has been receiving more mainstream recognition recently and has received attention from major news corporations. The value of a single bitcoin recently passed the £8000 mark, and this has sparked the interest of the IRS in America.

On the 29 November 2017 a federal court ordered Coinbase, which operates the largest U.S. exchange for buying and selling Bitcoins, to hand over information to the IRS on over 14,000 customers suspected of evading taxes. Recently the UK government have started discussing regulating Bitcoin. The UK Treasury has said Anti-money laundering regulations should be updated to include Bitcoin and other virtual currencies. Yet even with the attention that cryptocurrency has received, it can still be confusing to understand how it works.

So how does it work?

Bitcoins are stored in a virtual wallet. Your wallet can be saved to a hard drive or memory stick, or more commonly it can be stored online by a wallet provider such as Coinbase. Coinbase also acts as an exchange where people can buy, sell or trade Bitcoins for other currencies such as Dollars, Euros and Pounds etc. They can also be exchanged for other cryptocurrencies such as Ethereum or Litecoin.

Bitcoins are created by computers carrying out a process called ‘mining’. Imagine there is a giant math problem that needs solving. You can set your computer to start working out the solution. One computer isn’t enough to work out the solution by itself, but by combining the processing power of millions of computers it becomes possible. Each computer that is ‘mining’ is given a small part of the equation to work on, and when it works out the answer it is rewarded with a small amount of Bitcoin and given the next part of the equation to work on.

What are the miners trying to work out?

People are sending bitcoins to each other over the bitcoin network all the time, but unless someone keeps a record of all these transactions, no-one would be able to keep track of who had paid what. The bitcoin network deals with this by collecting all the transactions made during a set period into a list, called a block. It’s the miners’ job to confirm those transactions and write them into a general ledger. This ledger is what the bitcoin miners are calculating to earn their reward.

What are the tax implications?

Back in March 2014 HMRC issued guidance on the tax treatment of Bitcoins and other cryptocurrencies but, given the recent surge in interest in cryptocurrency trading and the gains that can be made, it is likely that this will be revisited soon.  Currently, if you are running a business and are buying and selling goods and services using bitcoin or other cryptocurrencies, they are treated in the same way as if you were using a foreign currency.

For individuals, it may be possible to claim that some transactions in cryptocurrencies are so speculative that they could be treated as gambling, so will not be taxable at all. Alternatively, the individual could be deemed to be “trading” in cryptocurrencies so any gains made would be subject to income tax. If the activity does not fit into either of these categories, it will be treated as a capital transaction, subject to capital gains tax. Given the current interest in virtual currencies, it is vital that any gains are reported before HMRC start asking questions!

At Wright Vigar we have a specialist team on hand to advise you on all tax matters. If you would like more information on the specifics covered in this article, or would like to discuss your personal situation in more detail please contact Sue Mossom, Tax Manager at Wright Vigar, on 01427 611296 or email sue.mossom@wrightvigar.co.uk – we would be delighted to have an opportunity to work with you.