What is a cryptocurrency?
If you’ve heard of Bitcoin then you’ve heard of a cryptocurrency. Bitcoin is the most well-known ‘crypto’ but nowadays there are thousands of alternatives.
The technical aspects of cryptocurrencies are constantly evolving. Generally, most cryptocurrencies:
• Can be used as a medium of exchange, like traditional currencies.
• Are built on a network of independent computers (or nodes). These computers are what keep the network secure and process transactions.
• Use blockchain technology, which itself is built upon cryptographic principles, hence the name.
• Are decentralised. Once created, no central institution, bank, authority, or country is needed to operate the cryptocurrency.
A couple of other terms that crop up frequently with crypto are:
• Mining and Staking: nodes on the network can earn cryptocurrency for running the network.
• Exchange: an online marketplace where people buy and sell cryptocurrencies.
Is it here to stay?
When bitcoin first appeared in 2009 they could be bought for pennies. It was considered a niche technology, and not many people were interested in it. It took two years for a bitcoin to hit a $1 value. Today a single bitcoin has a market value of around $30,000. If you’d invested £100 into bitcoin in 2011, that investment could be cashed in for £3m today.
The combined value of all cryptocurrencies in the world, as of early 2023, is around a trillion dollars. Bitcoin makes up around half of that. For context, a trillion dollars is around 10 times the amount of physical cash in circulation in the UK. The total value of crypto has been higher in the past, peaking at nearly three trillion dollars in 2021.
So, while there are crypto-enthusiasts, and crypto-sceptics, it can’t be denied that the figures behind cryptocurrency, and the fact it’s been around for over a decade, make it look like more than just a fad.
The trillion-dollar question however isn’t just whether cryptocurrency, as a technology, is here to stay, it is which crypto will win the battle to become the dominant coin. Bitcoin is still in the lead at the moment, with some countries (El Salvador and the Central African Republic) even having adopted it as their official currency. Perhaps a new upstart with slightly better blockchain technology will take its place in the future. Will bitcoin suffer a fall as rapid as its rise?
To say cryptocurrencies have had their ups and downs would be an understatement. Cryptocurrency and speculation go hand in hand. Crypto-investing is definitely not for the faint-hearted. Not only is it unregulated, it’s highly volatile and a number of exchanges themselves have collapsed. Fortunes have been made and lost on crypto.
How is it treated for tax purposes?
Critics of crypto point out that it isn’t actually used all that often for what it was designed – to pay for things. The vast majority of crypto transactions are people buying and selling cryptocurrencies with a view to making a profit. The potential applications of crypto as currency is one thing, the reality is they are traded much more like stocks and shares.
It’s perhaps not surprising therefore that the UK tax rules treat cryptocurrencies as investments, and not like currencies. Transactions in crypto are therefore typically treated as capital gains transactions.
This is good news for those making modest gains dabbling in the crypto-market. An individual can make £6,000 in capital gains in the current tax year without having to pay any capital gains tax. That allowance covers all types of gains in a tax year, so may not be available if someone has made gains on other assets.
There are a number of practicalities that make reporting crypto gains much more difficult than other investments. Calculating gains on most investments is usually straightforward. Better still if a broker is able to provide gains figures at the end of a tax year. Crypto transactions are typically much more numerous and convoluted. Exchanges simply can’t provide users with the same type of tax information that traditional UK investing platforms can – that exchanges cater to customers globally is a key reason they don’t do this.
It is possible that HMRC take the view that someone is in the full-time business of trading stocks and shares, and the same applies to crypto traders. This is rare, and it can be complex to ascertain when someone has crossed the line from capital gains into trading. Anyone held to be trading would have to produce accounts and be subject to income tax and NIC on profits.
‘Mining’ crypto is effectively the exchange of computer resources, to contribute to the running of the network, and receiving some of the newly minted cryptocurrency in exchange. ‘Staking’ is similar but is more like receiving interest on your crypto. In a similar vein, in recent years there has been an emergence of ‘DeFi’ (Decentralised Finance) platforms which offer services similar to traditional financial lending and saving products, but using cryptocurrency. These various crypto income streams are treated as income for tax purposes, rather than capital gains. There may be additional considerations to correctly classify the type of income, whether there are expenses to be claimed (mining in particular can be very energy intensive) and if it is a larger operation, whether it constitutes trading.
In more recent years, a newer type of digital asset has emerged. Non-Fungible Tokens (NFTs) are assets on a blockchain, so similar to crypto in that respect, but different in that they tend to relate to a single unique piece of digital intellectual property such as an artwork. All bitcoins are the same, and you can own any fraction of any bitcoin. Conversely, NFT’s are usually unique and the item is owned in its entirety. For tax, NFTs are treated the same ways as cryptocurrency, so fall into capital gains. The term ‘cryptoassets’ has emerged to cover both cryptocurrencies and newer assets like NFTs.
HMRC are certainly getting more sophisticated both in terms of their guidance on cryptoassets and how they are working with exchanges to get information about taxpayers activities. From April 2024 the Tax Return will contain a specific capital gains tax section for reporting crypto transactions. It’s increasingly important to ensure crypto transactions are separately tracked and reported on returns.
Our tax team can assist you with any tax questions or calculations in relation to your crypto portfolio. Get in touch with tax@sowerby-llp.co.uk for more information.
_________________
James May, Tax Manager
May 2023