Breaking Down the Mystery of Cryptocurrencies (Part II)

In the first article on cryptocurrencies, we focused on what digital coins are and how they are produced. In this second article, we will discuss the types of currencies and their volatility.

Initial Coin Offering (ICO)

Instead of an IPO, when coming into the marketplace, digital coins go through an ICO or initial coin offering, which the fund uses to raise capital investment, just as a publicly traded company would during an IPO. In 2017, there were 435 successful ICO’s. In an ICO, investors buy into the offering with either fiat money, which is a government declared legal tender, that is not backed by a physical commodity or by other digital coins. During the ICO, the investor receives digital tokens, which is similar to a share of a company, for the investment made. If the ICO produces the funds needed, the investor will receive the new cryptocurrency. If the appropriate amount of funds is not raised, then the ICO is unsuccessful and the money is returned to the investor. ICO’s can be more fluid than an IPO, where they can be structured with either a pre-set or dynamic token price or limits on the number of tokens to be produced.

Just like an IPO, investors are hoping for a quick return and a high payout, but buyer beware; as an ICO is unregulated and there are many scams out there. Every time that there is an ICO, it is another open-source project and people from all over the globe can assist in the code base, creation of an exchange or transactional fees. Cryptocurrencies are a volatile market and in September of last year, the People’s Bank of China banned ICOs, stating that they were disruptive to the economic and financial stability of the country and this year, Facebook, Google and Twitter all banned ICO advertisements.

Types of Digital Currencies

Each cryptocurrency runs over an exchange and we previously learned about Blockchain. I selected my favorite browser and searched for digital exchanges and found 200 currently in the marketplace. In watching the exchanges and currencies over the past several months, the one thing that I’ve found is that it’s almost impossible to find the same information twice, let alone the same site. In the last 24 hours, here is what the market looked like:

September 1                                    November 4                                  November 5

Exchange Types Market Volume Types Market Volume Types Market Volume
Binance 280 $1B 385 $21B 291 $712M
Huobi 155 $211M 283 $9.4B 196 342M
HitBTC 316 $154M 820 $194M 385 205M

In addition to the exchanges, there are over 1600 types of cryptocurrencies and the prices change just as frequently as the exchanges do. The following examples show the volatility from September to November.

September 2018        November 2018

Cryptocurrency Market Volume Market Volume
Bitcoin $125B $1.124B
Ethereum $29B $314M
Ripple $13.3B $383M

 Here is a short breakdown of cryptocurrencies:

Bitcoin

Bitcoin was named the top performing currency four out of the last five years.

Bitcoin Cash

Bitcoin Cash (BCH) is another type of digital currency, that can be transacted from a Blockchain wallet and can be used like cryptocurrency or exchanged for another type of currency, like bitcoin or ether.

Bitcoin Cash works in a block size of 8 MB, which equates to the faster processing of more transactions. The wallet will work in the same way for bitcoin cash and determine processing fees for the transaction amount.

The next set of cryptocurrencies are outside of bitcoin and referred to as altcoins.

Ethereum (ETH)

Ethereum is changing the world of digital currency, by having a growing set of applications that span several industries and uses the currency for transactions. In looking at the apps, there were games, exchanges, gambling, finance, sports, mobile phone, video platforms and trading applications. There was even an application that promotes the production and trade of drugs on Blockchain. Please remember, that the open-source market is a creative think-tank of developers – if they can develop it, the Ethereum network can run it. In a decentralized and anonymous network, anything can be exchanged for a cryptocurrency.

Ethereum is a distributed public block chain network for sharing information across the globe that cannot be manipulated or changed, which attracts developers from around the world. Ethereum uses a cryptocurrency called ether or ETH that also runs in a decentralized platform that uses Smart Contracts or a protocol to transact directly among disparate, anonymous parties, in a traceable, transparent voting, and irreversible way. Ether is a tradeable cryptocurrency, and the interest is that the currency pays for transaction fees and computational services. Ethereum runs Distributed Applications (or ĐApps) to be built and run without any downtime, fraud, control or interference from a third party.

Ripple (XRP)

Ripple is now referred to as XRP and is a real-time network that offers instant, certain and low-cost international payments, by enabling banks to transact and settle geographic payments, with transparency, at lower costs. XRP doesn’t require mining and plans to distribute currency through business development deals, incentivizing liquidity providers who offer spreads for payments and by selling the currency as an investment to institutional buyers.

Investing & Taxes

Forbes describes the cryptocurrency market as risky and volatile and like other investments, there is no guarantee of a reward. The Nasdaq site states to only invest money that you can afford to lose. The investor needs to balance risk and reward when dealing in cryptocurrencies. Then there is the IRS, who finally figured out that they were missing out on a huge marketplace where taxes were not originally collected.

In 2014, the IRS issued Notice 2014-36 and stated their position that virtual currency should be treated as a property for U.S. federal tax purposes. Cryptocurrencies are not considered legal tender in any US jurisdiction, even if in some environments the cryptocurrency is circulated or used and accepted as a medium of exchange in the country of issuance.

The income or gains from the sale of a digital currency, can be treated like a capital asset, and therefore subject to either short-term (ordinary income tax rates) or long-term capital gains tax rates, if the asset held is greater than twelve months and subject to 15% or 20% tax rates-based on the income level.

On the flipside, for retirement account investors, the IRS has created a favorable tax environment for cryptocurrencies. Retirement accounts that generate income or gains with the purchase or sale of a capital asset, whether held short or long-term, does not need to pay any tax for their transactions and taxes are deferred to a later date or when the retiree takes a distribution, as the same rules apply as in a qualified plan. When retirement funds are used to invest in cryptocurrencies, the investor could defer or even eliminate the tax (ie: Roth IRA), due from the investment. If a retiree invests in mining versus trading, they could be subject to business taxable income rules, as the “mining” could be viewed as a trade or business.

@2018 All Rights Reserved

Sue Bergamo is the CIO & CISO at Episerver, a global digital commerce company. She can be reached at sue.bergamo@episerver.com.

*The content within this article are the sole opinions of the author.


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