Cryptocurrency & Blockchain Technology

Cryptocurrency & Blockchain FAQs

What is cryptocurrency (digital assets)?

Cryptocurrency is a type of digital token designed as a medium of exchange using cryptography as a form of security. Bitcoin is an example of a cryptocurrency. While investment in cryptocurrency remains relatively small compared to overall financial markets, this type of digital token has attached significant regulatory scrutiny across multiple jurisdictions.

It’s important to note that a cryptocurrency, contrary to what its name might suggest, is actually not a currency. While some companies may accept digital currencies in transactions, these aren’t legal tender and aren’t backed by the government. Cryptocurrencies are decentralized with no central authority or bank, are open to the public and don’t require trusted third parties to operate. In addition, cryptocurrencies aren’t readily convertible to cash and don’t exist with short-term maturity dates to be considered cash or cash equivalents.

Cryptocurrencies aren’t financial instruments because they don’t represent contractual rights to receive or exchange cash or another financial instrument. Cryptocurrencies likely aren’t inventory or commodities because they aren’t considered “goods,” as cryptocurrencies aren’t tangible assets.

Cryptocurrencies most likely fit into current U.S. GAAP under the intangible asset literature, as cryptocurrencies aren’t tangible assets, don’t have a physical substance and don’t represent a material right to receive cash.

What are digital assets?

A digital asset is something represented in digital form that has an intrinsic or acquired value, e.g., land, house, currency, vote, goods, certificates, identity, rewards, etc.

What is bitcoin?

Bitcoin is the best-known cryptocurrency. It’s a type of digital cryptocurrency in which a record of transactions is maintained and new units of currency are generated by the computational solution of mathematical problems. Bitcoin operates independent of a central bank or central administrator.

How are bitcoin and blockchain related?

Blockchain technology was regenerated to enable the existence of cryptocurrency such as bitcoin (and numerous other digital assets or records).

How does blockchain work?

Each transaction issued on the blockchain is confirmed by validating nodes (computers) through network consensus and written immutably to timestamped blocks.

How can blockchain be used? 

As a registry:

  • Blockchain provides a low-cost, automated, high-integrity method of storing transaction records.
  • User-specific encryption keys are used; therefore, records are kept in the ledger but accessible only by authorized users.

To transfer value:

  • This solution enables secure, near-real-time, low-cost transfer of value or records without an intermediary.

With smart contracts:

  • Blockchain creates technology with inherent properties to reduce risk associated with contractual agreements, transforming how contracts are executed.

What are the essentials of blockchain?

Peer-to-peer network – In a peer-to-peer model, every peer in the network is a server and a client, both supplying and consuming resources. A peer-to-peer network facilitates currency use without an intermediary or privileged third party.

Public key cryptography – A method for verifying digital identity with a high degree of confidence, enabled by using private and public keys. This allows for individual ownership and exchange of tokens among users.

Proof of work – A piece of code appended to data that validates the data’s authenticity and controls when it can be written into the system. This ingredient prevents double-spending by ensuring data is recorded chronologically.

What are the pros and cons of blockchain technology?  

Pros:

  • Allows people to own their own data  
  • Potentially creates an additional sense of transparency for transactions  
  • Decreases costs associated with auditing and legal matters  
  • Provides the ability for cross-border transactions 
  • Provides a transactional solution to those who don’t have access to financial institutions

Cons:

  • Uses complex technology
  • Faces regulatory implications
  • Undergoes changes through further implementation
  • Competes with platforms that potentially don’t transact or interact with each other

How are virtual currency transactions treated for tax purposes?

For federal income tax purposes, virtual currency is treated as property and general tax principles applicable to property transactions apply to transactions using virtual currency. For more information on the tax treatment of virtual currency, see Notice 2014-21. For more information on the tax treatment of property transactions, see Publication 544, Sales and Other Dispositions of Assets. The IRS is making it a priority to enforce and continue to provide guidance on proper reporting of cryptocurrency transactions. To stay up to date with IRS guidance on virtual currency reporting and taxation, reach out to your BKD Trusted Advisor.

What is a wallet? What type of wallet to use (hardware)?

Cryptocurrencies are not physically stored anywhere; a wallet contains the information required to move or spend a specific unit of cryptocurrency from one address on a blockchain to another. Since the purpose of a wallet is to hold this information, it can exist in several different forms: it can be software; it can be held in specialized physical devices called hardware wallets; or, it can be physically printed on to paper known as paper wallets. More technically, a wallet is a collection of private and public key pairings.

What is an exchange?

An exchange is a marketplace where people who have cryptocurrency can sell it, and people that want cryptocurrency can buy it, much like a stock exchange. In some instances, the exchange simply facilitates the transactions between two other people or entities, and in other instances the exchange itself participates in buying and selling cryptocurrency it owns. Some exchanges offer additional services such as a wallet service, where customers can store their cryptocurrency.

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