Everyone has heard about cryptocurrencies. They were already a “hype” last year. At times, it seems that we can’t stop hearing about Bitcoin or Ethereum or Peercoin in our work place, at home, on TV, or on the internet. Pretty much everyone has been exposed to the media buzz surrounding cryptocurrencies, but no one seems to have the full picture. Moreover, no one seems how to fit them into accounting and taxation frameworks.
Virtual (crypto) currencies are based on Blockchain technology, which is not an unprecedented invention, but closely tied to the evolution of the internet. Blockchain is a decentralized, distributed database of encrypted records (think of a ledger), which allows the transactions to be executed securely and automatically. The transactions can be non-financial, such as creating a secure voting system without human intervention, or financial, like investing in an option and receiving a payoff.
The idea of the first cryptocurrency, Bitcoin, was first mooted in a paper just after the financial crisis of 2008, by an unknown writer who used the name Satoshi Nakamoto
. He believed in a peer-to-peer electronic cash system, which allows people to send money to anyone, at any time, via an electronic currency, and which is based purely on the classic rules of demand and supply. His groundbreaking idea was to exclude bank and government regulation. Many programmers saw the opportunity, and later developed this vision further by creating new blockchains and cryptocurrencies. Today, almost every large company is affected by blockchain technology, leading to positive pressure on businesses to come up with new and innovative ideas. All attention is on the crypto world now.
With Bitcoin at the pinnacle of the crypto rush, virtual currencies suddenly became a serious investment alternative to individuals, start-ups and even to big broker firms. The main difference between real (fiat) and cryptocurrencies is that, while the fiat currencies have to be accepted by a third party, other than the supplier of the currency, the cryptocurrency transactions take place between two parties only, within the same virtual market.
Operations in the blockchain are very secure; and transactions can be executed without any regulation of banks or governments, since the system confirms the validity of each transaction without the need for any external intervention. Although the system has many inevitable benefits of speed and accuracy, every opportunity has its downside. The technology is completely anonymous, so it faces serious issues in regards to money laundering and the possibility of fraud.
Although the cryptocurrencies are usually treated as currencies, the Central banks of the EU Member States do not consider virtual currencies as equivalent to money. The European Central Bank even describes virtual currency as a “digital representation of value, not issued by a central bank, credit institution or e-money institution, which in some circumstances can be used as an alternative to money”. We need to understand the substance of cryptocurrencies to be able to determine their correct accounting and taxation treatments.
They do not fit into any financial category perfectly; they are similar to account receivables, currencies or investment, but do not meet any criteria completely. Although the main purpose of any currency would to be used as a base of trade, as a medium of exchange for goods and services, many codes, such as Ether, are hardly ever used for online payments. Many currencies and tokens are widely traded on many platforms, and can be used to determine a common value, but their functionality is so unique, that the word “currency” no longer covers their real definition. Many argue that the traditional accounting treatments and taxation rules therefore cannot be used and need to be revised to be able to accommodate these technological advancements.
Accounting and tax classifications, however, need to be specified to be able to include our assets in the books and pay the correct taxes. The substance might be more accurately defined if we investigate the source of our currencies. If we received them via mining, we can consider this transaction as “other income” and declare the benefit as our profit. Of course, if we have purchased them, we need to ask ourselves the question: “What did we purchase exactly”? As we have seen, the definition is not exactly covered by the word “currency”. So the classification can vary from account receivable to investments, which raises further questions of impairment and valuation of the asset.
Valuing these currencies is also very hard. Since there is no accepted exchange for the virtual currencies, the period end value is almost impossible to determine accurately. Further on, VAT is chargeable on the goods and services, but not on trading with currencies. Although cryptocurrencies are not exactly currencies, the law determines that mining falls outside the scope of VAT, whilst trading with cryptocurrencies are exempt supplies for VAT purposes.
With the accelerated advancements of this technology, the law and financial industry have to be more and more adaptable. The future favours those who can treat these developments as an opportunity and are always ahead of the changes. The gap between the financial and the technology industry is about to disappear helping the birth of a new era.