Key Cryptocurrency Terminology
In a previous post on cryptocurrency, we discussed the formation of the New York Cryptocurrency Task Force and its purpose. As we discussed, this unit will play a big role in shaping New York State policy regarding cryptocurrency. What’s more, this unit may ultimately end up impacting the policies of other states and even foreign governments. The members of this group, which must all be approved by Governor Cuomo, represent some of the most knowledgeable experts in the cryptocurrency space. In order to better follow the NY task force, and better follow our other tax articles on cryptocurrency, our readers should have a firm command of basic cryptocurrency terminology.
Without understanding these terms, you will likely be lost when reading some of the basic documents on cryptocurrency tax treatment, such as IRS Notice 2014-21. In this post, we will provide definitions for a few crucial pieces of cryptocurrency terminology. Once you master these terms, you’re in a better position to follow future cryptocurrency developments.
The initial cryptocurrency terminology we’ll consider is the “blockchain.” A blockchain is a “digital ledger” which records the transactions of a certain cryptocurrency. A blockchain is a public document, meaning that the transactions it records can be viewed by the general public. The transactions on a blockchain are all privately verified by other cryptocurrency holders. Even though the transactions on a blockchain may be viewed by the general public, the identities of those engaging in the transactions are not known. This enables the cryptocurrency to provide a measure of security and anonymity to its users.
As we discussed in our piece on Revenue Ruling 2019-24, a “hard fork” refers to the creation of a separate cryptocurrency (and separate blockchain) from an original cryptocurrency. This happens when one blockchain “splits” apart and becomes separate from the original. Even though a hard fork results in the creation of a new cryptocurrency on a separate blockchain, this doesn’t necessarily mean that units of the new cryptocurrency are distributed to crypto holders. This means that a hard fork doesn’t necessarily produce income for cryptocurrency holders. However, it is possible that a hard fork will result in income for holders, but this would involve a hard fork followed by an airdrop of the new cryptocurrency.
In the context of the cryptocurrency space, an “airdrop” refers to the distribution of units of a cryptocurrency to multiple crypto holders. An airdrop commonly occurs after a hard fork in an existing blockchain creates a new cryptocurrency on its own separate blockchain. The airdrop will distribute a certain quantity of the new cryptocurrency to various holders. Importantly, an airdrop triggers the receipt of gross income, as is clear from Rev. Rul. 2019-24. This is something that every cryptocurrency holder needs to understand. If an airdrop ever occurs after a hard fork, this means that you will have new income which you need to report and pay taxes on.
The term “mining” refers to the process of using computer power to verify cryptocurrency transactions. Transactions are verified when a computer solves a cryptographic puzzle. This puzzle ensures that the transaction is accurate and that the sender has the correct amount of funds. With bitcoin and other cryptocurrencies, mining doesn’t simply verify ongoing crypto transactions, it also generates more cryptocurrency. This new cryptocurrency is a reward for solving the cryptographic puzzle and the solver receives credit for it. Mining is, therefore, an income-generating activity, and those who engage in mining as a business need to keep track of their income for tax purposes.
Initial Coin Offering (ICO)
No review of cryptocurrency terminology would be complete without a mention of an initial coin offering, or ICO. An ICO is essentially the equivalent of an initial public offering, or IPO, in the stock market. In an IPO on the stock market, shares of a company which have just become publicly traded are made available to the general investor. Likewise, in an ICO, a newly created cryptocurrency token becomes available to the general investment community. ICOs can take place when an existing firm creates a new token, or a new firm launches a new token.
Reach Out to Us for Extra Information
This is just some of the more essential cryptocurrency terminology you need to know when it comes to virtual currency. There are plenty of other useful terms, but these terms are very important. You will see these terms all the time if you scan crypto documents, including the statements made by the IRS. At Mackay, Caswell & Callahan, P.C., we make an effort to stay up-to-date with current affairs and recent developments in the tax world. Lately, this has meant that we’ve devoted a lot of energy to mastering IRS treatment of cryptocurrency. We will continue to do this for as long as doing so creates value for our clients. If you’d like to learn more, contact one of our top New York City tax attorneys for extra information.
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