Cryptocurrencies are digital tokens available online via exchanges, initial coin offers (ICOs), and token events
A cryptocurrency is a virtual or digital currency that uses cryptography for security. Because of this security feature, cryptocurrencies are difficult to counterfeit. A defining feature of a cryptocurrency is that it is not issued by any central authority such as a central bank, making it theoretically immune to government manipulation or interference. For many, this is the best feature of cryptocurrencies.
Launched in 2009, Bitcoin is the most well-known cryptocurrency, and in recent years has captured a lot of media attention. Bitcoin's success has led to a significant number of competing cryptocurrencies, and most commentators think the number of available cryptocurrencies will only increase.
Cryptocurrencies are not legal tender (money that must be accepted as payment) and do not exist physically as coins and notes. When you buy cryptocurrency, it is held in a ‘digital wallet’. The cryptocurrency can then be used to buy goods or services from anyone willing to accept it. Cryptocurrency exchanges enable you to buy and sell cryptocurrency and some allow you to convert it back into money such as New Zealand dollars, so long as someone is willing to buy it.
Moving forward, most experts anticipate the use of cryptocurrencies to become more mainstream as the technology improves, making them more practical for use by the general population.
NZ taxation on crypto assets
In September 2020, NZ's Inland Revenue Service (IRD) updated its guidance on the tax treatment of cryptoassets. Crypto-assets is just another name for cryptocurrencies and/or virtual currencies.
IRD spokesperson Tony Morris says the IRD is doing the refresh to provide some certainty for taxpayers with cryptoassets.
“People can buy, sell, and exchange cryptoassets; provide goods or services in exchange for them; mine cryptoassets; and earn staking rewards (or “crypto interest”) among other things,” Morris says.
“There are no special tax rules for cryptoassets in New Zealand. The guidance clarifies how ordinary income tax rules apply to cryptoassets to help people understand their tax obligations.
“Essentially, cryptoassets are treated as a form of property for tax purposes. What people make from selling, trading or exchanging crypto-assets is taxable.
“This updated guidance allows people to work out what tax they need to pay when they sell, trade, swap, lend or mine cryptoasset transactions. They can find out what records to keep and work out what they need to put in their tax return.”
Investors would need to calculate the NZ dollar value of their cryptoasset transactions, as well as their income and expenses, and include that in their tax returns.
That could include income from mining, staking, lending, selling or being paid in cryptocurrencies.
“If you hold cryptoassets as trading stock, your income also includes the closing value of your trading stock. This is the value of the cryptoassets you hold as trading stock at the end of the income year.”
Traders could generally claim the cost of the assets, the depreciation of capital assets such as computer hardware, and interest charged on money borrowed to buy assets if there is a taxable profit involved.
Learn more at the relevant IRD webpage.
Initial Coin Offers (ICO)
Initial Coin Offers (ICOs) and token events are a form of fundraising where you receive tokens that carry certain rights, such as providing access to a new service or product, or an interest in an underlying asset or project.
Benefits and drawbacks of cryptocurrency
Cryptocurrencies make it easier to transfer funds between two parties in a transaction. These fund transfers are performed with minimal processing fees, allowing users to avoid the fees charged by most banks and financial institutions for such transfers. The anonymous nature of cryptocurrencies can reportedly make them popular with those seeking to avoid paying taxes or those wanting to launder money. Using cryptocurrencies may make you a target for scammers or businesses selling high risk investments.
Key to the genius of Bitcoin is the blockchain it uses to store an online ledger of all the transactions that have ever been conducted using Bitcoins, providing a data structure for this ledger that is exposed to a limited threat from hackers and can be copied across all computers running Bitcoin software. Many experts see blockchain as having important uses in technologies, such as crowdfunding and online voting.
Even major financial institutions such as JP Morgan Chase see potential in cryptocurrencies to lower transaction costs by making payment processing more efficient.
However, because cryptocurrencies are virtual and do not have a central source, a digital cryptocurrency balance could be wiped out by a computer crash if a backup copy doesn’t exist. Since prices are based on supply and demand, the rate at which a cryptocurrency can be exchanged for another currency can fluctuate widely. Many overseas cryptocurrency exchanges are unregulated and operate exclusively online – with no connection to New Zealand. This makes it hard to find out who is offering, exchanging, selling or buying it. It also makes it likely that you’ll never recover your funds if things do go wrong.
Cryptocurrencies are not immune to the threat of hacking. Still, many observers look at cryptocurrencies as hope that a currency can exist that facilitates exchange, preserves value, is more transportable than traditional metals such as gold, and is outside the influence of governments and central banks.
Cryptocurrencies are considered a very high-risk investment, if they’re considered an investment at all. This is partly because of their extreme volatility – or wide variation in pricing. As Bitcoin and cryptocurrencies start to become more ‘mainstream’ and less volatile, it is likely institutional investors will start to take some serious interest, and cautiously introduce it to some of their portfolios.
Mark Lurie, CEO of Biddable, says that there’s likely to be a strong move toward diversifying crypto-assets and managing such investments the same way that investors look at more traditional assets and investments.
Is is a fad?
Excitement over Bitcoin and other cryptocurrencies has as much, if not more, to do with the blockchain technology underpinning it as it does to do with a new kind of payment method. Blockchain technology has the promise of applications beyond just currency, and technological enthusiasts worldwide are exploring projects to develop this potential. As more such projects and applications emerge, the world of blockchain and the complex technology behindit are likely to continue to capture attention.
The Financial Markets Authority and cryptocurrencies
In New Zealand, financial markets are regulated by the Financial Markets Authority (FMA). The FMA have released several pieces of guidance related to cryptocurrencies. Anyone seeking to trade in cryptocurrencies should carefully read the FMA’s guidance, also searching for any recent FMA media releases or commentary. This includes ensuring they use a New Zealand-based cryptocurrency exchange provider, which:
- Is registered on the Financial Service Providers Register (FSPR)
- Is a member of a Dispute Resolution Scheme (DRS)
- Holds your New Zealand dollars in a trust account.
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