Cryptocurrency, or crypto, is a digital form of currency that acts similar to the US Dollar. You can purchase goods and/or services as well as trade them, like how you would trade shares of a publicly-traded company. While cryptocurrencies are relatively new to the financial spectrum, several have been able to take strong footholds on the market and continue to prove themselves a sustainable force.
To start, it is important to understand what cryptocurrency is. As a relatively new form of currency, it is vital to recognize that this is a digital currency. Meaning, it is not distributed, exchanged, or traded the same way as the US Dollar. Once a form of cryptocurrency is purchased with money, your dollar becomes a digital code. This code can increase or decrease in value, but cryptocurrency is not affected by inflation in the same way that the US Dollar can be. In fact, inflation for cryptocurrencies such as Bitcoin are predictable and even show consistency in deflation, a feature that exists because Bitcoin has a fixed supply of coins.
There are several types of cryptocurrency and it is important to understand that they are not all the same. The most common and popular type of cryptocurrency is Bitcoin which is the first form of a blockchain. Bitcoin started in 2009 when an unknown person under the alias of Satoshi Nakamoto proposed having a peer-to-peer electronic cash system. Bitcoin is public so that everyone can see where a Bitcoin was and where it has gone. This allows any individual to observe that a transaction was done without any risk of counterfeit Bitcoins or outside interference. It works to eliminate the need for traditional institutions such as banks.
The second most common form of cryptocurrency is Altcoin. Altcoins are similar Bitcoins, however, minor tweaks and changes have been made to differentiate them from Bitcoin. One great example of an Altcoin is Ethereum. Ethereum was designed and used to build different applications that can be used on blockchains. This results in faster transactions for cryptocurrency exchanges and allows for certain operations to happen once certain criteria are met. Currently, Ethereum is considered the second most popular cryptocurrency.
Tokens are another form of cryptocurrency. Tokens differ from Bitcoin and Altcoin in that they are used on decentralized applications or dApps. They can be used to discount the costs associated with fees from making a purchase or sale and are even used to fundraise for crowd sales. The downside to tokens is that in order to be able to purchase and use one, you have to already have an Altcoin compatible with the token. This means that if your Token requires you to buy or sell something via Ethereum, you must already own part of an Ethereum Altcoin. This allows you to start or complete the transaction, while also potentially decreasing the fees that can come with it.
In order for cryptocurrency coins to be available, they have to be “mined.” Mining is an electronic process that can take a great deal of time, especially as the amount of coins left available to mine becomes less and less. Once a coin is mined, the person who mined it may choose to hold that coin or sell it to the next person for a profit. As fewer coins are available to be mined, the process has gotten more challenging, resulting in a higher asking price for newly mined coins. However, this also has the effect of potentially decreasing the cumulative value of each coin. Bitcoin miners are now competing with each other to secure the roughly 2.5 million remaining Bitcoin before reaching the end of supply.
While it is important to note that the cryptocurrency market has great potential to grow and in turn provide short and long-term returns as an investment strategy, it is equally important to be informed of the potential risks involved. The biggest risk is the volatility in the market. Due to the decentralization of cryptocurrency, it can become heavily affected by supply and demand. There is a maximum of 21 Million Bitcoin that will ever be in circulation, and as a result the more that are up for sale on the market, the cheaper they will be. The opposite goes for when there are fewer coins available.
Due to the supply of the majority of cryptocurrency coins being limited to a specific amount, on top of the added aspect of the coins being digital, the volatility of cryptocurrency can be quite extreme. The influence on price can fluctuate at any point in time, most recently there was an approximately $22,000 increase in Bitcoins price.
While this is great for persons who were already invested in the cryptocurrency, the potential for the volatility to result in a loss is also substantial, while not yet seen to be quite as extreme. This volatility and potential profit have made it a new and interesting investment to several private and public institutions, further solidifying the cryptocurrency market as a potential powerhouse for profit gains. As the saying goes “all that glitters is not gold,” and it is especially important to not treat each cryptocurrency the same.
One glaring factor that needs to be considered is the fact that cryptocurrency is currently unregulated. This means that when you invest in cryptocurrencies, your money is not insured and is not backed by the FDIC, nor is it secured by the SEC. As a result, your money is not protected and is not guaranteed to be secured by the Federal government. The security and safety of any investments made in cryptocurrency are placed on the individual to investigate the means by which to protect and secure any and all accounts and investments made.
This could be through going through well-known cryptocurrency exchanges such as Coinbase or Gemini. Both of these exchanges are well known for their ease of use as well as the security steps they have put in place to make sure that their customers’ money is secure. The security of a trader’s account is extremely important due to each cryptocurrency being a digital currency.
Another risk associated with cryptocurrency is that due to its nature of being digital, your money becomes the target of hackers. If you don’t take the necessary steps to secure your accounts and ensure that your money stays in a safe place, you could, unfortunately, become the victim of cryptocurrency theft. This is when a person hacks into your cryptocurrency account or Cold Storage Wallet (as explained below) and takes your cryptocurrency funds.
A Cold Storage Wallet takes your cryptocurrency and removes it from online trading platforms in order to keep it from being online and available as a target for hackers and thieves. The cold storage wallet is another way to help to reduce the risk of your cryptocurrency being stolen from your account because hackers and thieves are unable to access these funds. The price of the cryptocurrency will still be affected and can fluctuate higher or lower based on the current market; it just cannot be accessed by anyone except the person who knows the product or “safe” key to open and utilize the cold storage wallet.
Next, we have the issue of understanding what type of property cryptocurrency is. In short, cryptocurrency is considered to be an intangible asset. This means that in regard to the IRS and taxation, they can be recorded at acquisition costs and once an impairment test is performed but cannot be returned due to impairment loss. The IRS stated in 2014 that “For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency” (Section 4, Answer 1)*.
As a result, depending on how the cryptocurrency is held, it could be placed under the classification as personal property, investment property, or business property. Meaning, it is up to the user to specify what entity the cryptocurrency is being held as. As an example, if you are using Bitcoin to make sales transactions as a Grocery Store owner, it would be classified under the business property category.
When making considerations for placing cryptocurrency into an Estate Plan it is important to make sure you do so in a secure and safe manner. The easiest way to explain this is to never leave passwords for exchange accounts and Cold Storage Wallets in places they may be compromised or easily found. When speaking with the person who you have designated to take care of your finances and/or assets (also known as a fiduciary), you would need to place the passcode to access and transfer the account for estate administration into your Estate Plan.
The fiduciary then would hold the complex, multi-character passcode needed for access to the investment and distribution of the estate’s cryptocurrency assets to the beneficiaries as needed and as permitted by the relevant estate planning document. Individuals who own cryptocurrency should be exceptionally cautious when selecting an executor or trustee. If for some reason the fiduciary used the passcode to access and manage the cryptocurrency account due to the lack of oversight, and should they make a transfer of cryptocurrency that is not authorized by the relevant estate planning document, the transfer, while traceable, would be nearly impossible to recover.
Adding cryptocurrency to your Estate Plan is much simpler than it may seem. Especially since the hard part of starting and securing your investments has passed. The first step to this process is to list each type of cryptocurrency you have in your Trust. The reason you do this is to ensure that it can be dispersed amongst your beneficiaries according to your wishes. Make sure to include each type of cryptocurrency you have invested in to ensure that none of it is lost and swept up in the residue/remainder of your estate. Keeping your family/beneficiaries informed can also help mitigate the chances of any uncounted cryptocurrency.
Secondly, you’ll want to make sure that any and all digital wallets are listed and accounted for. Many Websites and Applications have two-factor authentications so it would be important to include access to any device that those authentication codes would be sent to. It is also advisable that you place any passwords or secure keys in a secure location with directions on how your beneficiaries may access these in your Estate Plan.
You wouldn’t want your beneficiaries to be able to find the accounts without any means to access them. If you make it easy for your beneficiaries to access the account, you run the risk of it becoming easy for hackers and thieves to do so as well. Try to speak with these persons before finalizing your Estate Plan so they can have an easier time accessing the information they will need once the time comes for the Estate Plan to be executed.
With Estate Planning in mind, it is recommended that you place your cryptocurrency information into a Trust. This will help maintain the security of all the information you will have listed in the paragraphs above. Due to the security of the documents in a Trust and that they are not public record, you reduce the risk of potential targeted attacks from hackers. This would become especially important in the unfortunate situation of probate were to begin.
A Will would have to be examined by a probate court and thus preserved in the public record. If your information relating to your cryptocurrency account information was on the Will and not in a Trust, it would be easier for someone to target your beneficiaries and attempt to hack and steal your assets. Only the Trustee can access and view the documents and contents of a Trust meaning the security aspect of your cryptocurrency investment has an added layer of protection!
Cryptocurrency is a volatile and fresh new player in the financial investment market. It could continue to see steady progress to becoming a mainstream currency. While cryptocurrency is by no means a sure bet, it does have a standing that it will be around for the foreseeable future. The above information is only here to provide you with some things to consider when thinking long or even short-term at investing in the cryptocurrency marketplace. Mile High Estate Planning is a law firm, we render legal advice we do not make any investment recommendations.
One must always do research and speak with a financial advisor before making a financial decision. The intention of this article is to be informative only. If you would like to learn more about estate planning for cryptocurrency contact us today by email at Info@MileHighEstatePlanning.com or by phone at 833-Ask-Blake. We always start with a free initial consultation and if you later decide to hire us, we would be happy to take payment in several different forms of cryptocurrency.