Cryptocurrency for the Beginner
Cryptocurrencies were created in 2009. The creator is unknown. They called themselves Satoshi Nakamoto. (Nakamoto, Satoshi (31 October 2008) in a paper they wrote in 2014. "Bitcoin: A Peer-to-Peer Electronic Cash System" (PDF). bitcoin.org. Archived(PDF) from the original on 20 March 2014.) In that paper the creator provided to the world the source coded upon which all cryptocurrencies are made.
The term cryptocurrency is generally used to describe a digital asset in which encryption techniques are used to regulate the generation of additional units and verify transactions on the blockchain.
Before cryptocurrencies, an online payment had to go through a financial intermediary: American Express, a Bank, PayPal.
Cryptocurrencies allow a peer-to-peer transactions without the need of a financial intermediary.
Provided a person is willing to accept payment by cryptocurrency a transaction can be completed.
The first cryptocurrency was called Bitcoin.
The price of bitcoin skyrocketed into the thousands in 2017.
Though each cryptocurrency transaction is recorded in a public log, names of buyers and sellers are never revealed. Only their wallet IDs. While that keeps the users' of cryptocurrency transactions private, it also lets them buy or sell anything without efficiently tracing it back to them. Because of the anonymity, it has become the currency of choice for people online buying drugs or other illicit activities.
The challenge with cryptocurrency is that it was designed to be anarchical. To be a form of payment that supplanted the current structure of currencies that are controlled by governments. Because it was intended to be outside of the current economic systems of the world, the challenges with the use and future of cryptocurrency arise.
How are governments to deal with something designed to subvert their influence and control of payment systems? Should they adopt the use of cryptocurrency? Should they regulate its use? Should they be banned?
The Australian Government's regulatory agencies are grappling to answer these questions.
Three examples are in the areas of money laundering, issuing of cryptocurrency in Australia and taxation. We will quickly look at each of these.
In April 2018, Digital Currency Exchanges in Australia were regulated to adhere to Australian Money Laundering and Counter-terrorism financing obligations such as:
- adopting and maintaining an AML/CTF program to identify, mitigate and manage money laundering and terrorism financing risks
- identifying and verifying the identities of their customers
- reporting to AUSTRAC suspicious matters, and transactions involving physical currency of $10,000 or more
- keeping certain records for seven years.
Another example is the Australian Securities and Investment Commission's (ASIC) publication of its Information Sheet 225 on "Initial Coin offerings and cryptocurrency". Information Sheet 225 gives guidance about the potential application of the Corporations Act 2001 (Corporations Act) to entities that are considering raising funds through an initial coin offering (ICO) and to other crypto-currency or digital token (referred to as 'crypto-asset') businesses. In short, it treats ICO's as a form of right known as "chose in action" being of the nature of a share in a company. By saying that a crypto-asset has the same legal characterisation, as a share is not to say cryptocurrencies are shares. What is said is that crypto-assets have the same legal nature as shares: Just as a car has the same legal character as a cow.
The Australian Tax Office (ATO) has provided guidance as to how it views cryptocurrencies when used in Australia (see Tax Determinations TD 2014/25 and TD 2014/26). Unsurprisingly the ATO has a similar view to that of ASIC. Cryptocurrency is neither money nor Australian or foreign currency. The ATO puts cryptocurrency in the case of property, being an asset. A chose in action is an asset. Being a form of asset cryptocurrencies will be treated as assets for Capital Gains Tax purposes and will be treated similarly for tax purposes. The ATO has issued a paper to assist people using cryptocurrencies. (See www.ato.gov.au/General/Gen/Tax-treatment-of-crypto-currencies-in-Australia---specifically-bitcoin/)
To illustrate how a Self Managed Superannuation Fund (SMSF) could invest in cryptocurrencies consider the following points:
- SMSFs are not prohibited from investing in cryptocurrencies, the investment must:
- be allowed for under the fund's trust deed
- be in accordance with the fund's investment strategy
- comply with SISA and SISR regulatory requirements concerning investment restrictions.
- Cryptocurrencies, are CGT assets. A SMSF may acquire, dispose of or invest in these as they would in any other asset. When an SMSF engages in these transactions it must comply with the same regulatory requirements that apply to investments in other assets.
- Before investing in cryptocurrency, the trustee and members of a SMSF need to consider the level of risk of the investment. Trustees and members may then review and if necessary, update their fund's investment strategy to ensure the investment being considered is permitted.
- Trustees and members also need to ensure that investments in cryptocurrency are allowed under the SMSF's deed.
- The law requires trustees and members to ensure their SMSF's assets are held separately from personal assets. An SMSF's cryptocurrency investments must be held and managed separately from the personal or business investments of trustees and members. This includes ensuring the SMSF has clear ownership of the cryptocurrency. Accordingly, the fund must maintain and be able to provide evidence of a separate cryptocurrency wallet for the SMSF from that used by trustees and members personally.
- SMSFs must ensure their investments in cryptocurrency are valued in accordance with ATO valuation guidelines. The value in Australian dollars will be the fair market value which can be obtained from a reputable digital currency exchange or website that publishes its rates publicly.
The value of cryptocurrency can change constantly. For the purpose of calculating member balances at 30 June, the ATO will accept the 30 June closing value published on the website of a cryptocurrency exchange that reports on historical cryptocurrency values.
- SMSF trustees and members are being related parties of the fund. Being related parties they cannot make in specie contributions or other transfers of cryptocurrency to the fund.
- Where a trustee or member satisfies a condition of release, the SMSF can make an in specie lump sum payment by way of transfer of cryptocurrency. However, pension payments must be made in cash.
- Trustees and members will need to consider the fund's trust deed and any CGT implications associated with the transfer of assets such as cryptocurrency.
The creation, trade and use of cryptocurrency is growing quickly. While there is quick growth the future of cryptocurrencies is uncertain. Some see it as the future. Others are not so certain. As with any asset, it can be regulated and outlawed. China has banned its use. Australia as seen above has begun to monitor its use so that it can be taxed and to regulated as an asset.
by Steven Brown