Cryptocurrency, Taxes and the Legal System

The advent of the bitcoin has created a shock and stir within the financial system. Bitcoin and other cryptocurrencies offer a new method of payments which are outside the traditional economic frameworks and control. However, due to their complex and differentiating nature, it is unclear on what classification they have within our legal system. Is cryptocurrency an investment, a financial asset, property or does it fit into another category altogether? And, if it fits into any of those categories, what role does insurance play?

What is Cryptocurrency?

Although cryptocurrency, due to the popularity of the bitcoin, has become a recent buzzword. The concept is several decades old. Cryptocurrency is digital money has no physical counterpart; it is a computer program. Confused? Think of it this way. Online retailers, such as Amazon or Apple, often provide their customers with a reward or point system. These points can be used instead of fiat currency, or government issued currency and can be used towards making a purchase. When a gift card is purchased the real money used to buy it is transmuted into a digital coin, point or token which can be used on the retailer’s platform. These tokens are managed by the retailer and held in a database, but are never actually in possession of the customer. And this is where cryptocurrency is different.
The owner of a cryptocurrency owns the tokens they acquire and can be stored on a personal device such as a computer or smartphone. It can then be exchanged directly between individuals for goods and services.

Is It a Financial Asset or Property?

This is where the debate around cryptocurrency can get convoluted. Since cryptocurrency is software based this means it is malleable. The programmer(s) can virtually design it to fulfill various needs, and this can result in unclarity as to how, or who should regulate it. For instance, over the last several years tech startups have begun to use what is called ICO, Initial Coin Offerings, as a way to garner funding. Spiritually, the ICO is the same as IPO or Initial Public Offering, but because it is software, and thus malleable, this enabled startups to skirt around the traditional IPO regulations legally. The ICO was revolutionary when it was begun because it allows investors to put their money into a venture more easily. However, this also led many investors into losing their money on bad investments and, in some cases, outright scams. The SEC was slow to act, but earlier this year they finally released guidelines giving some regulation to the ICO and identifying it as a financial asset. However, not all cryptocurrency can be defined this way, and some argue that it instead should be viewed as property. For example, Bitcoin, the most popular cryptocurrency, is generally used like currency. Users store it in a digital wallet on a device, such as a smartphone or a computer, and buy goods and services from each other using like you would with the dollar. In 2014, the IRS created guidelines for how to list cryptocurrency in tax returns. More so they individually register all virtual currency as property within these guidelines.

Court Rulings

Last November, in Ohio a man attempted to use his homeowner’s insurance to compensate a loss of $16,000 worth of bitcoins which had been stolen from his online account. The court ruled that since the IRS classified virtual currency as property, then the insurance company had to compensate the plaintiff. While one court case does not definitively put this issue to rest, it still can be used as a basis for other cases and future federal and state laws.
In Illinois, lawmakers are mulling over how to handle the growing popularity of cryptocurrency. Some, such as Chicago mayor Rahm Emmanuel, see it as a possible way to pull the state out of its fiscal pit.

Sources:
www.propertyinsurancecoveragelaw.com/files/2018/10/Kimmelman.pdf
www.irs.gov/pub/irs-drop/n-14-21.pdf
https://www.sec.gov/files/dlt-framework.pdf