ELI12 crypto - FAQ

Following up on the cryptocurrency series from awhile back, I want to answer some Frequently Asked Questions (FAQ), and then I promise we’ll call it quits for awhile.

How is cryptocurrency actually currency?

Simply: cryptocurrency is currency in that it can be exchanged for goods and services.

I’ve used bitcoin to purchase domain names, buy virtual land in a Minecraft server, pay for pizza, trade for an Amazon gift card, and even buy coffee. The value went from a wallet app, in my control, directly to the other party, within minutes and without requiring an intermediary like a bank or Visa/Mastercard/American Express/Western Union.

Since Dogecoin has been in the news lately, I’ll share that I’ve used Doge as a currency as well, trading it for a gift card and even selling my iPhone 4 for DOGE. This happened in 2014, and unfortunately I didn’t hang on to the 3.2 million DOGE (current value $1.6M). But in that case, it was being used as a currency.

Do coins fail? In other words, what happens if a coin comes out and everyone stops paying attention?

Absolutely. Coins fail all the time. Something is worth exactly what someone else will pay for it, nothing more and nothing less.

We had this happen with a cryptocurrency called Garlicoin that I was tangentially involved in. There were Garlicoin wallets, mining pools, message boards, twitter accounts, all the usual stuff.

And then… people just lost interest. Within two months or so they were on to other memes. The Internet is funny like that.

Garlicoin lives on. You can download and install a Garlicoin wallet, mine some GRLC, and send it to a friend with a Garlicoin wallet. But since you can’t actually buy anything useful with it, who cares?

Do I need to move my crypto off Coinbase once I buy it? Why?

Short answer: no. Back when crypto was the Wild West, exchanges that pre-date Coinbase operated fast and loose. The most famous hack was of an exchange named Mt. Gox. You can read about their hack here. Back then, there were only a few exchanges you could trade bitcoin on. Some people chose Mt Gox, and I chose to do most of my trades through another exchange Bitstamp. I don’t recall my reasoning now. Looking through my password safe, I have a Mt Gox account but I don’t believe I did any trades through them. Not that it matters anymore!

These days, the risk of losing cryptocurrency because of the systemic failure of an exchange like Coinbase is much smaller than you losing the key to a wallet you control. Coinbase wallets have security features like multi-signature, where multiple people must assent before funds can be withdrawn, and lockout timers that make you wait a certain amount of time (usually 24-48 hours) before funds can be moved off Coinbase.

How are profits and losses taxed? Do I track everything myself or do I get a 1099 from Coinbase/Binance like I do from Fidelity or Schwab?

Speaking very generally and I am not your tax advisor and yada yada yada, cryptocurrency sales are treated like capital gains, and rewards from holding cryptocurrency are treated like dividends. I would say that tax treatment around sales of crypto is fairly established, but there isn’t great guidance around how to treat rewards.

A sale would be: you buy 1 BTC on 5/15/2021 at $47,510 and sell it on 5/16/2022 at $50,510, you would report a $3,000 long-term capital gain (less fees).

A reward would be: every five days, the Cardano network pays me a small amount of additional cryptocurrency, a reward for holding some of their coin and helping to secure the network. One tax approach is to treat that as a dividend and pay tax on that as ordinary income. But opinions vary. 😀

Can I buy crypto in my IRA?

Yes! But so far the fees for doing so seem expensive to me. See AltoIRA Crypto. It may make sense if you don’t rebalance often, though. Overall I have very positive experiences with Alto, though I haven’t used them for IRA crypto.

Who gets my crypto if I die?

These are mostly uncharted waters. Start with this book (I recommend getting the Kindle version). Now that my own cryptocurrency holdings are worth more than $50 million(*), it’s something I’m thinking more about. I’m going through the process of figuring this out right now with an attorney, so I can share more later.

Can I hide my crypto from creditors/litigation?

Probably not. All the legitimate exchanges now have AML/KYC controls in place. That, combined with blockchains being public ledgers of all transactions, means it’s difficult to do things on the blockchain that are truly anonymous. The reputation of cryptocurrency as being a haven for drug dealers and money launderers is pretty far from the ground truth. As it turns out cash is much better for that.

* - not really