You’ve probably noticed that the use of various cryptocurrencies is exploding! It seems like new coins and blockchain technologies are getting created every day. So, if you’re eager to learn more and invest in crypto but aren’t sure where to start, keep reading.
This post will review what cryptocurrency is, various ways to buy it, tax rules for crypto profits, and a strategy to start stacking coins. You’ll learn six ways to invest in crypto, including some clever, tax-advantaged options for avoiding capital gains taxes altogether.
What is cryptocurrency?
Cryptocurrency or crypto is digital money, known as tokens or coins, that you can use to buy goods and services or hold as an investment. Bitcoin is one of the most well-known cryptos, with a total value of about $1.1 trillion in December 2021. Still, there are thousands of alternative or altcoins, such as Ethereum, Solana, and Polkadot. The total value of all cryptocurrencies is about $2.6 trillion.
To understand how cryptocurrencies work, you need to know something about their underlying technology, which is a blockchain. There are different blockchains in use today, but their purpose is to verify transactions and store data in a secure, open ledger that anyone can see.
Blockchains are decentralized databases spread across many computers all over the globe. No one person or organization owns or manages public blockchains, making them difficult for hackers to manipulate.
Blockchain technology was developed for Bitcoin; however, other crypto networks, such as Ethereum, are also powered by blockchains. Also, there are many other uses for blockchain technology besides cryptocurrencies. They include smart contracts that automate the terms of agreements, recordkeeping for assets like real estate, and supply chain management.
To sum up, a blockchain is a distributed database with many uses, including powering cryptocurrencies.
Why do people use cryptocurrency?
If you wonder why people are investing so much money into crypto right now, there are various reasons. Many crypto supporters, including me, believe digital currency is the future of money.
While blockchain transactions are fully transparent, crypto is anonymous. That means you can buy, sell, and exchange it without revealing your personal information or identity. Crypto transactions are peer-to-peer, removing banks as middlemen who control the money supply.
While blockchain transactions are fully transparent, crypto is anonymous.
Many people buy crypto because they think it will increase in value despite its volatility. Bitcoin was trading around $20,000 in December 2017, hit an all-time high of $69,000 in October 2021, and is now bouncing around $48,000.
If the crypto roller coaster ride scares you, there’s a special crypto class called stablecoins pegged to specific assets, such as the US dollar. That gives you a way to own digital currency without any price volatility.
Bitcoin is a unique cryptocurrency because it’s hard-coded never to have more than 21 million coins created. And more than 18 million have been mined to date. Many people buy and hold Bitcoin because they believe its limited supply will cause the price to rise over time. This strategy is known as opens in a new windowHODLing, which stands for “hold on for dear life.”
How do you buy cryptocurrency?
To buy cryptocurrency, you must have a wallet, which can be an online app or offline hardware device, to store it. If you use an exchange, such as opens in a new windowBlockFi, opens in a new windowCrypto, opens in a new windowGemini, or opens in a new windowCoinbase, it’s as easy as opening an account, transferring your dollars, and making crypto purchases. They act as an investing platform and a opens in a new window“hot” online wallet. However, you can move your crypto into a “cold” offline wallet at any time for added security.
How is cryptocurrency taxed?
Crypto is taxed just like any other asset, such as opens in a new windowstocks and mutual funds, where you must pay opens in a new windowcapital gains tax when you realize a gain. For example, if you buy $100 of crypto and sell it for $150, you must pay tax on your $50 profit.
Also, when you buy something with crypto or trade crypto that’s increased in value, it’s a taxable event. Let’s say you bought a bitcoin for $20,000 that’s now worth $50,000, and you use it to buy a car. You’d have a $30,000 capital gain to report.
Other taxable events include:
- Receiving crypto as payment for a service or mining it.
- Lending crypto and receiving interest payments.
- opens in a new windowStaking crypto and earning interest or rewards.
So buying and holding crypto isn’t a taxable event. You only owe tax when you sell, spend, or trade crypto that’s risen in value, or you get paid interest on crypto you own. If you sell crypto for a loss, it can offset your gains, up to annual limits, just like other assets.
What are cryptocurrency capital gains taxes?
Capital gains tax rates depend on your tax filing status, income, and length of time you own an asset. If you own a coin (or other assets) for fewer than 365 days and sell it for a profit, you owe short-term capital gains tax, which equals ordinary income taxes. Today’s opens in a new windowtax brackets range from 10% to 37%, depending on how much you earn.
However, if you own a coin for longer than a year, you owe long-term capital gains tax, which ranges from zero to 20%, depending on your income. So, holding assets for longer than a year is a wise strategy for cutting taxes, especially if you’re a high earner.
Another smart way to avoid capital gains tax on crypto is owning it inside a tax-advantaged account, which we’ll cover in a moment.
Crypto exchanges must file form opens in a new windowForm 1099-K for clients with more than 200 transactions and more than $20,000 in trading during the year. And you must report crypto gains and losses on opens in a new windowForm 8949opens PDF file .
Taxable options to invest in cryptocurrency
Here are three popular ways to buy cryptocurrency that will trigger capital gains tax when you sell, use, or exchange it.
1. Crypto exchanges
As I mentioned, buying crypto through an exchange is an easy and popular way to buy and sell it. Just open your account and fund it, and you can buy just about any coins you like and keep them in a handy digital wallet.
2. Crypto savings accounts
Many crypto exchanges allow you to earn interest on specific coins. Like bank savings, you make a deposit, the institution lends it out, and pays you interest. You can receive earnings in crypto of your choice and at significantly higher rates than a regular bank.
Right now, you can earn these impressive interest rates on your crypto savings, depending on your balance and the duration you lock it up without being able to make a withdrawal, such as for one or three months.
- opens in a new windowBlockFi pays up to 9% APY on USD Coin (USDC), Gemini dollar (GUSD), Paxos (PAX), Dai (DAI), 5% on Ethereum (ETH), and 4.5% on Bitcoin (BTC).
- opens in a new windowGemini pays approximately 8% on Gemini dollar (GUSD), TerraUSD (UST), and USD Coin (USDC), 1.76% on Ethereum (ETH), and 1.49% on Bitcoin (BTC).
- opens in a new windowCoinbase pays up to 5% on Cosmos (ATOM).
- opens in a new windowCrypto pays up to 10% on USD Coin (USDC), 5.5% on Ethereum (ETH), and 4.5% on Bitcoin (BTC).
Unlike a regular bank, your money in crypto exchanges and savings isn’t opens in a new windowFDIC insured up to certain limits. You could lose your crypto deposit if the institution fails. However, s