The Taxman Is Catching Up On Cryptocurrency

Revenue agencies around the world are scrambling to figure out a way to tax cryptocurrency as governments are beginning to realize they are losing out on a vast source of revenue.

We’re now seeing how cryptocurrency would fit into our economy, and more people from institutions and the mainstream society starting to acknowledge them as a store of value and as a medium of exchange. Consequently, this would also mean tax obligations for miners, buyers, traders, merchants, and everyday users.

Here are things we need to know to prepare ourselves for the tax season. We’ll cover some important issues, fundamentals of taxation and how they would apply to our cryptocurrencies. But before we start, here at CryptMin and CryptEdu, we encourage you to always pay your taxes and report your capital gains to the government. It’s never fun having the taxman after you.

 

Tax Laws Are after It

Despite what people tell us in social media and cryptocurrency websites about privacy and anonymity, dealing with cryptocurrencies can leave behind footprints for the CRA or the IRS. Blockchain transactions are public records – everybody sees it, including your taxman.

The truth is blockchain transactions are more transparent than our traditional banking system. The key difference is the use of public keys instead of real names, which makes every transaction pseudonymous. However, since no two public keys are alike, once it gets tied to a real person’s name or company, authorities can easily track every transaction that was ever made with that public key. (Note: some “underground” cryptocurrencies encrypt their true addresses on the blockchain ledgers like Monero and Zcash, and thus more difficult to track.)

Some places where the CRA or the IRS can get a hold of your identity are cryptocurrency exchanges, online wallets, cloud mining sites, mining pools, and the social media. Although gateways are largely unregulated these days, it’s only a matter of time before governments and regulators will require each one of them to disclose information they have about their customers upon request.

Coinbase, for instance, are required to conduct KYC on their customers before they can start buying, selling, or trading on GDAX. Same is true with cloud mining sites when accepting payments from customers using their credit card or bank account. Genesis Mining does so whenever customers buy their mining contracts. They’ll have their customers’ public keys as well for payouts.

From the governments’ perspective, these are all treasure troves when looking for information about people who owes them money. Depending on the exchange, cloud mining company or the country they’re in, government agencies can have access to these customer data.

They could also set their sights on social media, particularly content creators in YouTube, Facebook, or Twitter who display their public keys for accepting donations, or even online stores who take cryptocurrency as payment for goods and services. And while customers and everyday users might get away with it by putting them in cold storage (mobile, hardware, or paper wallet), sooner or later, regulators will find a way to catch up on them as well.

 

Conflicting Views on Cryptocurrency

The IRA and CRA treats cryptocurrencies just like any asset. Their value may fluctuate from time to time, but until they go out and are sold in exchanges for fiat, holding these currencies is not a taxable event. A Capital gain tax will apply when selling cryptocurrencies in exchanges. However, determining the exact price on the date of acquisition is necessary to properly assess how much capital gain the seller is obliged to pay taxes for during the re-sell.

As you might expect, getting the numbers right on a person’s capital gain is going to take a lot of work and making sure every transaction in cryptocurrency exchanges are properly documented. It’s possible, for instance, that Coinbase would be asked to disclose their records for taxing purposes on each buy and sell and the dollar valuation on each individual transaction to see how much capital gain a customer has.

When using it to buy goods and services, or trading them with other cryptocurrencies, bartering laws will apply. This is where it gets a little tricky when you consider capital gains on your cryptocurrency for every purchase. For instance, you bought a thousand dollars’ worth of Bitcoin and decided to buy furniture with it when the value goes up by 50%.  The next month, you buy your furniture with Bitcoin which is currently priced at 1,500 USD. According to law, you’ll also have to pay for the gain tax as it is with bartering goods. In essence, you’re paying tax twice for buying furniture with Bitcoin – gain tax on Bitcoin and GST/HST on the furniture. And since you’re exchanging your digital asset on a short-term gain, it will be taxed just like a regular income which is the highest for capital gain tax.

Businesses will have to deal with the same problem when accepting cryptocurrency payments. If clients chose to pay with Bitcoin, which by definition is property/digital asset, they’ll have to report it as income (see the confusion?). This carries a lot of risk for business owners due to the volatility of cryptocurrencies. They might end up paying taxes on the sale despite the fact that the value of cryptocurrencies have already gone down.

 

Tax Implications for Miners, Traders, and Buyers

Regulators are catching up on cryptocurrencies fast. There will probably come a time when every cloud mining company, exchange, and wallet service in every country will be required to keep records about their customers in order to run their business. In this case, we need to prepare ourselves to avoid getting burned when the tax bill arrives.

Cloud mining companies can take advantage of tax deductions by writing off electrical and maintenance expenses in running their cloud mining facilities. This is a lot better than dodging regulations and taking a lot of risk of being caught and paying huge penalties or even losing the whole business. Technically speaking, cloud mining companies don’t pay out their customers – it’s a rental service. Whatever payout their customer receives depends on the mining pools they choose to join in and the currencies they want to mine with the hash power they bought from the cloud mining service. They might also take a cut from the mining rewards as a service charge on top of the rental fee or contract price (all depends on the cloud mining company). This is considered a taxable event, and laws regarding cryptocurrency transactions will apply.

Mining pools also take their share of the mining rewards as their service fee, usually around 1-4%, and hence, it is a taxable event according to laws on bartering, i.e. cryptocurrency for mining service. Exchanges and traders will be hit the hardest, especially day traders and swing traders. Under existing tax laws, short-term capital gains (assets acquired below one year) will be taxed as regular income. This applies, not only when cashing out and locking in their profits with fiat, but when buying other cryptocurrencies with it, e.g. buying Bitcoin with Ethereum.

Everyday users might also have to deal with this when buying or using cryptocurrencies for everyday transactions. Some complications may arise for buyers and business owners as mentioned earlier in this article.

Tax laws regarding cryptocurrencies still needs a lot of refinement; implementing it at its current state can be problematic and cause a lot of confusion. Sooner or later, our governments might come up with better tax laws regarding cryptocurrencies and begin the process of pursuing anyone who gets their hands on them. When the time arrives, we would have already prepared for such eventuality.

Interested in mining? Learn the basics of cryptocurrency mining at CryptEdu.com or start  hassle-free cloud mining at Cryptmin.com today.

What’s Next? Pushing the Boundaries of Blockchain Technology

Cryptocurrency could be running on a “different” blockchain, far better than its predecessors. Ethereum, became the first to have a “programmable” blockchain which made the currency in a class of its own. Today, we are entering into a new era of blockchain technology which promises scalability, interoperability, and sustainability with a first-of-its-kind third generation decentralized currency, Cardano.

We’ll explore the possibilities as well as the challenges in this new development in blockchain technology – what can it do to solve the prevailing issue of scalability and how far can it push the boundaries.

 

Blockchain Scaling and Its Challenges

Blockchain redefined the meaning of currency as a “trust-less” and “decentralized” medium of exchange allowing people to exchange value on a peer-to-peer network without a third party. It also solved the problem of double spending and fraud when dealing with digital assets in a virtual space with the combined strength of cryptographic functions and distributed consensus. But having such a high level of security also comes at the expense of speed and computing power.

Blockchain is difficult to scale because the exponential growth of the ever-increasing size, the necessary bandwidth to update all the ledgers across the network, and the proof of work algorithm which is self-limiting in terms of the number of transactions it can accommodate at a given time.

Some of the proposed solutions are, to take mining out of the picture, and use an alternative method of confirmation such as proof of stake and consensus protocol. Unfortunately, any attempt to improve scalability which takes mining and proof of work out of the way also tends to become convoluted and unsecure. There seems there is no way to create a blockchain that is both scalable, secure, and decentralized without losing some of its properties, one way or the other, or, writing a blockchain protocol from the ground up using an entirely different programming language.

Tinkering with the block size could only worsen the situation as bigger blocks would increase the blockchain size exponentially, thus consuming more bandwith and slowing down the network even more. The Bitcoin Cash hard fork of August 2017 attempts to solve Bitcoin’s scalability problem by following this route. However, it is doubtful that such measure could sustain the impact of mass adoption.

Some developers are now taking a different approach in their efforts to make a scalable, interoperable (communicates with other blockchains), and sustainable blockchain.

 

Making Blockchain a Lot “Smarter”

The simplicity of Bitcoin’s algorithm proved to be its greatest strength in terms of security. It is less prone to have errors and is more secure compared to other complex systems. Consequently, this would also mean less room for innovation within the blockchain itself (scripting used in Bitcoin is not “Turing-complete”). Moreover, developers couldn’t make drastic changes to the code without causing a fork in the blockchain. In such a case, the best scalability solution is to have a second layer for micro-transactions which “clears” each time these bundled transactions are broadcasted as one to the first layer, i.e. the blockchain. This is the idea behind Lightning Network.

However, to make this work, it should remain “trust-less,” secure, and shouldn’t involve a third party by adding a set of rules on top of the Bitcoin network to ensure that every transaction between two parties is settled upon meeting the conditions, or they can be rolled back if one of them refused to cooperate. Some of these rules include opening and pre-funding off-chain payment channels (or side-chains), “time-locks,” and having a “refund addresses” in case it fails to execute the agreement.

Ethereum accomplished the task with the idea of a “smart contract” between two or more people. After mining, the contract comes into force and becomes an immutable part of the blockchain. It uses a proprietary programming language (Solidity) which is more flexible than the script used by Bitcoin, and is primarily used for ICOs to fund projects and issue tokens to contributors. Some developers can make some interesting use of smart contracts such as the popular online blockchain game, Cryptokitties, where people can buy, sell, or breed virtual kittens on the Ethereum blockchain for profit.

Ethereum is regarded by developers as the second generation of blockchain technology for making such remarkable achievement. Blockchain technology is no longer just a method of making secure payments and storing value like Bitcoin, but also a more secure way of creating immutable, automated contracts without requiring a mediator in a physical sense. This opens up a world of possibilities for blockchain as a versatile platform for business and everyday use.

 

 

The Third Generation of Blockchain Technology

Cardano is considered by some as the third generation of blockchain technology for several reasons. First of all, it has a blockchain built with scalability in mind and uses a programming language known only to a few developers (Haskell and Plutus). Unlike the programming languages used in second generation blockchain which goes through a number loops and procedures one string at a time, it deals with the process of creating smart contracts and verification using a functional language which is more efficient. In other words, instead of commands, it uses mathematical formulas, i.e. functions.

An Ethereum smart contract, for instance, can go through a hundred iterations and procedures before coming up with a single output. This results in higher computational cost and could easily overload the network without some sort of regulatory mechanism that limits the number of loops or strings on a given contract. Ethereum came up with the idea of “gas”, which is the equivalent of mining fees for Bitcoin. This way, users cannot arbitrarily overload the network with excessive number of iterations. However, like Bitcoin, it also brings up the issue of scalability, computational cost, and sustainability

Cardano seeks to address this problem by revising the way blockchains should work. However, nothing is set in stone as of the moment and we couldn’t know for certain whether such proposal will have enough support from developers and the cryptocurrency community. Haskell and Plutus programming language is not so popular but can be extremely useful when applied to blockchains because it offers more flexibility.

There’s also a learning curve, should developers choose to support Cardano’s vision of a scalable blockchain, and it would have to compete with the developers’ attention who are fully engrossed in perfecting Lightning Network for Bitcoin, and the proof of stake scalability solution for Ethereum. One possible scenario is that all three of them will come to fruition about the same time, and by then we would have three or more fully scalable currencies which use different methods in achieving the same goal. Or, we may come up with just one solution that would annihilate other currencies and become the gold standard of future blockchain-based currencies. Could it be Cardano, Ethereum’s updated proof of stake version, or Bitcoin running on Lightning Network? The world watches as the story continues to unfold.

Interested in mining? Learn the basics of cryptocurrency mining at CryptEdu.com or start  hassle-free cloud mining at Cryptmin.com today.

Solving the Cryptocurrency Puzzle

Cryptocurrency gives people a glimpse of what our financial system could look like in the next five to ten years. From its infancy, we’ve already seen the potential of cryptocurrencies like Bitcoin and Ethereum to revolutionize traditional banking through a system of payment which doesn’t require intermediaries.

This method is proving itself as a fast, reliable, and cost-effective means of communicating value, touted by enthusiasts as the Internet of money, far better than our centuries-old banking system with its painfully slow and costly transactions. However, in recent years, we’re starting to see some of its growing pains as it goes through the slow process of mass adoption.

Developers are now looking into these problems with a renewed sense of urgency as cryptocurrencies gear towards mainstream integration. It is expected for the next couple of years to be the most turbulent in all of cryptocurrency history, and one which will decide the fate of our status quo.

 

In Search of the Missing Piece

Blockchain protocols lend to the blockchain’s immutability and varying degrees of decentralization. Like any software, they are far from being perfect. There are over a thousand cryptocurrencies in circulation today, and all of them will have to somehow deal with their own issues one way or the other.

Bitcoin has had a number of BIPs to solve this lingering problem of slow confirmations. By mid-2017, they managed to increase the block’s capacity by almost double without causing compatibility issues with old, existing wallets. With the adoption of Segwit, Bitcoin accomplished two things at once: fixed a software glitch (transaction malleability), and reduced confirmation times.

However, such measure won’t guarantee a long-term, let alone permanent solution, to Bitcoin’s transaction woes. At the time of writing, there are over **50,000 pending transactions in Bitcoin’s blockchain mempool, waiting to be confirmed, and they’re constantly piling up at a rate of 2-3 unconfirmed transactions per second. Developers have been working round the clock testing and finalizing Lightning Network for Bitcoin, the success of which will enable Bitcoin to break the sound barrier and bring this whole debate of scalability into a close.

(**That number went down to <2,000 unconfirmed transactions, probably due to increased Segwit adoption by wallet users and providers, or to some early adopters of the Lightning Network.)

Ethereum has had its own share of problems and fixes, most notably the Decentralized Autonomous Organization (DAO) attack of June 2016 and the hard fork that ensued to prevent further loss of funds. Smart contracts is one of Ethereum’s major selling point which enabled contracting parties to make an agreement that executes after satisfying certain conditions, or rolls back if it hasn’t.

Ethereum’s biggest hurdle is the ominous “difficulty bomb” built into the system which makes it nearly impossible to mine without incurring losses to miners after a certain point in time. Hence, the only solution is to migrate from a “proof of work” to a “proof of stake” method of confirming transactions. With the release of the Casper update for Ethereum, they hope to achieve exponential rate of confirmations and scalability in preparation for worldwide adoption.

 

The Proof of Work Concept

Proof of work had its roots in the early 90s to deter users from launching denial of service (DoS) attacks performed by spamming websites and establishments with superfluous requests. Interestingly, proof of work was also coined from the standpoint of giving value to a currency like the shell money used by inhabitants of the Solomon Islands.

Proof of work underpins major currencies such as Bitcoin, Etherium, Bitcoin Cash, and Litecoin in confirming transactions on a blockchain, which can only be achieved through mining. Proof of work helps create a system which is resistant to fraud and hacking since there are no viable means to circumvent the process except by brute-forcing through an inordinate number of trial-and-error.

In proof of work, only truth matters, in this case, the correct nonce and the corresponding hash which would allow transactions to be confirmed. In return, miners are rewarded for their efforts and new units of currencies are created and added into their accounts (hence the idea of mining).

Such method opens up the possibility of individuals with the most powerful mining hardware taking control, and in effect centralizing all the hash power to an elite few. Thus, a self-regulating mechanism was put in place to assure that only a specific number of confirmations can be done at a given time (difficulty increases/decreases with the network’s hashing capability).

Bitcoin also has several BIPs to increase network efficiency, such as the inclusion of mining fees. With this, they hope to alleviate congestion by putting a premium on higher transaction fees and eliminating the possibility of saboteurs spamming the network with high volumes of worthless micro-transactions.

As it turns out, some solutions can also have unforeseen consequences down the line, namely, difficulties with scaling. The first cryptocurrency, Bitcoin, was not really intended for everyday use but only as an alternative means of exchanging value outside the realm of government regulations. Scaling would not have been an issue back then. However, much has changed, and more countries and businesses are looking towards cryptocurrency as the way forward to their old and antiquated monetary system.

 

Proof of Stake and Its Potential Risks

Proof of stake adds another twist to the way transactions are confirmed. Similar to mining, participants validate and confirm transactions which are added on top of the blockchain. However, instead of using hash power, they would stake their currencies and lock them up for each round of staking. It also requires continuous uptime in order to be chosen by the algorithm, and, by being chosen, confirm transactions, and receive their rewards.

There are many nuances on how proof of stake are implemented in various cryptocurrencies based on how they try to mitigate the risks associated with staking, e.g. monopolozing, inflation rates, and network stability. Most prominent among cryptocurrencies which use proof of stake includes Peercoin, Blackcoin, Nextcoin, Bitcoin Plus, Cardano (premined) and soon to be Ethereum Casper update.

Staking is touted by several crypto-enthusiasts as the only road to scalability and worldwide adoption because it solves a lot of issues with associated with mining which uses proof of work such as power consumption and confirmation times. Although plausible with proof of stake being cost-effective and faster than proof of work, it could quickly turn into a can of worms if not implemented correctly.

Proof of stake tend to favour “stakers” (the equivalent of “miners” using proof of work) with huge quantities of currencies in reserve as they could handily beat small-time stakers with the increasing level of difficulty. Stakers can do the same thing as did every miner, creating a pool of stakers or the so-called master nodes to consolidate all their assets and have a fighting (or “winning”) chance of being randomly selected by the algorithm to confirm transactions.

Some proof of stake implementation prevents monopoly by capping the amount of currency that could be staked, “coin age,” and ticket waiting times. Putting a limit to staked currencies is intended to level the playing field for everybody and encourage more people to participate in staking. On the other hand, coin age and ticket waiting times regulate the frequency participants can stake, Peercoin, for instance, is set to a minimum of 30 days and a maximum of 90 days.

Inflation and network stability are some of the common issues with a proof of stake protocol. Developers are careful enough not to overdo one aspect over the other and seal off potential gaps and loopholes that can cause instability or discourage people from participating. Most proof of stake protocols and algorithms are still in the process of development and rigorous testing. The much anticipated Casper update for Ethereum could be released anytime this year, effectively moving to proof of stake through a hard fork.

 

Ripple and the Consensus Protocol

Consensus seems to be the antithesis of a decentralized method of confirming transactions which rely on proof of work or proof of stake. At its core, it is a trust-based method whereby transactions or any form of agreement between two parties are validated and confirmed by way of consensus. The result is almost instantaneous confirmations, averaging at a rate of 1500 transactions per second.

Ripple breaks the mould by being the first to implement the cryptocurrency version of the “hawala” system, allowing it to deliver lightning fast transactions outputs consistently at only fractions of a penny. However, there is an obvious downside with this kind of method. Despite having the trappings of decentralization as one of the cryptocurrencies listed in exchanges, it is, by all accounts, a centralized currency backed by tech giants and financial institutions.

Unlike mining and staking, there are no incentives as a “validator,” except that fact you earn more trust and contribute to the stability of the whole network. Validators are usually large entities like banks and commercial establishments which might benefit from it through cross-border transactions. However, since all the currencies that will ever exist are already pre-mined, the currency’s value and every asset tied to it are at the mercy of whoever holds the majority of it (hint: 55% is held in escrow by Ripple).

 

The Lightning Network and the New Bitcoin

The proposed Lightning Network solution for Bitcoin, Ethereum’s plan on moving to proof of stake, and Ripple’s meteoric rise towards the end of 2017 sends a strong signal to the cryptocurrency community and to the world that a major change in the current financial system is forthcoming.

Lightning Network, if successful, will usher the golden age of Bitcoin and cryptocurrencies in general. In so doing, we might also have a slightly different view about the new Bitcoin, particularly with its strong stance for decentralization. We might have to welcome the possibility of having off-chain payment channels and smart contracts to communicate with the blockchain instead of having every wallet users transmit countless numbers of micro-transactions to the blockchain every single time. The result would be a dramatic increase in transaction outputs, and the ability to scale with a fast-growing number of users.

Lightning Network could be the missing piece of the puzzle, the final solution to Bitcoin’s scalability issues, and the last hurdle towards worldwide adoption. But it is, by no means, the only way. If, for some reason, Lightning Network failed to materialize, it would not be the end of the road for Bitcoin. It would just be the beginning of a long journey towards perfection and worldwide adoption.

 

Interested in mining? Learn the basics of cryptocurrency mining at CryptEdu.com or start  hassle-free cloud mining at Cryptmin.com today.