Recent media hysteria and reports of massive returns have had most investors wishing they jumped on the crypto-currency bandwagon years ago. While some lamented another opportunity missed, many rolled the dice in search of an overnight fortune.

Despite its popularity, most people still don’t understand what a crypto-currency is or how it works.

What is crypto-currency?

Crypto-currency is a digital form of currency that operates independently of a central bank. Various encryption techniques are used to regulate the generation of currency units, while a peer-to-peer ledger system verifies the transfer of funds. It is important to distinguish crypto- currencies as a form of currency rather than a traditional investment, such as listed shares. Crypto-currency much like any other currency must fundamentally achieve ONE thing: be used as an effective means of exchange. The issue here is that many crypto-currencies, including bitcoin, are still not widely accepted as a form of payment for goods and services. While some merchants do accept crypto-currencies, most do not and in some countries it is illegal to use as a transaction medium.

Risks and rewards

As with any investment, there are risks associated with investing or trading in crypto- currency. Unlike regular currencies that are regulated by central banks and measured against other currencies, crypto-currencies are valued largely on supply and demand. Given most are not yet widely used, relative to other currencies, small spikes in demand can lead to large fluctuations in price.

While this may be seen as a positive, especially when the value is increasing, the flip side is that any downturn is usually just as severe as evidenced by the most recent crash. This risk can be acceptable to some provided their investment is part of a broader overall strategy and they are willing to take on a higher risk investment.

However, a crucial factor driving demand is the willingness of merchants to accept crypto- currencies as a form of payment. Why would a merchant wish to hold accounts which can fluctuate so heavily on a minute by minute basis? Without the support of merchants it is hard to see maintainable value in crypto-currencies.

Many questions have also been raised around the security of crypto-currencies. Blockchain, a continuously growing list of records secured and linked using cryptography, has allowed many crypto-currencies to be traded securely. This technology is easily replicable and there are now numerous crypto-currencies and banks utilising blockchain. However, there have been a number of cases where crypto-vaults have been hacked and digital currencies by their very nature are susceptible to cyber security attacks.

While blockchain has changed the way in which transactions are processed and may well become the norm, the currencies attached are continually being superseded. The technology will bring to light great investing opportunities, which investors will continue to seek, but the speculation over crypto-currencies will drive ongoing volatility.

Taxation implications

The ATO has provided guidance as to the tax implications of investing in bitcoin and other crypto-currencies with the same characteristics.

The ATO view is that bitcoin is neither money nor a foreign currency, and the supply of bitcoin is not a financial supply for GST purposes. Instead, bitcoin is to be treated as an asset for capital gains tax (CGT) purposes, meaning investors will be taxed on any capital gain made on trading in bitcoin and other crypto-currencies, much like they would for listed share investments.

However, there are generally no tax consequences when using crypto-currency to purchase goods or services for personal use, provided the cost of the currency is $10,000 or less. Businesses that receive bitcoin for the sales of goods or services are required to include the value in Australian dollars as part of their ordinary income in the same manner as receiving non-cash consideration under a barter transaction. The value in Australian dollars will be the fair market value obtained from a reputable bitcoin exchange. GST is also applicable on any such sales as though it were a normal cash transaction. The treatment is also the same for any business purchases made using bitcoin.

The world of crypto-currencies and blockchain is complex and ever-evolving. To discuss any crypto-currency related tax issues, please contact our office.

Williams Hall Chadwick would like to thank existing clients for your ongoing referrals. We are always happy to assist referrals and new clients with their financial matters.

This article contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.