Ask An Expert: Cryptocurrency 101

PHOTO COURTESY CHRIS ODINET Chris Odinet

Cryptocurrency has been a hot term over the past several years—some say that it's a sham, while others believe it will change the world.

The truth is somewhere in between, according to Chris Odinet, a University of Iowa professor of law and the Michael and Brenda Sandler fellow in corporate law who teaches and writes about consumer finance law and the regulation of financial technologies. Before you decide to use cryptocurrencies, here are four things he suggests you consider.

What are cryptocurrencies?

It's better to think of cryptocurrencies as cryptoassets. They are like assets because we talk about them like property. They're crypto because the assets don't have a physical form but instead exist only as entries in an electronic ledger.

If you own a cryptoasset, then your identifying information is listed in the ledger next to the entry. You can transfer the cryptoasset to someone else by having a new line entered into the ledger that indicates the transfer. In this way, it's like a bank account statement, showing transfers of digital money.

What are cryptocurrencies used for?

People tend to use cryptocurrencies for two purposes: for making payments and as investments. To understand this, consider that a cryptoasset will have a certain value. What's that value? It's the amount of money that someone will pay the holder (in real government-backed money) to obtain the cryptoasset. In this way, it's just like anything else. What is a car worth? It's worth whatever people will generally pay for it in the market.

Let's say a given single cryptoasset (we'll call it HawkCoin) is valued at $75 when Herky obtains it. Herky can do two things with it: first, Herky can find someone with a good or service costing $75 that he wants. If the other party will accept it, Herky can transfer the HawkCoin to that other party in exchange for the good or service. In this case, the cryptoasset is being used like currency.

Herky might also believe that the HawkCoin will increase in value over time. With this in mind, Herky might decide to hold on to the cryptoasset until the value increases and then sell the HawkCoin. In this scenario, the cryptoasset is being used like any kind of investment property, such as a share of stock in a company or a rare baseball card. Buy low, sell high.

Where can I buy and transfer cryptocurrencies?

There are many kinds of cryptocurrencies. The most common are Bitcoin, Ethereum, Binance, and Dogecoin. You can purchase these and many more through online trading companies called cryptocurrency exchanges. Once purchased, the cryptocurrency is stored in the buyer's digital wallet, which is an account that is typically held with the exchange company. A transaction involves transferring the cryptocurrency to another person's digital wallet.

What are some legal issues when buying cryptocurrency?

There are quite a few. For example, the IRS treats cryptocurrencies as property, not as legal currency. That means when a cryptoasset is sold, the seller may have to recognize a gain or loss on the sale. If there is a gain, then the individual will have to pay taxes on that gain. This could occur, for example, if the cryptoasset is purchased for less than the amount for which it later sells. Typically (although not always) these transactions will trigger capital gains taxation, which would be similar to gains recognized on the sale of bonds and stocks.

Here's the bottom line: None of this is legal advice, so if you're thinking about buying cryptocurrencies, talk to an attorney or relevant tax professional. Don't get caught by surprise!