Cryptocurrency Frequently Asked Questions

Cryptocurrency Frequently Asked Questions

Bitcoin: what is it and why is it important?

Bitcoin stands at the forefront of the digital age as a pioneering form of currency. Unlike traditional money, Bitcoin operates on principles that redefine financial transactions: Decentralization, Open Source, and Peer-to-Peer networking.

At its core, Bitcoin is devoid of physical form. It exists solely within a transparent, public ledger, granting open access to all its transactions and maintaining a high level of transparency. This decentralized nature means that Bitcoin operates independently, free from control or backing by any central banks or governments.

Our enthusiasm at Bitcoin.com for this revolutionary digital currency is boundless. We see Bitcoin as more than just a financial innovation; it's a potential catalyst for global change. Our mission is to demystify Bitcoin for you, making its complex ecosystem accessible and comprehensible. There's a wealth of knowledge to uncover, and we're here to guide you every step of the way in your journey through the world of Bitcoin.

Who developed bitcoin?

The original Bitcoin code was designed by an individual or group using the name Satoshi Nakamoto, under MIT open source license. In 2008, Nakamoto outlined the idea behind Bitcoin in this white paper.

Bitcoin is the first successful digital currency built upon cryptography rather than reliance on central authorities. Satoshi left the Bitcoin code in the hands of developers and the community in 2010. Hundreds of developers have added to the open source code throughout the years.

What is blockchain?

Blockchain in the context of Bitcoin is a revolutionary technology that acts as a public ledger for all transactions within the network. The core concept of blockchain is its decentralized and distributed nature, meaning it isn't stored in a single location or controlled by a central authority. Instead, it's a chain of blocks, each containing a list of transactions, spread across a vast network of computers.

In Bitcoin's blockchain, every transaction made with Bitcoin is verified by a network of nodes (computers) and then chronologically added to a block. Once a block is filled with transactions, it's linked to the previous block, creating a chain. This process is secured through cryptography, ensuring that once a transaction is added to the blockchain, it becomes immutable and cannot be altered, effectively solving issues like fraud and double spending.

Bitcoin's blockchain is maintained by miners, who use powerful computers to solve complex mathematical problems, validating transactions and adding new blocks to the chain. As a reward for their efforts, miners are awarded Bitcoin, incentivizing a robust and secure network. The transparent, immutable, and decentralized nature of Bitcoin's blockchain makes it a groundbreaking technology, not just for cryptocurrency, but for various applications requiring secure, transparent record-keeping.

What is double spending?

Double spending is a potential issue in digital currencies where the same digital token can be spent more than once. This is a unique problem for digital money, as digital information can be replicated easily. Bitcoin addresses this issue through its decentralized ledger, the blockchain. When a Bitcoin transaction is made, it's broadcast to a network of computers (nodes). These nodes verify the transaction's legitimacy and its history, ensuring the same bitcoins haven't been spent previously. Once verified, the transaction is added to a block in the blockchain, which is then confirmed by miners. This confirmation process, combined with the chronological ordering of transactions in the blockchain, prevents double spending by making it extremely difficult to alter the transaction history or to spend the same bitcoins again without the network noticing.

What can Bitcoin Do?

Bitcoin transcends the role of a mere digital currency, positioning itself as a powerful instrument for an unprecedented overhaul of our current financial landscape. Its capabilities extend far and wide, offering transformative changes in various facets of financial interactions:

Decentralized Transactions: Bitcoin operates on a decentralized network, liberating it from the influence and control of central banks and governments. This aspect is crucial for economic freedom, as it allows individuals to have full control over their financial assets without the interference of centralized authorities.
Enhanced Economic Autonomy: By providing a currency that is not subject to the whims of geopolitical and economic policies, Bitcoin empowers individuals, especially those in unstable or inflation-prone economies. It offers a stable alternative to national currencies that can be devalued through government actions.
Borderless Transactions: Bitcoin knows no borders. It facilitates international transactions without the need for currency conversion or the delays and fees associated with traditional banking systems. This global reach enables individuals and businesses to participate in a worldwide economy seamlessly.
Inclusive Financial Participation: One of Bitcoin's most significant advantages is its ability to include the unbanked or underbanked populations. By offering a simple entry point into the financial world through internet access, it opens doors for millions who are currently excluded from traditional banking services.

In essence, Bitcoin's role as a digital currency is just the beginning. It heralds a new age of financial independence and global inclusivity, challenging and reshaping our traditional understanding of money and its flow. This transformative power of Bitcoin is what makes it a pivotal force in the journey towards a more equitable and accessible financial future.

What is Bitcoin mining?

Bitcoin mining is the process by which new bitcoins are entered into circulation and the network is secured. It involves solving complex computational puzzles using specialized hardware. Miners compete to solve these puzzles, and the first one to find a solution gets to add a new block of transactions to the blockchain, a decentralized public ledger. In return for their efforts, miners are rewarded with a certain number of bitcoins, as well as transaction fees paid by users. This mining process not only introduces new bitcoins at a controlled rate, adhering to Bitcoin's cap of 21 million total coins, but also plays a crucial role in maintaining and securing the Bitcoin network, making it resistant to fraud and attacks.

How can I buy Bitcoin?

Bitcoins can be bought from various sources. For most people, the easiest way is through our self-custodial Bitcoin.com Wallet app where you can also buy, sell, and trade the most popular cryptocurrencies. You can also purchase Bitcoin online directly from our website. With both of the above methods, can pay via credit card, debit card, bank transfer with fiat currency, and using online payment services like Paypal.

Another option to buy Bitcoin is via Bitcoin Teller Machines which are similar to cash ATMs. Finally, it is of course possible to purchase Bitcoin peer-to-peer, whether in exchange for local currency, or as payment for goods or services.

For step-by-step instructions on buying Bitcoin, and to get more information such as the key factors to consider with each purchase method, please see this guide.

Bitcoin.com maintains a list of online exchanges and brokers who sell Bitcoins. Our aim is to provide the best quality services via our website, so anyone can easily obtain the cryptocurrency from a wide array of Bitcoin buying / selling platforms.

Yes, Bitcoins can be sold in various ways. For most people, the easiest way to sell Bitcoin is with Bitcoin.com Wallet app, where you can set up a connection to your local bank to sell Bitcoin for your local currency. Bitcoin can also be sold online via our website. Another option to sell Bitcoin is via Bitcoin Teller Machines which are similar to cash ATMs. Finally, it is of course possible to sell Bitcoin peer-to-peer, whether in exchange for local currency, or as payment for goods or services.

For step-by-step instructions on selling Bitcoin, and to get more information such as the key factors to consider with each selling method, please see this guide.

Can you sell Bitcoin?

For step-by-step instructions on selling Bitcoin, and to get more information such as the key factors to consider with each selling method, please see this guide.

Why trust Bitcoin?

Bitcoin's reliability and integrity stem from its adherence to three core principles of technological freedom: decentralization, open-source code, and true peer-to-peer technology. Here's why these foundations make Bitcoin a trustworthy choice:

Decentralization: A Network Beyond Control

Autonomous System: Unlike traditional currencies controlled by central authorities, Bitcoin operates on a decentralized network. This means no single entity, be it a government or financial institution, can manipulate or dictate Bitcoin's value or flow.
Resilience and Security: Decentralization makes the Bitcoin network more resilient to attacks and fraudulent activities. With no central point of failure, it's more secure against systemic risks.
Open Source Code: Transparency and Collective Development
Auditable by Anyone: Bitcoin's open-source nature means its code is available for anyone to review, audit, and improve. This transparency builds trust, as it prevents hidden vulnerabilities and ensures that the system operates as intended.

Community-Driven Innovations: The open-source approach allows for continuous improvements and innovations by a global community of developers, making Bitcoin a collaborative and ever-evolving project.

True Peer-to-Peer Technology: Empowering Users
Direct Transactions: Bitcoin enables direct transactions between users, eliminating the need for intermediaries. This peer-to-peer approach reduces costs, increases transaction speeds, and enhances user autonomy.
Equal Participation: Every participant in the Bitcoin network has equal authority. This egalitarian structure contrasts sharply with traditional financial systems, where power is often concentrated among a few.

Blockchain: The Ledger of Trust

Immutable Record-Keeping: At the heart of Bitcoin is its blockchain, a peer-reviewed, unchangeable ledger that records every transaction. This ensures a high level of data integrity and trustworthiness, as altering any recorded information is practically impossible.
Mathematical Trust: Bitcoin's trust model is built on cryptographic principles and mathematical algorithms. This reliance on math and cryptography, as opposed to human trust, provides a robust and objective foundation for security and integrity.

In conclusion, Bitcoin's trustworthiness is not just a product of its technological features; it's a result of a paradigm shift in how we understand and use money. By aligning with the principles of decentralization, open source, and peer-to-peer interactions, Bitcoin presents a compelling alternative to traditional financial systems, built on transparency, security, and user empowerment.

Is Bitcoin anonymous?

Bitcoin is often perceived as an anonymous digital currency, but it's more accurate to describe it as pseudonymous. Every Bitcoin transaction is recorded on a public ledger known as the blockchain. This ledger displays the transaction history of each Bitcoin address (which is a string of alphanumeric characters), rather than the personal identity of the users. While this means that individual transactions can't be directly linked to a person's identity just by looking at the blockchain, the anonymity can be compromised. If a Bitcoin address is ever linked to a person's identity, their past and future transactions made with that address can be traceable. Furthermore, many cryptocurrency exchanges require identity verification, creating potential links between identity and Bitcoin addresses. Therefore, while Bitcoin offers a higher degree of privacy compared to traditional banking systems, it's not entirely anonymous. Participants in Bitcoin transactions are identified by public addresses – long strings of around 30 characters you see in a person’s Bitcoin address. For every transaction, the sending and receiving addresses are publicly-viewable.

What happens if I lose my Bitcoins?

If you lose your Bitcoins, unfortunately, they are typically irrecoverable. This is because Bitcoin operates on a decentralized network without a central authority to oversee account management or recover lost funds. Your Bitcoins are accessed through private keys, which are essential for conducting transactions. If you lose your private keys or the wallet where they're stored without having a backup, your Bitcoins are essentially lost in the network. To prevent such situations, it’s crucial to back up your wallet and understand the best practices for digital asset security. Regularly backing up your wallet ensures that you can recover your funds if your device is lost, stolen, or damaged. For more information on how to backup and restore a crypto wallet, visit this guide. Additionally, familiarizing yourself with effective digital asset security measures can safeguard your investments against potential threats. Learn more about securing your digital assets here.

Who is in charge of Bitcoin?

Nobody is "in charge" of Bitcoin – at least in the sense that Bitcoin is not a company or organization, has no governing body and no organizational structure. Bitcoin is simply a software protocol, like HTTP (aka the Internet) and SMTP (aka email).

This has been the case since Bitcoin’s creator, the person (or persons) calling themselves Satoshi Nakamoto, released their creation into the wild in 2009. There are, however, certain groups who can exert influence over the way Bitcoin functions through various means. Again, though, there are no individuals who can claim to speak for these groups, and they contain a plethora of opinions and incentives within. Examples of such groups are:

Developers

These are the people who write and maintain the software the Bitcoin network runs on. Although Satoshi Nakamoto released the first version of Bitcoin himself in 2009, the code has since been re-written and updated by subsequent programmers. The developers choose what updates to make to the protocol, and consider ways it can be improved.

Miners

These are the people (and companies) that own the machines that generate new Bitcoins and keep the network secure by validating transactions. As a result, they have the power to "vote" with their hardware and choose which Bitcoin software to support. Developers may create and release radical revisions to the Bitcoin protocol, but they'll have no effect unless the Bitcoin miners choose to adopt them.

Users

That's you. At the end of the day, if regular users decide Bitcoin no longer fulfils their needs, then it will have no value.

What is a Bitcoin Wallet?

Like the name suggests, a Bitcoin wallet is an application that stores, sends and receives bitcoins. You can think of it like you would a leather wallet full of physical cash, and basically that’s all you need to use Bitcoin.

The most common wallets are smartphone-based and use the device’s camera to scan QR codes to save the user from needing to copy/paste long Bitcoin addresses. Other people have desktop versions or use browser-based wallets. The interface is always similar to the end user, though the way they function and handle private keys (the ‘key’ which allow you to spend your Bitcoins) and user privacy can be very different.

Some apps have features that add value to your Bitcoin-using experience, like location-based Bitcoin business guides, links to exchanges to trade in and out of fiat currencies, more secure vault storage, or the ability to hold digital tokens other than just Bitcoin.

Apart from smartphone and desktop apps, you can also buy specialized hardware devices to keep your keys completely offline, or even print a wallet on paper to keep them as safe from hackers as possible. These are the best options for users holding large amounts of Bitcoin.

Bitcoin users now have a wide selection of wallets to choose from, and because of this competition, features have improved vastly over the past couple of years. But with more choice comes the need for more caution: fraudulent Bitcoin wallets have begun to appear that mimic the look of popular wallets, but are actually malware that steal Bitcoins. Be very careful the wallet you’re installing is the real one.

Use the Bitcoin.com Wallet app, trusted by millions to safely and easily send, receive, buy, sell, trade, and manage Bitcoin and the most popular cryptocurrencies.

Why does the Bitcoin price move so much?

Bitcoin's price is known for its significant fluctuations, primarily because it is still in the process of becoming a dominant currency for global payments. Currently, it is more prevalent among traders and price speculators, making its value highly sensitive to market forces of supply and demand. This sensitivity is often influenced by speculators' trends and reactions to news events, causing sudden and sharp price movements.

Generally, news that suggests Bitcoin is moving closer to widespread adoption will boost its price. Conversely, news indicating obstacles to its mass adoption can lead to a decrease in value. The factors influencing Bitcoin’s price can range from events within the Bitcoin ecosystem, like major hacks or technical developments, to broader economic and political developments. For instance, regulatory changes in major markets such as the EU, China, Japan, or the US can significantly impact the price.

Internal factors, such as miners' meetings to discuss protocol changes, also play a role. The price might dip if consensus on critical issues like block size or scaling is not reached. Moreover, global economic or financial news that questions the stability of traditional financial systems can lead to an increased interest in alternative assets like Bitcoin, thereby increasing its price.

Bitcoin's price can also experience erratic fluctuations without clear reasons, driven by factors like trader psychology, market dynamics, and technical triggers. This unpredictability is a significant concern for those who argue that Bitcoin cannot become a mainstream currency until its price stabilizes. However, it's also possible that a widespread shift towards Bitcoin in response to a crisis in traditional currencies could lead to a dramatic rise in its price, followed by stabilization.

As Bitcoin continues to evolve, those interested in its market movements can find it both fascinating and challenging to predict. While trading on these movements can be tempting, it requires caution due to Bitcoin’s inherent volatility and unpredictability.

Can I make money mining Bitcoin?

Yes… and no. The days where anyone could make money mining Bitcoin with a desktop computer or GPU cards are unfortunately long gone. The total computing (or “hashing") power of the network has risen exponentially since the introduction of application-specific integrated circuits (ASICs), or machines designed specifically to solve Bitcoin’s mining proof-of-work algorithm and nothing else.

For a brief introduction to Bitcoin mining and some basic options, see Bitcoin.com’s guide here.

It is still possible for individual miners to make some money by purchasing their own ASIC-based equipment, however most mining takes place in large factory-like environments with hundreds of machines, in places where energy is cheap. And once your machine is superseded by a newer model a few months after purchase, its ability to compete on the network (and thus its earning potential) is greatly diminished, along with its resale value.

You also need to consider energy costs where you live. Bitcoin-mining ASIC machines run very hot and consume large amounts of electricity. You’ll need to subtract the costs of electricity and cooling from the profits you make.

However, if you have access to cheap electricity, don’t mind (a lot of) extra heat and you think the Bitcoin price is going to increase exponentially in future, try mining for yourself. You’ll learn a lot about how the Bitcoin network works, and the network needs more individual miners to keep it secure and decentralized.

In fact, a large number of individuals mine Bitcoin to contribute back to the network in this way, as well as just for the fun of it. There’s also always the possibility, though increasingly remote, that an individual miner will mine the next block and receive the full reward for doing so.

If you still want to mine and don’t want to own or manage your own devices, various “cloud mining" companies exist. These are large operations located in data centers around the world. Users buy a share of the mining power available and receive rewards in proportion to their shares. Like all Bitcoin services, there are trustworthy and untrustworthy operators, and cloud mining is subject to the same risks and price fluctuations as managing your own equipment – so be sure to do your research and ask questions before parting with any money.

When does the IRS consider crypto mining as a business?

In general, the IRS states a hobby activity is done mainly for recreation or pleasure. The IRS uses the following criteria to determine whether a taxpayer’s profitable activity is deemed a hobby or a trade or business. Please note one factor alone is decisive and all factors must be considered:

Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records.
Whether the time and effort you put into the activity indicate you intend to make it profitable.
Whether you depend on income from the activity for your livelihood.
Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
Whether you change your methods of operation in an attempt to improve profitability.
Whether you or your advisors have the knowledge needed to carry on the activity as a successful business.
Whether you were successful in making a profit in similar activities in the past.

Whether the activity makes a profit in some years and how much profit it makes.
Whether you can expect to make a future profit from the appreciation of the assets used in the activity.

How do I report Bitcoin mining income?

Hobby miners need to report their income from mining on Form 1040.

To report business income from mining, the taxpayer will report the amount received as self-employment income and any related mining business expenses on Schedule C and Form 1040. Additionally, the self-employment tax born by the taxpayer will be calculated and reported on Schedule SE and Form 1040.

What can you buy with Bitcoin?

You can purchase just about anything with Bitcoins, from goods like clothing, electronics, food and art to handmade crafts. Bitcoin can also be used to purchase large items like cars, real estate, and investment vehicles such as precious metals.

What is a Bitcoin address?

A Bitcoin address is a long string of 27 - 34 numbers and letters that acts similarly to an email address. The address enables the Bitcoin blockchain to recognize when Bitcoins are sent and received. These addresses can be used by anybody, from single individuals to businesses, to multiple people accessing the one address if desired.

It is also considered more secure not to re-use addresses, but instead to use a unique address every time you send and receive Bitcoins. This increases the privacy of your transactions to a degree and helps in avoiding public tracking of your funds.

How do Bitcoin transactions work?

Bitcoin transactions are a seamless yet intricate process, involving a few key components: the transaction amount, input (sending address), output (receiving address), and private keys. These elements work together to ensure the secure transfer of Bitcoin between parties.

Here’s a breakdown of how it works:

Initiating the Transaction: To send Bitcoin, a user inputs the recipient's address (the output) and the amount they wish to transfer.
Role of Private Keys: The sender must have access to the private keys associated with the Bitcoin they wish to spend. Private keys act like a digital signature, confirming the sender’s ownership and authorization of the transaction.
Miners and Verification: Once initiated, the transaction is broadcast to the Bitcoin network. Here, miners play a crucial role. They confirm and verify the transaction by including it in a block of other transactions, which is then added to the Bitcoin blockchain.
The Blockchain: The blockchain is a comprehensive, public ledger that records all Bitcoin transactions from the currency's inception. This ledger ensures transparency and security, as it is immutable – meaning once a transaction is recorded, it cannot be altered or deleted.

Through this process, Bitcoin transactions maintain a high level of security and reliability. The blockchain's role as a public ledger not only provides transparency but also a traceable history of all transactions, which is fundamental to Bitcoin's integrity. To explore Bitcoin transactions and other data points, many resources are available, including the Bitcoin Explorer.

How does the blockchain work?

The blockchain records all of the newly minted Bitcoins rewarded to miners who find blocks. Blocks are sets of sent/received transactions that miners confirm for the network. As these actions take place within the Bitcoin protocol, the blockchain acts as a ledger of account for all transactions undertaken within the Bitcoin network.

What is a full node?

A full node in the Bitcoin ecosystem is a fundamental component that plays a crucial role in validating and relaying transactions across the network. These nodes are voluntarily operated by a diverse array of participants, including individuals, groups, and organizations such as merchants. They contribute significantly to the health and security of the Bitcoin network. Here’s what sets full nodes apart:

Transaction Validation: Full nodes rigorously verify transactions and blocks according to the Bitcoin protocol. They ensure that transactions within a block adhere to Bitcoin's rules, preventing invalid transactions from being confirmed on the blockchain.
Global Distribution: Full nodes are distributed worldwide, creating a robust and decentralized network. This global spread enhances the security and resilience of the Bitcoin network against potential attacks or failures.
Protocol Enforcement: By independently validating transactions and blocks, full nodes help enforce the consensus rules of the Bitcoin network. This is crucial for maintaining the integrity and trustworthiness of the entire system.
Altruistic Function: Unlike miners, full nodes operate without direct financial reward. Their contribution is largely altruistic, aimed at maintaining the network's health and security.
Benefits for Operators: While they don’t receive direct compensation, running a full node offers specific advantages. For merchants and individuals, it provides increased security and privacy. They can directly validate transactions, enhancing their ability to detect double-spending attempts and ensuring greater autonomy in transaction verification.

In essence, full nodes are the guardians of Bitcoin's ledger, ensuring that the rules of the network are followed and that transactions are processed correctly. Their operation, while altruistic, is a cornerstone in the stability and trust of the Bitcoin network.

What is a public key?

In the realm of Bitcoin, each address comprises two crucial components: a public key and a private key. The public key plays a vital role in the Bitcoin ecosystem, serving multiple purposes.

Receiving Bitcoins: The public key is what others use to send Bitcoins to your address. Think of it like an email address; you share it with others to receive messages (or in this case, Bitcoin).
Verifying Transactions: When Bitcoins are sent to your address, the public key is used to verify the transaction's signature. This step is crucial as it ensures the transaction is legitimate and the Bitcoins are indeed being sent to the correct address.
Securing the Process: The public key is essential in finalizing transactions. It works in tandem with the private key to maintain the security and integrity of your Bitcoin holdings.

On the other side of the coin is the private key, which is akin to a password. This key is what allows you to access and spend your Bitcoins. It signs transactions, providing proof to the Bitcoin network that you are the rightful owner of the address and that the transaction is valid. The analogy of the private key being a key to a safe is quite fitting; just as a key opens a safe, the private key unlocks your ability to access and use your Bitcoins.

Furthermore, the private key can be used to sign a message, proving ownership of the Bitcoins at a particular address. This entire system is underpinned by asymmetric cryptography, a branch of mathematics that ensures the robust security of these keys. In this way, public and private keys work together to provide both accessibility and security in the Bitcoin network.

How can I accept Bitcoin payments?

It is very easy for any merchant to accept Bitcoin. Merchants can accept Bitcoin both online and at physical locations by using a merchant service payment provider like Bitpay, or even just using a simple wallet address generated on their own device.

Merchants can accept Bitcoin through a payment processor, through a Point-Of-Sale (POS) device or simply using their own tablet or smartphone. Adding Bitcoin as a payment method for your store can also increase your customer base for those who like to pay with cryptocurrency, as well as broadening your company’s reach into the global market. Read more about our merchant solutions for more information.

Are there fees involved?

Yes, sending Bitcoin does involve certain fees, commonly referred to as the 'Miner's fee.' These fees serve as an incentive for miners, who play a critical role in the Bitcoin network. When you send Bitcoin, a portion of the transaction is allocated as a fee to these miners.

Purpose of Miner's Fee: Miners use their computational resources to verify and confirm transactions, adding them to the Bitcoin blockchain. The fees compensate miners for the electricity and hardware resources expended in this process.
Dynamic Fee Structure: It's important to note that these fees aren't fixed and can vary based on network congestion. During times of high transaction volumes, fees may increase as more users compete to have their transactions processed quickly.
Transaction Priority: Paying a higher fee can often lead to a faster confirmation of your transaction, as miners prioritize transactions with higher fees.

Ultimately, these fees are vital for maintaining the efficiency and security of the Bitcoin network, ensuring that your transactions are processed in a timely and secure manner.

What does "unconfirmed transaction" mean?

In the context of Bitcoin, an "unconfirmed transaction" refers to a transaction that has been initiated and broadcast to the network but has not yet been validated and confirmed by miners. Here's what you need to know about unconfirmed transactions:

Waiting for Confirmation: When you make a transaction with Bitcoin, it first enters the network as unconfirmed. It remains in this state until miners validate the transaction and include it in a block on the blockchain.
Confirmation Time Variability: A Bitcoin transaction confirmation usually takes about 10 minutes. However, depending on network congestion and the fee you pay, it may take significantly longer for your transaction to confirm.
Solving Congestion Issues: The Bitcoin community and developers are continuously exploring solutions to improve transaction times and manage network congestion. This includes discussions and development of new technologies and protocols.
Transaction Expiry: If, for some reason, a transaction remains unconfirmed for an extended period, typically around 72 hours, the network may drop it. In such cases, the Bitcoin would return to the sender's wallet, as if the transaction never occurred.

Is Bitcoin legal?

Bitcoin is legal in most jurisdictions in the world but there are a small number nation states that have banned its use, such as Ecuador. Wikipedia has a great guide on how Bitcoin is treated in all the countries around the world and explains regulatory policies surrounding it. Regulations vary from one border to the next so you should always research your location’s laws before participating in the network.

How to make a Bitcoin paper wallet?

Paper wallets are a great way to keep Bitcoin offline and out of hackers’ reach. Creating paper wallets is easy but losing the paper also means the Bitcoins are lost forever so be careful. Paper wallets contain both private and public keys which allow you to spend your Bitcoins.

The most common way that people create paper wallets is using paperwallet.bitcoin.com where users can generate a fresh new Bitcoin address and related private key. The website will ask the person to initiate some steps and are then given both public and private keys after the process. After printing a copy, you can load as much Bitcoin as you want into your public QR-code.

This service, however, does come with a caveat. There are any number of technical reasons why generating a private key on a machine that you don’t control is a bad idea; these range from man-in-the-middle (MITM) attacks to untrustworthy site operators, and everything in between.

However, downloading the Bitaddress code and running it on your own machine offline can mitigate these risks. This can be further secured by doing so on a machine that is not (and has never been) connected to the internet.

How does the IRS classify crypto?

The IRS 1040 Form Instructions note the following description of crypto, referred to holistically as “digital assets”:

“Digital assets are any digital representations of value recorded on a cryptographically secured distributed ledger or any similar technology. For example, digital assets include non-fungible tokens (NFTs) and virtual currencies, such as cryptocurrencies and stablecoins. If a particular asset has the characteristics of a digital asset, it will be treated as a digital asset for federal income tax purposes.”

By prominently highlighting whether a taxpayer has dealt with digital assets in the broadest sense on Form 1040, the IRS has indicated no longer room for taxpayers to claim they were unaware that crypto transactions need to be reported. If a taxpayer checks Yes, then the IRS looks to see if Form 8949 (which tracks capital gains or losses) has been filed. If the taxpayer fails to report their taxable cryptocurrency transactions, the IRS may impose a penalty on any underreported taxes.

Are all crypto transactions taxable?

No, not every crypto transaction is taxable. The following activities are not considered taxable events:

Buying digital assets with cash
Transferring digital assets between wallets or accounts that you control
Gifting cryptocurrency (excluding large gifts that could trigger other tax obligations)
Donating cryptocurrency, which is actually tax-deductible

What crypto transactions are taxable?

The following crypto activities are taxable events:

Selling digital assets for cash
Trading one type of digital asset for another
Using crypto as payment
Mining or staking crypto
Receiving airdropped tokens
Getting paid in crypto
Receiving interest or yield in crypto

When you sell, trade, or use crypto as a form of payment, you dispose of digital assets; that disposal could result in gain or loss depending on your cost basis in the units disposed of and the value of the digital assets at the time of disposal. Regardless of whether you had a gain or loss, these transactions need to be reported on your tax return on Form 8949.

When you receive cryptocurrency from mining, staking, airdrops, or a payment for goods or services, you have income that needs to be reported on your tax return. The amount of income you report establishes your cost basis.

What is cost basis?

The cost basis is the original purchase or acquisition price of an asset. If you purchase 1 BTC for $10,000, that is your cost basis, which is then used to calculate any capital gain or loss from disposing of it thereafter. Tracking cost basis across the broader crypto-economy can be difficult, as assets are transferred across different wallets and exchanges.

At Legacy Tax & Resolution Services, we have found that come tax season, customer support issues regarding “missing cost basis” dominates the industry at large. It is for this reason that Legacy Tax & Resolution Services and other industry leaders are partnering to solve this widespread issue. Legacy Tax & Resolution Services is building the industry-leading solution for tracking cost basis across a network of top exchanges, wallets, and platforms.

When do you have to pay taxes on Bitcoin?

The sale or exchange of cryptocurrency is a taxable event subject to capital gains tax. For example, if you exchange Bitcoin for Ether, you will need to tax the capital gain or loss resulting from this transaction.

How is Bitcoin taxed?

The sale or exchange of cryptocurrency will result in a net gain or loss and will be taxed as a short-term capital asset at ordinary income tax rates or as long-term capital assets at reduced rates, depending on the amount of time the capital asset is in the hands of the taxpayer (i.e. holding period). That means if you hold crypto for more than a year (without selling or exchanging it), you will pay long-term capital gains when you sell or exchange.

Do you pay taxes on Bitcoin mining?

In general, all income or rewards received by a taxpayer in excess of $400 generated from the mining of cryptocurrency must be reported to the IRS. The taxpayer must also identify whether they are a hobby or (self-employed) business miner for tax reporting purposes.

If the taxpayer is a hobby miner, the income received by the taxpayer as it relates to cryptocurrency mining will be treated as ordinary income.

If the taxpayer is deemed to be engaged in a trade or business for which virtual currency mining generates trade or business income and owns/leases their own mining (business) equipment, the taxpayer must report any income or rewards received as self-employment income. Expenses related to the mining business activity including but not limited to depreciation of mining equipment, electricity, and hardware may be deducted for tax purposes. Business miners are also subject to self-employment tax at a rate of 15.3% for the 2017 and 2018 tax year.

Do crypto-to-crypto trades qualify for like-kind exchanges?

In a recent Chief Council Advisory, the IRS found that certain cryptocurrencies did not qualify as like-kind exchanges under section 1031 prior to the Tax Cuts & Jobs Act of 2017. The IRS’s ruling, while limited to coin exchanges involving Bitcoin, Ether, or Litecoin, provides insight on the IRS’s current thinking on the subject.

The ruling presented the following stated question: If completed prior to January 1, 2018, does an exchange of (i) Bitcoin for Ether, (ii) Bitcoin for Litecoin, or (iii) Ether for Litecoin qualify as a like-kind exchange under § 1031 of the Code?

The ruling set forth the following conclusion: No. If completed prior to January 1, 2018, an exchange of (i) Bitcoin for Ether, (ii) Bitcoin for Litecoin, or (iii) Ether for Litecoin does not qualify as a like-kind exchange under § 1031 of the Code.

What is a Form 8949?

Form 8949 tracks the Sales and Other Dispositions of Capital Assets. In other words, Form 8949 tracks capital gains and losses for assets such as cryptocurrency. On Form 8949, a taxpayer details the number of units acquired, their dates of acquisition and disposal, cost basis, and any capital gain or loss.

Capital gains and losses are taxed differently according to whether an asset was held for more than one year. Long-term capital gains for assets held longer than one year are taxed more favorably than short-term capital gains for assets held less than one year.

How do I report my cryptocurrency gains and losses?

You would report your cryptocurrency gains and losses on Form 8949.

How to determine crypto gains or losses

Whether you have a gain or loss on the disposal of a digital asset depends on the value of the asset at the time of disposal measured against the cost basis of that asset.

In late 2019, the IRS issued guidance on acceptable cost-basis methods for calculating gains and losses on cryptocurrency. The IRS guidance specifically allows for only two cost-basis assignment methods:

First in First Out (FIFO)
Specific Identification

What is FIFO (first in, first out)?

First-in, First-out (FIFO) assigns the cost basis where the oldest unit of crypto you own is sold or disposed of first.

What are the potential benefits of FIFO?

FIFO currently allows the universal pooling of assets, which makes this an easier method to apply than Specific Identification.

The IRS FAQs don’t specifically address what method is required for FIFO, so a taxpayer can use either approach – pool all their accounts together or prepare separate FIFO calculations for each wallet or account.

You can weigh your options, but if the exchange issued a Form 1099 to you, then it probably used a by-exchange approach. The same approach is likely easiest when completing your tax forms and could also reduce the chance of an audit because your return will match the information the exchange provided to the IRS.

What is Specific Identification?

Taxpayers can also elect to use Specific Identification. Specific Identification allows you to select which cryptocurrency unit is disposed of in a transaction to minimize any gains or losses.

In the following example, you purchase 1 BTC at a price of $5,000 on June 1, 2023. On August 1, 2023, you purchased an additional 1 BTC at a price of $7,000. Later, you sell 1 BTC for a price of $10,000. Using Specific Identification, the taxpayer can choose to dispose of the 1 BTC with the highest cost basis first as an approach called HIFO (highest, in first out) – to minimize capital gains.

So, instead of tracking the proceeds of the $10,000 sale for 1 BTC against the unit purchased at $5,000 on June 1, 2023, the net capital gains are matched against the unit purchased at $7,000 on August 1, 2023. In this case, Specific Identification and HIFO enable taxpayers to minimize their net capital gains liability by $2,000.

What are the requirements for Specific Identification?

The IRS, however, has imposed requirements upon taxpayers that want to use Specific Identification.

First, a taxpayer must, “show (1) the date and time each unit was acquired, (2) your basis and the fair market value of each unit at the time it was acquired, (3) the date and time each unit was sold, exchanged, or otherwise disposed of, and (4) the fair market value of each unit when sold, exchanged, or disposed of, and the amount of money or the value of property received for each unit.” In simpler terms, the IRS requires a complete set of transaction records when a taxpayer wants to use Specific Identification.

Second, the IRS guidance requires that Specific Identification be done on a per account and per wallet basis. Legacy Tax & Resolution Services provides support for Specific Identification on a per account or wallet basis in order to legally minimize users' taxes and reconcile to any Forms 1099 issued by exchanges. Legacy Tax & Resolution Services automates the process by specifically identifying, by exchange, the assets with the highest-in, first-out (HIFO) for disposition to reduce taxable gains.

Although HIFO by exchange is the most common approach for optimizing taxes under the Specific Identification method, HIFO isn’t the only option. Taxpayers could choose to assign their cost basis under a different method, such as Last In, First Out (LIFO), but this approach typically makes little sense because they would likely end up with a larger tax bill.

I received payment for services or goods in cryptocurrency. Does that get the same treatment as gains from trades? Does that even trigger a taxable event?

So if you pay for goods and/or services with crypto, the IRS treats the transaction similarly to other instances where property or assets are used as a form of payment. As a result, using crypto to pay for goods or services constitutes a taxable event, and any gains or losses must be reported.

Tax forms issued by cryptocurrency exchanges

A cryptocurrency exchange could issue Forms 1099-MISC, 1099-B, and/or Forms 1099-K to its users. Regardless of whether any of the below forms are issued, taxpayers are always responsible for reporting any and all digital asset income, gains, and losses on their annual income tax return.

1099-MISC

The Form 1099-MISC reports ordinary income that will be taxed according to your income tax bracket. This form provides information for various income payments such as crypto earnings, referral bonuses, staking, yield generation, mining, airdrops, hard forks, and other income received through a centralized cryptocurrency exchange. If you’ve received $600 or more this year in crypto earnings or bonuses, a 1099-MISC will likely be made available by the platform that issued the payments (most top exchanges provide them).

1099-B

A Form 1099-B is used to report the disposal of taxpayer capital assets to the IRS. Traditional financial brokerages provide 1099-B Forms to customers, but cryptocurrency exchanges have not been required to do the same in the past.

A law passed by Congress in 2021 will soon require digital asset brokers to report users’ capital gains and losses via Form 1099-B (or another form specific to digital assets called 1099-DA). When digital asset brokers begin providing 1099 Forms to customers, it will become much easier for taxpayers to know their tax liability and ultimately file Form 8949. Gains reported on Form 8949 are taxed pursuant to capital gains treatment instead of ordinary income.

1099-DA

Digital asset brokers, as outlined in the Infrastructure Investment and Jobs Act (IIJA) will be required to significantly expand tax information reporting. Digital asset brokers will be required to report customers’ transfers and original cost basis – for both broker-to-broker and broker-to-non-broker (or external wallet address) transfers – in a new form called the 1099-DA (digital assets) to both individuals and the IRS. The final format of the 1099-DA is not yet released but is expected to be clarified soon.

How are exchange and network transfer fees taxed?

Millions of Americans have participated in the crypto-economy – buying, selling, or transferring digital assets. These activities typically require fees to be paid as part of the transaction, either to a centralized exchange or as a network transaction fee to the validators confirming the transactions on a blockchain. For many, the question is how those fees are treated for tax purposes – can they be deducted, or do they provide any potential benefit?

Fees incurred in conjunction with the acquisition or disposition of a crypto asset provide some tax benefit. Whenever crypto is bought or sold (or converted to another asset) on a centralized or decentralized exchange, the U.S. tax code permits fees paid with respect to those transactions to be taken into account for tax purposes.

Fees incurred simply by transferring crypto assets among accounts or non-custodial wallets likely provide no tax relief because they are not directly connected to the acquisition or disposition of property.

What is the tax rate for crypto?

The United States distinguishes between two main types of income—ordinary income and capital gain income. Capital gain income can be long-term or short-term. If you receive crypto as payment for goods or services or through an airdrop, the amount you receive will be taxed at ordinary income tax rates.

If you’re disposing of your crypto, the net gain or loss amount will be taxed as capital gains.

What are short-term capital gains?

If you hold a particular cryptocurrency for one year or less your transaction will constitute short-term capital gains. Short-term capital gains are added to your income and taxed at your ordinary income tax rate.

What are long-term capital gains?

If you held a particular cryptocurrency for more than one year, you’re eligible for tax-preferred, long-term capital gains, and the asset is taxed at 0%, 15%, or 20% depending on your taxable income and filing status.

The specific income levels change annually, but we’ve provided a general breakout below:

If you’re in the 10% or 12% tax brackets based on your filing status, you’ll generally pay a 0% capital gain rate.
If you’re in the 22%, 24%, or 32% tax brackets based on your filing status, you’ll generally pay a 15% capital gain rate.
If you’re in the 35% and 37% income tax brackets, you’ll generally pay a 20% capital gain rate.

What is a tax loss carry-forward?

The difference between capital gains and losses is called net capital gain or loss. If you have a net capital loss, you can deduct that loss on your tax return—up to $3,000 per year. If your net capital losses exceed $3,000, the portion over $3,000 is a capital loss carryforward and can be included in your capital gain calculation for the following tax year.

For example, if you had a net capital loss of $5,000 for tax year 1, you would deduct $3,000 of that amount on your tax return for tax year 1. The remaining $2,000 would be carried forward and used to calculate your net capital gain or loss for tax year 2. If you also had a loss in tax year 2, then the $2,000 carryforward could be used in tax year 3 along with any carryforward from tax year 2.

How can investors offset capital gains with capital losses?

The IRS allows investors to claim deductions on cryptocurrency losses that can lessen their tax liability or potentially result in a tax refund. Crypto losses must be reported on Form 8949; you can use the losses to offset your capital gains—a strategy known as tax-loss harvesting—or deduct up to $3,000 a year from your ordinary income (the allowable capital loss deduction).

When offsetting your capital gains with losses, pay attention to the holding period of the assets in the red. You can only offset long-term capital losses against long-term capital gains and short-term capital losses against short-term capital gains. Once you’ve offset losses of the same type, your short-term losses are used first against your allowable capital loss deduction of $3,000. If you have not reached the limit on the capital loss deduction after using your short-term losses, use your long-term losses until you reach the limit. Any remainder above $3,000 will be carried forward into the next year, retaining its long- or short-term character.

How are crypto taxes enforced?

The IRS doesn’t say how it decides which tax returns to examine, but the assumption is that it will review the information provided on a tax return, such as the answer to the virtual currency question on Form 1040 or the information on Form 8949.

The IRS appears to pay close attention to individuals who received a Form 1099 from an exchange and will use its computer system to check the Form 1099 information against what a taxpayer reports on their tax return.

Notably, if a taxpayer answers No to the virtual currency question or doesn’t include a Form 8949 and is issued a Form 1099 from an exchange, that taxpayer is more likely to be audited; the IRS now has information that may result in penalties on top of whatever additional tax may be owed. Honest answers are always recommended.

The IRS released its first cryptocurrency guidance in 2014 and specified this asset class is taxed as property. Since that time, the crypto community has seen increased enforcement, audits, and pending regulations – and Legacy Tax & Resolution Services has helped millions of taxpayers automate and file their cryptocurrency taxes.

The question of whether or not a taxpayer deals in crypto assets (also referred to as “virtual currency” and officially now “digital assets”) is now placed front-and-center for millions of Americans to see. The U.S. Individual Income Tax Return (Form 1040) for 2022 asks,

“At any time during 2022 did you: (a) receive (as a reward, award, or payment for property or services); or (b) sell, exchange, gift, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?”

Understanding digital asset tax liabilities may be confusing, especially in regard to blockchain jargon such as “airdrops,” “staking,” etc. But as a taxpayer or an enterprise leader, it’s your responsibility to stay educated on potential tax liabilities for dealing with digital assets such as BTC, ETH, NFTs, etc. Regulators are taking notice – especially as an estimated $50 billion worth of crypto taxes have gone unreported.

Other crypto tax considerations

How is crypto staking or mining taxed?

ETH staking rewards may potentially be taxed as income equal to the value of the coins at the moment of receipt. But without the ability to unlock funds until an eagerly-awaited network upgrade is complete, and given ETH’s price volatility, staking tax liabilities can be confusing. Without formal IRS guidance, a taxpayer may be able to reasonably argue that taxable income should be deferred until funds are entirely unlocked.

Rewards or yield earned by staking other cryptocurrencies will be taxed as ordinary income – and the same applies to any income earned by mining on networks such as Bitcoin.

How are crypto airdrops or hard forks taxed?

Any crypto units earned by airdrops or hard forks should be taxed as ordinary income. Hard forks are similar to airdrops in that you can receive new coins but are fundamentally different occurrences. An airdrop is when new coins are deposited into your wallet or crypto exchange account, but a hard fork is an event where a single blockchain splits into two separate, parallel chains. Holders of coins on the original chain could also receive coins on the new unique chain after the hard fork’s split.

How are crypto debit card payments taxed?

Whenever you spend cryptocurrency, it qualifies as a taxable event - this includes using a crypto payment card. If the price of crypto is higher at the time of a purchase than when you acquired it, the disposal of that crypto would be recognized as a capital gain and taxed accordingly. If you make purchases with your crypto debit card when your assets are in a loss position, you can actually use this capital loss to offset capital gains with a strategy called tax-loss harvesting.

How are crypto bankruptcies taxed?

In 2022, market turbulence and bankruptcies swept the crypto industry. Many users were left with inaccessible funds and severe uncertainty as to their tax situation.

From a tax perspective, if customers are not made whole in the bankruptcy, a tax deduction may likely be claimed, but only after payout from the company is made or known:

The deduction can be claimed once the amount of any payout is determined with reasonable certainty
The amount of the deduction should be equal to an individual’s investment (cost basis) in the lost crypto less the amount of any payout received
The deduction will likely be treated as an ordinary loss rather than a capital loss
How are crypto gifts and donations taxed?
The IRS distinguishes between a donation and a gift for tax purposes dependent on who receives the cryptocurrency. If you send cryptocurrency to a qualified charitable organization, this is considered a donation, also referred to as a charitable contribution. If you send cryptocurrency to family, friends or a crowdsource campaign for someone with medical bills, it’s considered a gift.
Neither gifting cryptocurrency to a friend nor donating cryptocurrency to an eligible charity are taxable events, but donating the crypto may have an additional tax advantage - depending on your situation, you may be able to claim a charitable deduction on your tax return for donated crypto. Learn more about donating or gifting crypto and its potential tax implications here.

How are crypto-to-crypto transactions taxed?

Exchanging one crypto for another is a taxable event, regardless of whether it occurs on a centralized exchange or a DeFi exchange. If you trade 1 BTC for 10 ETH, for example, that would qualify as a taxable disposable of 1 BTC priced at the fair market value of the 10 ETH acquired in the transaction.

How are NFTs taxed?

NFTs qualify under the IRS definition of “digital assets.” As such, they are considered property and are thus subject to capital gains or ordinary income taxes. In addition, certain NFTs may be considered “collectibles” by the IRS and, therefore, would be subject to higher taxes than other capital assets. NFT stakeholders are eagerly awaiting formal IRS guidance on whether they should be taxed as “collectibles.”

Can I claim any cryptocurrency losses? Is anything deductible?

Yes, you can write off crypto losses on taxes even if you have no gains. If your total capital losses exceed your total capital gains, US taxpayers can deduct the difference as a loss on your tax return, up to $3,000 per year ($1,500 if married filing separately).

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