Stare at crypto charts, and you might ask, “How does cryptocurrency gain value?” This confuses those not in the know about crypto. It might seem strange seeing investors swing between happy and sad within minutes of tracking the prices. If you hold any of the coins, you should know why the prices move wildly.
More countries are allowing citizens to invest in digital currency, but they’ve implemented taxes on them too. As a responsible investor, you should know how cryptocurrency taxes apply to your portfolio. It can be hard in the US because it can have capital gain tax and income tax. Don’t worry because I’ll discuss more details about crypto value and taxes!
Start by talking about how cryptos have value in the first place. Then, I’ll discuss how cryptocurrency gains value. After that, I’ll explain how crypto taxes work in the United States and show the taxable actions. These tips only work in the US, as other countries have different crypto laws.
Table of Contents
Why do cryptos have value?
To answer “How does cryptocurrency gain value?”, we will talk about the first one: bitcoin or BTC. It came out in 2009, intending to create a new financial system.
Unlike fiat currencies, bitcoin would have no central bank or government controlling it. Instead, it uses a decentralized network called a blockchain.
This provides a system by the people and for the people. It’s “for the people” because people can help run the network by confirming BTC transactions. In exchange, they earn more bitcoin.
The drawback of this free system is that the asset mainly gets value via speculation. In other words, bitcoin and other cryptos have value because people think they do!
You might scoff at this idea, but that’s the case with the bills in your wallet. Back then, the US dollar had gold backing its value. That’s why USD was as good as the precious metal.
On August 15, 1971, President Nixon removed this gold standard. The dollar has value because everyone believes you can buy something with it.
If you look throughout history, this has been the case for every form of money. People are the ones who see value in things. That’s why they used seashells and rocks as money back then.
Sadly, trust in the US dollar is falling fast because of hyperinflation. Believe it or not, more investors are choosing cryptos over gold as a hedge against the rising prices!
How do cryptos gain value?
As more people want to invest in bitcoin, cryptocurrencies gain value. This is when one of the most basic principles of economics apply: the law of supply and demand.
According to this rule of thumb, increased demand means higher prices. That’s one way cryptos gain value, but the following factors have an impact as well:
- Speculation – When Elon Musk tweets Dogecoin (DOGE), its price increases. This may seem silly, but news like this is an effective way of checking how the market will behave. If investors believe a coin will cost more, then more of them will rush to buy them while they’re cheap. This keeps going until the value rises high enough.
- Acceptance – Nowadays, people want cryptos because the networks have more features. For example, Ethereum (ETH) lets you use smart contracts. More use-cases mean more people want to buy a cryptocurrency.
- Whales – Some investors buy and sell coins worth millions of dollars. They’re called “whales” in crypto slang because they can make huge waves in the market. One large transaction could cause a huge bump in price or a massive selling frenzy!
- Blockchain scalability – A crypto network should be ready to handle more users as time passes. If the network could handle the extra load, its token would likely increase in value. Otherwise, it could hurt the user experience, so people might exchange its tokens for another one and reduce prices.
Read More: Why Does The Crypto Market Keep Crashing?
How are they taxed?
You can answer “How does cryptocurrency gain value?” in two ways. It can work as a capital asset and earned income. This means it has two types of crypto taxes too.
Cryptos work like stocks because their prices rise and fall too. The term capital gains tax has two forms: short-term and long-term in the US. Let’s see how they work for cryptocurrencies:
- Short-term capital gains – You pay these for cryptos you’ve only held for less than a year. Also, you may deduct losses worth a maximum of $3,000. Capital losses above that amount can reduce next year’s taxes.
- Long-term capital gains – Once you’ve held cryptos for more than a year, you stop paying short-term capital gains taxes and start paying long-term ones. Your tax liability will depend on your tax bracket and tax rate. If you want to learn more about this type of tax, click here.
Next, let’s talk about how cryptos provide taxable income. This happens when you do the following things with your cryptocurrencies:
- Selling them for cash
- Buying stuff with them
- Buying crypto using another on an exchange platform
- Mining or confirming transactions to earn more coins
- Receiving them as payment or from an airdrop
- Earning rewards from crypto staking, depositing coins to earn more
Explaining how this type of tax works with cryptos will take a long time. Visit the IRS website to learn more about terms like cost basis and ordinary income.
Make sure to file your tax returns properly and on time. It’s hard to do it yourself, so you might want to ask for help from a tax preparer. You can find many websites that can help too.
Note that this article is not meant to give investment advice. If you’re interested, be sure about your goals and plan how you’ll go about it. That way, you can pick the best assets.
Also, check out Financial Daily Updates for more crypto articles. You can also learn about other assets here, such as stocks, bonds, index funds, and more!