Is Crypto a Miracle or Scam?

Cryptocurrency is officially mainstream. Approximately 16 percent of all Americans have invested, traded, or used a decentralized, blockchain-based token, which is a number that seems to increase everyday. The Super Bowl—the singular marquee event for advertisers—was absolutely canvassed with crypto platform ads, picking up ultra high-profile celebrity endorsers in million dollar commercial productions. At last, a financial apparatus once condemned to the arctic regions of the economy has firmly pried its way into common society.

For those of us who haven’t made the jump yet, crypto appears to be both enticing and terrifying—caught in an uncomfortable place between a pernicious scam and a potential miracle. There are so many questions worth considering. What happens if you invest money into a coin that crashes? How easy is it to pull money out? Have you already missed the boat? And, a big one lots of people likely don’t even think about: what about tax season? The idea of navigating any Ethereum holdings in April is terrifying. Which is why I consulted H&R Block‘s cryptocurrency tax experts, as well as other financial experts, to help navigate these treacherous waters.

The more you talk to people about crypto, the more you understand that currently, this is a realm filled with hedges, guesswork, and theories. That opens up a lot of room for potential, as well as plenty of exposures. With so much volatility, many that have remained on the sidelines might wonder why anyone would put their money into these assets. 

“If you look at the people with the most wealth, they start to say, ‘How can I diversify [my investments] even further, as not to see as many swings in my portfolio?’” says Marc Russell, a financial adviser. “For the average investor, when you start to think about diversification, I’m starting to think that crypto is a good way to go. However, you do not want to put everything into crypto, because you do have that volatility.”

Russell, like many crypto agnostics, allocates only 10 percent of his portfolio to individual stocks and cryptocurrencies—essentially the “higher-risk” portion of his balance sheet. That’s because, as finance folks and H&R Block’s own tax experts explain, crypto is still in its nascent form, and we do not yet know how the decentralized revolution will meld with global economic policy. But it’s likely only a matter of time.

Transactions involving cryptocurrency are taxable. Because tax reporting guidance is in its early stages for cryptocurrency, consumers may have questions about how to ensure they get it right. For instance, one of the most fascinating things I learned when consulting with H&R Block’s crypto tax specialists is that as of right now, there aren’t any rules preventing investors from taking current tax losses on “wash sales” in regards to digital tokens. In layman’s terms, a wash sale is when someone sells a security at a loss and immediately buys it back up within 30 days—artificially creating a tax deduction. This practice is disallowed by the United States Tax Code for other assets. The loss from a wash sale is deferred until the replacement property is disposed of…but those same provisions haven’t carried over into crypto—emblematic of how murky so many crypto parameters are in 2022.

“The analysis is that wash sale rules apply to stocks and securities by law, but the IRS treats cryptocurrency as property,” says Megan Hurlbert, a Tax Research Analyst at H&R Block. “Because the wash sale disallowance rules are specifically limited to stocks and securities, they do not currently apply to cryptocurrency.” 

Frankly, the reporting challenges that digital currency has wreaked upon the tax filing process is truly profound. The experts at H&R Block pointed out to me literally dozens of potential cryptocurrency transactions that could complicate your tax return. For instance, if someone pays you for a service in Bitcoin, you will generally report that as wages or business income on your tax return. Then, you will have another reportable transaction when you sell that Bitcoin, at which point you gain or loss would generally be taxed like any other capital asset. Do you enjoy working the DeFi markets every morning like a stock market? Make sure to keep a record of all of those transactions, because as Hurlbert says, “You need to have reliable records to prove how much you paid for each asset, how long you held the asset and how much gain or loss you incurred on the transaction. Some exchanges will track most of that information for you, but the ultimate responsibility is yours to have proof of any gain or loss.” 

But it does feel like a singularity between fiat currency and blockchain coins is coming sooner than later. In New York City ATMs are equipped with the ability to cash out Bitcoin, and the country of El Salvador just adopted the currency as a nationally accepted tender. One of the stumbling blocks a lot of people struggle with in crypto is the idea of encapsulating our hard-earned wages in an ethereal, intangible capital asset—rather than, you know, a summer cottage or a pile of Treasury bonds. The solution to some of these anxieties is the much-hyped metaverse, which is a term at the tip of every Fortune 500 CEO’s tongue lately. The idea is that in the near future, all of us will be frequently entering a parallel reality, defined by the digital ownership of goods, where cryptocurrency stands as the monetary system of record. If that horizon comes to pass, suddenly crypto holdings will be rendered far more usable—in a traditional commercial sense—than they are right now. Russell was initially a metaverse skeptic, but lately, he’s found himself buying in.

“There’s a lot of unhappy people in the world. They feel stagnant. They don’t have the job they want, whatever it might be. There’s a lot of wants out there. Imagine being in a world where you get all of that, and you’re essentially playing The Sims with your life,” he says. “When I think about the growth rate of gaming in general—I read something the other day that there are more young boys who play games than those who play football and basketball combined—and if everyone is in [the gaming world,] capitalism will certainly play a part.”

“It goes back to your specific goals. If someone wants to reach their retirement goals, their education goals, or the goals they have for their children, and if they feel like they can reach those goals by investing in the S&P 500, then go for it. But if you want to get more returns, if your goals are more lavish,  you have to take on more risks,” he says. “That’s the way I would think about it. If it meets their goals, traditional investing is the way to go. But if they want to reach [different] predefined future goals, then I think it’s fine to take on a little more volatility, a little more risk.”