Chapter 01
How Can Virtual Currency Be Used?
Cryptocurrency can be used to purchase goods both tangible and digital, once transferred into an encrypted, digital wallet.
Before it can be spent, cryptocurrency must be transferred into a digital wallet – usually encrypted. A virtual currency user may have multiple wallets and is not required to conduct transactions using their lawful name.
Although virtual currency is limited by its virtual nature, cryptocurrency still has several uses. Most commonly, it can be used to purchase goods, both tangible and digital.
Acceptable expenditures include:
- Selling your cryptocurrency back to an exchange, such as Coinbase. This is particularly profitable if your cryptocurrency is presently worth more than you paid for it.
- Loading money onto a prepaid card, which can later be used at any facility that accepts debit/credit cards.
- Purchasing gift cards.
- Paying bills. Presently, there are 13 companies that will accept cryptocurrency as a form of payment for goods, services, or debt repayment. These companies include MasterCard, Starbucks, AT&T, Etsy, and PayPal.
- Barter/trade between two cryptocurrency users. Cryptocurrency can be sent from one user to another for a relatively small fee, paling in comparison to the transaction and transfer fees traditional institutions charge.
- Purchasing tangible goods, such as computers, cars, and gaming systems.
The Decentralized Finance Sector
The Decentralized Finance Sector (DeFi) was created as an alternative to traditional financial services and its goal is to challenge and eventually replace traditional financial services providers.
- DeFi consists of smart contracts, which power decentralized applications (DApps).
- DApps allow participants access to saving, investing, and trading.
DeFi has recently seen the emergence of peer-to-peer loans using cryptocurrency as collateral.
Decentralized finance’s ultimate goal is to challenge, and eventually replace, traditional financial services providers.
Cryptocurrency may not be used to secure loans through banking institutions because transactions are immutable, meaning that cryptocurrency used as collateral may not be used in another transaction. Cryptocurrency, however, can be used as collateral in a private transaction between two users.
One of the larger “appeals” of cryptocurrency is that its user base extends to people who don’t otherwise have access to the traditional financial system due to age, nationality, identification documents, or other hardships.
No Bank Account? No Problem.
Users aren’t required to provide social security numbers, citizenship documents, or background checks. Nor are they required to possess bank accounts.
Virtual currency is available to all who possess an internet connection. With just a smartphone, users can become their own bank.
This is a particularly “marketed” benefit, as there are currently millions of people around the world who are “unbanked” and have no access to financial institutions.
Take DeFi loans for example: cryptocurrency holders no longer need to submit to traditional banking requirements. There is no need for credit checks, intrusive questions, and identifying information. Two parties may come together and exchange cryptocurrency for fiat currency.
Furthermore, cryptocurrency users are not bound by the restrictive nature of banking institutions. Not only do banks have the ability to garnish income, but they often facilitate asset seizure initiated by governmental actors.
There is often little to no recourse for account holders once the money has left their bank accounts. Account holders are often forced to censor their views and conduct, for fear of government entities freezing their assets.
With cryptocurrency, the owner must consent to the disposition of their assets. Virtual currency also facilitates 24-hour, round-the-clock trade, all day, every day.
Additionally, fiat currencies are subject to economic ebbs and flows. As displayed by multiple recessions, banks are extremely vulnerable and rely on the economic market to determine their value.
Account holders are never truly in control of their money. The value depends on how others value it.
Cryptocurrency provides an alternative to this paradigm: its value is determined by its users. Non-users influence its value to a small degree, as cryptocurrency relies on non-users becoming users to facilitate trade and increase value.
Unlike fiat currency stored through financial institutions, cryptocurrency transactions cannot be disputed or “charged back.” This adds a level of security that banks are presently unable to provide.
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What are Non-Fungible Tokens and Why do They Exist?
Although you’ve heard “cryptocurrency” being thrown around a lot, you may not have heard of non-fungible tokens. Non-Fungible Tokens, commonly known as NFTs, are units of data that take the form of “digital objects.”
With NFTs, the possibilities are endless. They can take the form of art, video games, music, and more. NFTs are essentially digital consumables. Examples include:
- Digital artwork
- Domain names
- Digital clothing
- Digital avatars
- Music
Although they exist in the virtual space, NFTs do not have the properties of currency and are not considered a form of virtual currency.
Creating NFTs requires the creator to have access to the Ethereum blockchain, an open-source platform. Open-source platforms are available for viewing to all.
Once on the Ethereum blockchain, users must create a digital wallet, load it with cryptocurrency, and pay the appropriate blockchain fee.
In exchange for this fee, Ethereum allows creators to license their product. This process is known as “minting an NFT.”
Once an NFT is minted, creators are permitted to display, sell, or trade their product on any platform.
Simply minting an NFT does not create an exclusivity agreement through Ethereum.
There are no restrictions on how NFTs can be created, meaning they do not need to originate in the digital universe. A painter can upload a scan of a 3-D painting and mint it as an NFT. Similarly, an artist can record a song in a recording studio, but then mint it as an NFT.
NFTs are a highly lucrative industry, whose market has seen unprecedented growth over the last twelve months. In fact, many of the most popular NFT platforms weren’t even invented until mid-2020.
Although the surge in activity will eventually subside, the overall growth of the NFT market will still likely be unprecedented in years to come.
Why Do NFTs Exist?
NFTs possess one key feature that sets them apart from other commodities in the digital world: they are non-fungible, meaning that they are unable to be replicated or re-produced, except by their creator.
As mentioned earlier, NFTs and cryptocurrencies are NOT the same. Each NFT has its own unique set of identifiers and therefore cannot be interchanged with another asset.
Conversely, Bitcoin is a fungible asset. One Bitcoin can be traded for another, and neither will lose value because of the transaction.
Because all NFTs are verified via the blockchain, they possess a digital signature of sorts. This signature allows potential consumers to verify the authenticity of the product.
This is a stark contrast to 3-D works of art, which can be easily replicated and require well-trained experts to authenticate. With NFTs, any potential buyer can validate their proposed purchase with the simple click of a button.
In fact, NFTs contain the following safeguards that allow them to remain “non-fungible”: Embedded transactional information.
NFTs store the “history” of everything the NFT has interacted with. This includes its creator, subsequent purchasers, and viewers.
Confused? Think of it this way: most library books contained check-out slips detailing who had checked out the book from the library. This feature is a digital version of that check-out slip, a token identification number.
This unique identifier number is assigned to all NFT creations to differentiate them from one another; and a smart contract, which is an implied contract that is essentially tagged to the usage of the NFT.
As a condition of utilizing or purchasing the NFT, you must agree to its respective smart contract, which usually contains copyright prohibitions and anti-infringement laws.
Although NFTs can technically be replicated (such as screenshots), the duplicate copies will not contain the blockchain identifier, thus rendering the copies worthless.
Like cryptocurrency, NFTs create digital scarcity, which is contrasted to most digital creations, which are almost always infinite in supply. NFTs also exist on a blockchain.
NFTs aren’t for everyone. Their value is derived solely from what someone is willing to pay for it. They are essentially digital “collector’s items”, where the owner has “bragging rights.”
NFTs may only be held by one owner at a time, meaning owners can buy and sell NFTs at their discretion. NFTs’ unique data makes it easy to verify their ownership and transfer tokens between owners.
Blockchain technology and NFTs afford artists and content creators a greater benefit than perhaps their consumers. NFTs provide creators with a unique opportunity to monetize their wares.
Musicians no longer need record labels or studios to sell their albums. Instead, they can be directly sold to consumers, allowing artists to keep a larger portion of the profits.
In addition, creators can program in royalties, so they’ll receive a percentage of sales whenever their NFT is sold to a new owner. This is an attractive feature that most “middlemen” such as record companies and galleries do not offer.
In contrast, physical goods of a similar nature are often too easy to replicate – thus the staggering demand for cheap, counterfeit goods and the all-too-common presence of flea markets and similar enterprises.
By transitioning from producing physical goods to NFTs, creators can ensure the quality and authenticity of their product and control its supply – thus increasing demand and revenue.
Consumers of NFTs can authenticate their purchase and possess a means of product validation, should they choose to sell their NFT.
As a bonus, NFTs are also far more environmentally friendly and are generally cheaper to produce than their physical counterparts, as they do not require physical equipment.
How are NFTs Purchased?
NFTs are generally purchased on the digital marketplace, from websites such as Nifty Gateway, OpenSea, and VIV3. To purchase NFTs, consumers must generally have a digital wallet and in many instances, virtual currency. The method of payment is generally at the discretion of the creator or seller.
Thank you in advance for reading “The Ultimate Guide to Bitcoin, NFTs and Virtual Currency Taxation.” It was a labor of love and our law firm welcomes all questions, comments, concerns, and feedback that you may have about this free resource.
