The Contractor’s Guide to Bitcoin

It’s been virtually impossible not to have noticed the cryptocurrency craze that’s taken the world by storm in recent years.

Spearheading this phenomenon is bitcoin, the first cryptocurrency to have been created. But whether it’s bitcoin, euretherum, litecoin or even dogecoin, it seems that one minute their value is rocketing, only for it to plummet moments later.

Whichever way you look at it and whatever your view, there’s no denying that cryptocurrency is big news - it’s even been described by some commentators as the future of money. That doesn’t make it any easier to grasp though. And if you find yourself puzzled by bitcoin, don’t worry, you aren’t alone.

To help you make sense of it all, we’ve written a jargon-free breakdown of the basics to help freelancers and contractors get a firm understanding of bitcoin and its tax implications.

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What is cryptocurrency?

Starting from the very top, cryptocurrency is digital currency - think virtual money that is stored on something called a ledger (an online wallet) and can be used to trade across borders without exchange rates and anonymously.

One of the key things about crypto is that it’s ‘decentralised’, which means it’s not attached to, managed or controlled by governments and banks, in the way that the pound is.

Where is cryptocurrency stored?

It lives on something called blockchain technology, which has been referred to as the ‘glue that holds the network together’. Blockchain is a vast public ledger account that records every transaction ever made.

What is bitcoin?

Bitcoin was founded as the first cryptocurrency, as far back as 2009. It’s the best-known and, as things stand, by far the most valuable cryptocurrency out of the 4,000+ available today.

How is bitcoin earned?

This is where things get a little more complicated. You might have heard the term ‘mining’, which is how bitcoins and many other cryptocurrencies are created.

People compete to ‘mine’ bitcoins, using incredibly smart computers to solve complicated maths problems and puzzles. Do it successfully and you’re rewarded with payment, in the form of bitcoin.

But don’t take on this challenge lightly. With bitcoin’s value rising overall in recent times, it’s become more difficult to mine for coins. So it could be years before you mine a single coin, meaning you spend more on electricity for your computer than the amount your bitcoin is worth.

How does bitcoin increase and decrease in value?

This is where the difference between cryptocurrency and traditional currency becomes apparent. Unlike the pound, dollar, euro and so on, with bitcoin there’s no government or authority in charge, able to influence the value of the currency - whether due to inflation rates, monetary policy or economic growth.

Instead, bitcoin’s value is based on a number of factors, including:

  • Market confidence (Elon Musk buying $1.5bn investment saw bitcoin’s price rise)
  • The supply and demand for bitcoin (the more people want it the more expensive it becomes)
  • The cost of mining bitcoins
  • The rewards given to those who mine it
  • The exchanges it trades on (how much of a cut the likes of coinbase take)
  • The number of other competing cryptocurrencies (ethereum, dogecoin etc)
  • Its internal governance
  • Regulation (China banned bitcoin, which impacted its price)

Is bitcoin a smart investment?

Every investment carries a risk, but with bitcoin and cryptocurrency as a whole, the sheer volatility of its price means investors should be particularly cautious. As with all investments, you should only invest money you can afford to lose.

Of course, bitcoin has made plenty of people very wealthy. For example, if you had invested $1,000 in 2008, your investment would have been worth over $287million in 2020.

But on the other hand, the past year has seen some major fluctuations in its price, which has led to huge losses. On 13th April 2021, bitcoin’s value hit a record high of $63,375, only for it to crash to below $30,000 just a few months later on 22nd June.

How safe is bitcoin?

Because every transaction is recorded publicly on blockchain it’s tricky for fraudsters to copy bitcoins or make fake ones to sell to unsuspecting investors.

And increasingly, thanks to the advanced technology it sits on and through greater regulation, bitcoin is becoming more widely accepted as a legitimate currency - and one that can be used to buy many goods with.

While on the subject of security, you might have heard of horror stories of people losing their online wallets (containing bitcoins) or the passwords to access them. This means their investment is locked away. So it goes without saying that you should take great care in storing all your information. Lots of people choose to do this offline, via physical memory sticks called ledgers.

Where can you buy bitcoin?

Buying bitcoin is fairly straightforward and can be done on a crypto exchange site, such as coinbase or binance. These websites are like marketplaces for cryptocurrencies and take a small fee for transactions.

Can you invest in bitcoin through your limited company?

Absolutely. Buying bitcoin is no different to making any other investment via your company. With this in mind, any profit you make on investments should you sell your bitcoin will be subject to Corporation Tax.

Does buying and selling bitcoin impact tax liability?

Your tax liability is likely to be impacted if and when you sell your bitcoin investment, given it will increase your company or personal income assuming it has risen in value. If you put money into cryptocurrency from your personal account - rather than business - you will be taxed if you earn a profit, but in this scenario, Capital Gains Tax (CGT) comes into the equation.

Also worth noting is that you cannot reduce your tax liability by investing in cryptocurrency, due to the absence of tax relief on this investment.

To learn about the tax implications of investing in bitcoin and cryptocurrency through your limited company, please don’t hesitate to contact one of our accountants. Alternatively, for professional investment advice contact our partner, Contractor Wealth, who will be delighted to help.

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