Taxation and tokenization are important concepts in the cryptocurrency world that every crypto investor and enthusiast should understand to get a better grasp of the crypto world. If you have no idea what these concepts mean and how they can impact you personally and the cryptocurrency industry at large, read along.
First, let’s find out what crypto tokenization means.
Crypto tokenization refers to the process of converting a valuable object into a digital token usable on the blockchain application. Tokenization is a means through which crypto investors are offered a stake of ownership or voting rights within a blockchain.
The process of tokenization typically involves taking an asset such as real estate, art, or even a stock, and creating a digital representation of it on a blockchain. The digital token is then issued and can be purchased or sold by investors, who own a portion of the underlying asset.
You may wonder why cryptos are tokenized. Here are some benefits of crypto tokenization you may be unaware of:
Thanks to crypto tokens, investors can conduct direct transactions by bypassing middlemen and intermediaries who make such transactions not only strenuous but expensive as well.
Their elimination reduces each exchange’s processing time and transaction costs, making value transfer smooth, cost-effective, and more streamlined. This can make investing more accessible and affordable for smaller investors.
Tokenized assets are available to a larger target audience. By reaching out to a larger group of people, market liquidity automatically improves while some limitations on some assets such as real estate or fine art like liquidity premium are completely removed.
Tokenizing assets can increase their liquidity by enabling them to be traded on a global market 24/7.
Crypto tokens are blockchain-based, allowing users to effortlessly access and trace their transaction histories. Transactions can also be recorded on the blockchain automatically, contributing to the token’s overall transparency.
Crypto tokenization makes a digital asset reach a wider audience and thus, easily accessible to prospective investors. More so, its outstanding features are a big plus for the cryptocurrency industry as they offer opportunities for smoother, faster, and cheaper transactions.
This transparency can provide investors with greater visibility into the underlying assets and the investment process, which can help build trust and confidence in the market.
Improved asset-liability management is another important benefit of crypto tokenization. By tokenizing crypto assets, improved transparency and accelerated transactions are guaranteed. These benefits collectively help to manage risks associated with holding cryptos better.
Crypto tokenization holds tons of benefits for the crypto community, especially users and holders. they can effortlessly and swiftly perform transactions without going through a third party, a unique experience for users who conduct international transactions.
By digitizing assets and creating tokens that represent them, financial institutions can potentially reduce the costs associated with managing and storing physical assets. This can lead to cost savings that can be passed on to investors and customers.
The Internal Revenue Service (IRS) considers cryptocurrencies as a store of value or a medium of exchange that makes them pass as convertible virtual currencies. This implies that any income or profits from cryptos are taxable.
However, cryptocurrencies attract different types of taxes. In some cases, you may not be taxed on incomes or profits you make from your digital assets. As a crypto holder or investor, you should understand how cryptocurrencies are taxed and the available exceptions.
It should be noted that cryptocurrencies themselves are not taxable. No holder will be taxed for holding any digital asset of their choice. However, crypto holders may be taxed for capital gains under the following conditions:
Most crypto investors or holders at one time or another sell their digital assets to raise money. You will be taxed for selling your cryptos to another user. You’ll be liable to capital gains tax whenever you sell your crypto for another on any crypto exchange.
Crypto sales refer to the act of selling cryptocurrencies for fiat currency or other cryptocurrencies. When a person sells their cryptocurrencies, they may realize a profit or loss depending on the price at which they bought the cryptocurrency and the price at which they sold it.
Cryptocurrencies are gradually becoming accepted means of payment across the globe. Several corporations and organizations accept payments for goods and services in fiat currencies. You’ll be taxed when buying goods in Starburst, or paying for services with crypto in Microsoft. When booking your flight in CheapAir with your favourite crypto, you’ll be taxed also.
So, when performing such transactions, chances are you will pay taxes on them.
Crypto swapping also attracts taxes, although many crypto holders and users aren’t aware of this. When you exchange your crypto asset for another, you will be charged a fee for the exchange, although you don’t literally exchange cash.
Whenever you trade your Bitcoin for Ethereum or Monera for Bitcoin Cash, the transaction is considered taxable and you’ll be taxed.
In a crypto swap, users can exchange their cryptocurrencies with each other using smart contracts that are executed on the blockchain. Crypto swaps are typically executed on decentralized exchanges (DEXs) that operate on a blockchain network, such as Ethereum.
Sometimes you may receive free coins as rewards or bonuses through hard forks and airdrops. The value of the received free coins you received for marketing purposes in airdrops or during hard forks will be considered income and will attract appropriate fees.
Capital gains tax refers to the fee charged on the profit when an investor sells his/her investment for the year on which the profit is made.
According to Investopedia, “An investor will owe long-term capital gains tax on the profits of any investment owned for at least one year. If the investor owns the investment for one year or less, short-term capital gains tax applies. The short-term rate is determined by the taxpayer's ordinary income bracket.”
Hence, if you make a $200 profit on a crypto asset you hold for a year, you must record the $200 as a capital gain for the year in question. The profit will be taxed under capital gain taxes. The tax is calculated based on the difference between the purchase price (also known as the cost basis) and the sale price of the asset and is only payable when the asset is sold.
Note, however, that not all crypto-related events are taxable because there are exceptional cases. Some non-taxable crypto events are:
It should be noted that capital gains tax differs from one country to another. This implies that crypto holders and users should understand the applicable tax rules in their specific regions.
It is important to keep accurate records of all cryptocurrency transactions, including the purchase price, the sale price, and any associated fees, as this information will be used to calculate the capital gain or loss on the sale.
Koinly gives a comprehensive crypto taxation analysis that may help users across the globe to understand crypto taxation rules and regulations that are peculiar to their regions, how to avoid tax traps, and other helpful tips.
Crypto tokenization is a welcome development that has broken some of the major barriers undermining traditional transaction systems. It has also made online crypto-based transactions fast, smooth, and less expensive.
Similarly, understanding crypto taxation will help you to avoid pitfalls that may cost you a fortune as a crypto holder or user.