17 Aug 2022

Cryptic crypto and unnavigable NFTs – some considerations before diving in

Cryptocurrencies and NFTS have increased in popularity in recent years, with many of those with expendable income considering dipping their toe in these types of investments.

But with complexities surrounding taxing cryptos and NFTs – and increasing numbers of Monahans’ clients seeking advice in this area – we’ve outlined some of the important considerations.

What are cryptocurrencies and how are they taxed?
Crypto is defined as ‘any form of currency that exists digitally or virtually and uses cryptography to secure transactions.’ Despite its rising popularity, there are limitations to its capabilities.

Planning around cryptocurrencies can prove difficult because they can fluctuate so rapidly and timing is everything. This can make advising clients around the topic challenging. We can, however, help you to understand the potential implications of investing in cryptos and NFTs and what elements should form part of your considerations, such as tax and security.

HMRC taxes crypto assets based on how it was acquired and the number of transactions that have been made, so it can be subject to either capital gains tax or income tax. In the majority of cases, an individual will be holding the cryptocurrency as a personal investment and capital gains tax will be payable when the crypto asset is sold.

As there are many different types of cryptocurrency, one crypto currency can be used to buy another. Along with the matching rules that are used to identify a disposal, this can make the process of calculating the gain quite complicated.

As mentioned above there are various way, apart from buying crypto that you can receive your currency.

  • ‘Mining’ crypto involves using computers to solve difficult mathematical problems in order to generate new tokens (the denomination of the crypto).
  • Staking – locking up crypto assets to earn passive income through interest
  • Fork – a change in protocol in the blockchain, the software that powers the crypto
  • Airdrop – a free distribution of crypto to promote a new currency.

An NFT is a Non-Fungible Token and is slightly different. Whilst crypto can be exchanged as a digital currency, an NFT is much like a painting, in that it is bought and sits as its own entity. NFTs are more likely to be taxed as a capital gain, unless you have created an NFT which you go onto sell and could potentially be taxed as a trade.

The implication of these emerging technologies is that this area of tax is developing very quickly. For cryptocurrencies, guidelines are constantly updated as the technology evolves.

Be aware of your security
As with all investments there will always be an element of risk at play, but there are some aspects within your control. Security for instance, is crucial. It is possible to lose your digital wallet – for example if you lose your smartphone and have your wallet stored in one app – but protecting against this by backing it up in a secure manner will save you from the potential loss of your precious funds. For example, a ‘seed phase’ is a complex password based around a series of random words that is virtually impossible for a cybercriminal to crack.

Record, record and record again
If you are considering investing in a cryptocurrency or an NFT the most vital habit is to ensure that you are keeping a record of everything that you are doing. There are various platforms which can help you to do this. Records of crypto assets can include:

  • Paper (cold) wallets, containing the individual’s public and private keys;
  • Hardware (cold) wallets which resemble a USB, containing the individual’s public and private keys;
  • Electronic (hot) wallets on devices;
  • Other records of transactions and balances such as downloads of their wallet activity from a crypto assets exchange; and
  • Details about the crypto asset, such as: the type of crypto asset, date of the transaction, if it was bought or sold, number of units involved, value of the transaction in pound sterling (as at the date of the transaction) and the cumulative total of the investment units held.

Of course, if you are considering exploring the world of digital assets, the fluctuations of cryptocurrency and NFTs mean that there is always a risk of losing the money that you invest and you should never invest beyond your means. If you are eager to get involved, seek advice, ensure to maintain detailed records of your investments, and keep all of your digital assets and passwords safe and secure.

If you would like support, please get in touch with me or one of my colleagues today, and we’d be more than happy to help.

Kathryn Bridgeman