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Bitcoin: Its place in your wallet or SMSF portfolio - 4th April 2018
While bitcoin may be the most well-known cryptocurrency, there are nearly 1,500 in existence. In its simplest form, a cryptocurrency is a "peer-to-peer electronic cash system", which means that the currency is not in a physical form like cash but sits in an electronic register.
What makes bitcoin work, where previous
attempts at electronic cash did not, is in
the magic of something called blockchain. One of the problems with earlier
electronic cash was that it was possible for those with the skills to fool the
system and allow multiple transactions of the same piece of currency.
Bitcoin and other forms of blockchain get
around this. Rather than having a
central ledger of all transactions, blockchain relies on a decentralised network of ledgers, all of which
have a complete record of every transaction of every bitcoin. Every one of
these ledgers must be the same before the system recognises a transfer of a
bitcoin or part thereof. There is
extensive cryptography to secure the transactions.
As
a digital currency, bitcoins are sent and received via digital addresses. The
system uses public key cryptography to make and verify digital signatures used
in bitcoin transactions. Users are assigned a private access key enabling
access to bitcoins stored in a digital wallet. Users are able to transfer money without
utilising centralised banks and third-party payment channels.
To further enhance the system, there is a
permanent limit on the number of bitcoins that will ever be created.
This ensures that the value of the
bitcoin isn't destroyed by the electronic
equivalent of just printing money. The
consequence of this however is that bitcoins are scarce. As we know, if a
commodity is scarce but in demand, the
value of that commodity will increase, as we have seen with bitcoin and other cryptocurrencies.
The problem this creates though is that the
commodity can be used for speculative purposes, which isn’t bad when you buy
low and sell high but can be very damaging in a boom-and-bust scenario of
investment bubbles.
The other thing about bitcoin and the like is
that ownership can be relatively anonymous, with the ability to hide
transactions from governments and regulators. For this reason it is favoured by crime syndicates, money
launderers and terrorist networks (and the odd white collar criminal too). It
is this element that has bought cryptocurrencies to the attention of regulators
and why they may in the future be subject to regulation.
Tax and bitcoins
Cryptocurrency in Australia had until recently
been subject to what was labelled "double taxation". Legislation effective from
July 1, 2017 aligned the goods and services tax (GST) treatment of digital
currency with money. Before this, anyone using cryptocurrency as payment
effectively paid GST twice — once when buying the bitcoin and again on its use
in exchange for goods and services subject to GST.
The ATO deems bitcoin to be neither money nor
foreign currency, but also holds that it can be regarded as an asset for
capital gains tax (CGT) purposes.
A far as conducting transactions with bitcoin,
the ATO states that it views such transactions as akin to barter arrangements.
In conducting a business transaction therefore, the same process would be
followed as when, for example, receiving a non-cash consideration under a
barter transaction, with the consideration recorded at fair market value. This
can be obtained from a reputable bitcoin exchange.
For individuals, when buying items online for
personal use or consumption, there is generally no income tax or GST
implications. Any capital gain or loss realised by disposing of bitcoin is
generally disregarded - as a personal use asset, provided the value of the
bitcoin is less than $10,000.
ATO advice is that certain records should be kept for any bitcoin transactions:
- the date of the transactions
- the amount in Australian dollars (which can be taken from a reputable online exchange)
- what the transaction was for
- who the other party was (even if it's just their bitcoin address).
SMSF investment
The dramatic rise in value (and then fall) of
bitcoin and other cryptocurrencies has
sparked interest among SMSF trustees on its potential as an investment, particularly
in a marketplace of low-interest rates,
erratic sharemarkets and an easing in property.
But its relatively short history makes it hard
to predict, and there is uncertainty what
(if any) future regulation will be placed
on it. There are also uncertainties on how to manage cryptocurrencies within
the tightly regulated SMSF space.
The ATO has made it clear that, at the moment,
it cannot stop an SMSF investing in a cryptocurrency like bitcoin. There is no specific
prohibition in the relevant legislation, and
it is permissible as long as it meets the other rules for investment.
But this does not mean there are
no pitfalls for SMSF trustees.
The first thing a trustee or administrator must
do is to check the trust deed. As it is a relatively new investment vehicle
few, if any, trust deeds will deal with it directly, and may need amending.
It will also be necessary to review the investment strategy. Bitcoin is volatile, and in its short history there have been many booms and just as
many busts. Therefore bitcoin only suits
those investment strategies that are prepared to take risks. As it pays no
income and is subject to wide variation, it is
also unlikely to be suitable for fund
members in or near retirement phase.
Another thing to realise with cryptocurrencies
is that they have no physical assets backing them up - if they fail, you lose everything. They are only as valuable as someone is
willing to pay for them, which also makes them particularly hard to value.
Given the electronic nature of cryptocurrencies, there is a need to ensure
that there is a clear separation between
the fund's assets and those of trustees.
Thus, if you have both personal and SMSF investments in bitcoin, they need to be clearly
separated. The ATO has highlighted this as an issue of concern, and something
they will look out for when reviewing SMSFs with cryptocurrency investments.
One advantage though of cryptocurrencies is
that all transactions are recorded. Therefore
they can be checked by auditors (and regulators), however it is advisable to
also keep a written note of all transactions including buying and selling
prices and dates.
A new issue of concern for SMSFs that invest in
bitcoin is that given the wide fluctuations in value, a fund may unwittingly
breach the transfer balance cap of $1.6 million and have to wear the headaches
and restrictions that breaching the cap brings, in particular if other
contributions have been made to the fund.
Both the ATO and ASIC have issued a warning to SMSFs investing in cryptocurrencies.
They are a highly speculative investment and not recommended for those who are
not willing to make riskier investments.
There is little long-term history
of their performance, so it is difficult
to understand how they will perform over time.
Having said that, there is nothing currently preventing an SMSF
from investing in cryptocurrencies like bitcoin. Just make sure you do your homework and are
prepared for the risk they present. Also, be aware that while at the moment
they are lightly regulated (if at all) this is unlikely to be the case long
term.
Key bitcoin concepts
- Blockchain - facilitates secure online transactions (bitcoin transaction). It consists of two types of records; transactions and blocks.
- Blocks - hold batches of valid transactions using cryptography.
- Transactions - denotes the volume of bitcoins purchased which must carry the digital signature of every input (transaction) owner.
- Mining - is a record-keeping service performed through a computer system.
- Wallets - stores the digital credentials of bitcoin holdings.
- Transaction fees - fees are based on storage size of transactions generated.
- Supply - 12.5 bitcoins per block until 2020, and the afterwards 6.25 bitcoins per block for 4 yeras until next halving. This halving continues until 2110-40, when 21 million bitcoins will have been issued.
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