Rule Breaker Mailbag: Some Thoughts on When National Currencies Become Cryptocurrencies

Two common themes of articles, commentary, and discussion at The Motley Fool are the War on Cash and the rise of cryptocurrencies. The transition to using more plastic and digital payment platforms is something we can all see, and given its ubiquity, it doesn't seem to confuse most folks. Bitcoin and its ilk, though, require advice from the experts to get a grip on. And when you combine those two ideas -- the War on Cash and the rise of cryptocurrencies -- well, then the questions get even more interesting.

So in this segment from the Rule Breaker Investing podcast, Motley Fool co-founder David Gardner brings back his favorite in-house cryptocurrency maven, Aaron Bush, to give his take on some possible futures for blockchain-related finance, and to explain how investing in cryptocurrencies impacts your taxes.

A full transcript follows the video.

This video was recorded on Jan. 31, 2018.

David Gardner: Mailbag Item No. 9: It's time to talk cryptocurrency, so we have to bring Aaron Bush, our Motley Fool cryptocurrency... I don't know if "expert"... I mean, is anybody really an expert emerging? Authority. How about that, Aaron? I need to bring you in to answer this. Maybe one other this time around.

Aaron Bush: Well, thanks for having me, again! I'll take any title I can get.

Gardner: Excellent. Good. Great attitude. Very Foolish of you. Aaron, you read this note. I shared it with you ahead of time because I wanted your perspective. Let me read it. This one goes like this. "My name's Greg Allen. I'm a sophomore at the University of Colorado, Boulder studying finance, math, and minoring in economics and, potentially, computer science, if I can find the time. I'm fairly confident I've had discussions about bitcoin, blockchain in at least one of my classes every week I've been at CU since my first week of classes one year ago.

In finance, there is the People's Bank of China working on transitioning the yuan to a cryptocurrency. In math, there's the puzzle of hash function." By the way, I'm not going to claim to understand all the things that Greg is talking about in this, but maybe Aaron does. "In econ, there's a Peruvian economist using blockchain to establish property rights in developing countries, and in comp psych, everyone is trying to figure out how to hack bitcoin or make their own cryptocurrency. The blockchain and the innovations surrounding it have been causing so much disruption in each one of my chosen fields of study," Greg writes, "that it's become hard not to think of long-term applications.

Now, in recent episodes of the Motley Fool Money podcast, the war on cash has been mentioned. With governments and companies around the world making the move toward eliminating cash, I don't think it's too bold to say that most of the cash around the globe will be gone within 25 years." And I think I'd agree with you.

"While the older generations have quickly dismissed the cryptocurrencies of today, younger people are tired of cash and are increasingly demanding digital money over cash." Even some not-so-young people like maybe me, for example. "A month ago, a friend of mine was upset he was paid back some money in cash because, he said, he didn't know what to spend it on. Now I know that sounds wrong," Greg says, "but it's true.

What I don't think has been properly addressed by the whole war on cash movement is where exactly the money's going. It's not hard to imagine that instead of cash made of paper the world will operate on cash made of long streams of data, which could be equally hard to forge.

Now, this digital cash could be treated as valid U.S. currency and traded as legal tender; however, there needs to be some way to ensure that this set of data representing that amount of money actually belongs to this person and is the actual amount the buyer says it is. To keep track of this, it's feasible each government would come up with a blockchain ledger for its individual currency, as this has proven so far to be unforgeable, but a heated debate in my econ class last semester left the room split on whether or not every currency being transitioned to a blockchain cryptocurrency would essentially be the same as having a global currency where exchange rates don't exist."

By the way, this is a very thoughtful note, Aaron. I know you're not possibly going to be able to speak to all of this, because this is Greg's reflections on a year of classes in fields that are very relevant, and it's all being talked about and there's a lot of disruption. Anyway, I'm going to keep going with Greg's note.

Bush: Great.

Gardner: We're near the end, but this is really fun stuff. "What this has led me to think about is how today's cryptocurrencies play into the war on cash. There are several serious flaws in today's cryptocurrencies that would make it pretty hard for governments to follow their models; however, it seems that there will always be a market for a currency such as bitcoin that's linked to an online wallet instead of an individual's identity for legal and illegal purposes," Greg writes. "If my assumptions are right, could bitcoin and other cryptocurrencies have a long-term value that hasn't truly been recognized?"

Maybe we should start there, Aaron, but the last couple of things he says are, "Could the war on cash lead to an actual use for these cryptocurrencies, and have cryptocurrencies just come too early for markets rationally to make sense of it?" Greg closes he's the director of finance for his student government at the University of Colorado, Boulder. "By the way, thank you folks for the great podcasts you guys put out. They've been great guides for my investing strategies for the past three years." Love to hear young people getting it going. "And wouldn't have been able to find my biggest returns without them."

Well, thank you, Greg Allen! And now Aaron Bush, let's talk.

Bush: All right.

Gardner: Aaron, I figure you brought some ideas, here, and I don't want to deflect that, but is it a fair thing to initially ask the question that Greg asked of you toward the end? Should we start there? If his assumptions are right, could bitcoin and other cryptocurrencies have a long-term value that hasn't truly been recognized?

Bush: I think that's a good question. I'm going to say yes. That might sound surprising given the bubbly behavior that is out there. People jumping in...

Gardner: And people making 5X their money in two weeks. These kinds of things. It's happened a lot over the last year.

Bush: ... without really understanding what they're doing. I still think that there is long-term value that has not been recognized. I will caveat that by saying I think 95%+ of what's out there will fall 95%+. I think that's important to understand. That said, there still is that 5% or the top few assets that are attacking really big, important markets and are doing so in smart ways, just waiting for the proper infrastructure to be in place. I absolutely do think that smart investors looking at the right places over time will find unrecognized value.

Gardner: I think we can both grant Greg that possibility. Aaron, what else was prompted in your mind by his note?

Bush: Still answering that core question, I'll say I think there is unrecognized value from future applications for two main reasons. One is that cryptocurrency is largely a misnomer, and many people don't recognize that. While certain crypto assets do enable digital currencies, there are other use cases.

Blockchain fundamentally transformed digital networks into markets, and these networks can represent computing resources. They can represent online communities. Prediction markets. Many other things that haven't even been thought of yet, probably. Currency is one application, but really the tokens that the crypto assets are chopped into just capture the scarce value of whatever that underlying service is, so I think we'll see more than people are expecting.

Second, while blockchains may be used for government-backed currencies one day, to me that's kind of ironic, because bitcoin's breakthrough was allowing digital currencies to be owned by "the people" for the first time, absent any government or central authority. The fact that it lives on the internet and transcends any man-made, national boundary and can't be shut down; I think that's a pretty big deal and the implications for what that means are yet to be seen.

Gardner: Aaron, do you have bitcoin yourself?

Bush: Yes, I do own some bitcoin.

Gardner: And how many cryptocurrencies do you have, assuming you have more than one?

Bush: Right now, I only have three, but I expect that to ramp up pretty significantly.

Gardner: And why is that?

Bush: Part of that for me is that it's been a learning process, and so I started with the biggest, most popular ones really just to learn.

Gardner: Such a great way to think and act. Test and learn. Dip your toe in.

Bush: Right. And through owning Bitcoin and Ethereum, the two largest crypto assets, I've learned a lot about how the space works, and have really come to understand that what you see in the mainstream media is pretty misleading in that there are lots of other really interesting projects that are out there.

I have taken it kind of slow to get into other ideas, because there really is so much hype out there, I don't want to just jump in without fully knowing what I'm doing with my money, but I have started a slow process of ramping up my investments into other things.

And just as the infrastructure in this asset class builds, more will be made possible, and I expect more worthwhile investments to come online in the next several months and years.

Gardner: So, Greg Allen, there are some thoughts for you. Aaron, I can't let you go without asking you just one more quick question, because people do keep writing in about this. Nishant Guman, or maybe Gumani, wrote me and said, "Hi, David. Started following blockchain and cryptocurrencies. Recently listened to the Rule Breaker Investing podcast in these topics. I enjoy listening to them. Helped a great deal in developing my understanding on digital currencies.

"My question," he said, "is if I sell my bitcoins or Ethereum, etc., then what are the tax implications? How do we get around it while filing taxes? Owing to the fact that cryptocurrencies are highly volatile at this point, I think that knowing the details thoroughly regarding buying and selling them is very important before investing."

"I'll say on a side note that I have a friend who's invested in one of the lesser-known currencies, which has done very well for this person. It turns out, however, he can't just sell it. There's not just a ready market. You can't just liquidate it right on Coinbase. He would have to convert it into other cryptocurrencies, I think he was telling me recently."

Do you have anything for us about buying or selling, or tax implications?

Bush: Keep in mind I'm not a tax expert, so take this with a grain of salt.

Gardner: There are none associated with this podcast.

Bush: But the last time the IRS laid out any crypto guidelines was in 2014, and quite a bit has changed since then. I suspect that this year, 2018, will probably be a landmark year for taxation policies, and we will learn more what to expect. This is how I'm treating it and how I expect things to be treated going forward.

Gardner: Yes.

Bush: Pretty much every event, whether it's mining, selling, airdrops, or even just exchanging one token for another token; all of that will be a taxable event.

Gardner: If you're generating a gain...

Bush: If you're generating a gain or income.

Gardner: Or I guess even a loss.

Bush: Or if it is coming in as income vs. capital gains, too.

Gardner: Indeed.

Bush: So, it could be treated a little bit differently, there. And even though most people view bitcoin and altcoins as digital currencies, the IRS views it as property, so that's why it's treated that way. That means selling, exchanging will trigger the capital gains tax, and receiving crypto as income, whether it's from mining or a form of payment of some type will be taxed as income.

My recommendation about how to treat the taxes is just to play it conservatively. I would keep track of all of your sells and come tax season, just go ahead and report your sales. This is a more annoying process than stocks, simply because exchanging tokens for other tokens is just how you get your foot in the door. That triggers selling events, when really you're just trying to buy something in the first place. I think it's best to just play it safe, there.

I do suspect that over time we will see pretty dramatic changes in how crypto assets are taxed. I think that privacy coins paired with anonymous wallets will be a pretty huge phenomenon and that will let people shield their actions from the government. I'm not recommending doing that.

Gardner: We don't do that on this podcast.

Bush: Honestly, I don't know how the government will react when these things come online, so I do think that this is a morphing environment that the IRS will have a tough time adapting to; but just in terms of buying, selling, and exchanging, I would treat it very similarly to how you would treat either income or stocks with capital gains.

Gardner: Excellent, Aaron! And yes, neither you nor I are tax experts; and even if we were, it's not even entirely clear right now. But I think it is always prudent to pretend that it's all real, because it pretty much is and probably will be recognized as such, as law continues to evolve and notice what's happening in the world. Aaron, thank you very much for yet another appearance. Maybe three of our last 10 podcasts. You're my most frequent guest. Thanks!

Bush: Well, it's an honor, David. Thank you!