Crypto Trading
Crypto trading has gone from a niche hobby to a mainstream financial activity in a very short time. These days, many people and businesses trade digital currencies (like Bitcoin and Ethereum) and altcoins. The fluctuating nature of cryptocurrencies, which are produced and can be bought and sold anonymously, means that accounting for crypto trading is anything but straightforward. However, this is important to get right because it will affect your business’s –
- recordkeeping,
- reporting and
- compliance with tax regulations.
Here is a guide to help you get it right, keeping you organised and compliant.
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Understanding Crypto Trading
Definition and Types of Crypto Trading
Crypto trading is the process of trading in cryptocurrencies, such as buying, selling, and exchanging, to make money.
There are several types of crypto trading which are:
Spot Trading: Buying and selling cryptocurrencies for immediate settlement.
Margin Trading: Borrowing funds to trade larger positions, amplifying potential gains and losses.
Futures and Options are contracts that give you the right to buy or sell an asset at a certain price in the future.
Key Terminology
To navigate crypto trading accounting, it’s essential to understand key terms:
- Cryptocurrency: Digital or virtual currency secured by cryptography.
- Tokens: A type of cryptocurrency that represents an asset or utility.
- Altcoins: Cryptocurrencies other than Bitcoin.
- Exchanges: Platforms where cryptocurrencies are traded.
- Wallets: Digital tools for storing and managing cryptocurrencies.
- Trading Pairs: Cryptocurrencies that can be traded for each other (e.g., BTC/ETH).
Initial Setup for Crypto Trading Accounting
Choosing Accounting Software
The first step is choosing the right accounting software that allows you to integrate with
- exchanges,
- automatically import transactions, and
- generate tax reporting.
This includes CoinTracking and CryptoTrader.Tax or Koinly.
Setting Up Accounts
Separate accounts for different types of transactions:
Each type of transaction belongs to a specific wallet or exchange account.
- Categorise accounts correctly within your accounting software,
- keep track of different types of crypto activity correctly, and
- report them as such.
Establishing Record-Keeping Practices:
Keep meticulous
- records of all trades,
- wallet balances, and
- exchange statements:
- dates,
- amounts,
- types of trades, and
- associated fees.
You’ll need these when it comes time to report to the IRS and audit yourself.
Recording Crypto Transactions
Purchase and Sale Transactions
For example, if you pay $10,000 for an equivalent of cryptocurrency, including transaction fees, note the sum ($10,000) and the asset in your account. So, for $10,050, you can purchase 0.05 Bitcoin. At the same time, when you sell the cryptocurrency, be aware of the sale price and any fees that might apply.
Transfers Between Wallets
All transfers between personal wallets and the exchanges, along with the associated fees, are recorded. They do not trigger taxable events. But they will show up in your books.
Mining and Staking Rewards
Mining rewards, in turn, should be recorded as income at their fair market value when received. Staking rewards refer to earning additional coins by holding and verifying transactions and should also be recorded as income.
Airdrops and Forks
For airdrops or free crypto distributions, the income would be recorded at the fair market value of the new token. For a fork of a blockchain (where a chain splits in two), any new tokens received would be recorded at the fair market value at the date received.
Valuation and Measurement
Determining Fair Market Value
The value of transactions in cryptocurrency is also important to determine. The fair market value of transactions in digital currency would be determined using exchange rates or pricing services at the time of the transaction and then reported accordingly to accurately reflect the realised capital gains and losses.
Cost Basis Calculation
When it comes to figuring out your cost basis, here are some common methods to consider when you’re trying to determine gains or losses:
- First-In, First-Out (FIFO): The first coins purchased are considered the first sold.
- Last-In, First-Out (LIFO): The last coins purchased are considered the first sold.
- Specific Identification: Each coin’s purchase and sale are matched individually.
Revaluation of Holdings
Unrealised gains and losses should be booked on a mark-to-market basis: that is,
- at the end of each reporting period, your portfolio should be valued as if it were being sold at the current market price.
Income and Expense Recognition
Recognising Trading Gains and Losses
Realised gains and losses are different from unrealised gains and losses. Realised gains/losses occur when you sell or trade crypto. Unrealised gains/losses are the change in the value of your holdings, which needs to be tracked in order to report accurately for taxes.
Deductible Expenses
While many crypto trading expenses are not deductible, some are.
- If you’re trading cryptocurrency, you can deduct
- trading transaction fees,
- software and
- hardware costs, and
- professional fees, such as those paid to an accountant or a lawyer.
Characterising these expenses as business expenses rather than personal expenses will lower your taxable income.
Interest and Dividends
Suppose you earn interest from lending platforms, such as Bitcoin or USDT loans, or divs from crypto-assets, such as the airdropped STEPN tokens. In that case, you will need to declare them as income, including the fair market value at the time the interest or divs accrue.
Tax Implications and Reporting
Taxable Events
Identifying taxable events is key to compliance. These include:
- Trades and sales of cryptocurrency
- Conversions between different cryptocurrencies
- Using cryptocurrency to purchase goods or services
- Capital Gains Tax
Income tax applies to cryptocurrency transactions. The tax rate depends on the duration of the holding period:
Short-term: Held for less than a year, taxed at ordinary income rates.
Long-term: Held for more than a year, taxed at lower capital gains rates.
Filing Requirements
You should use the correct form and add-on schedules, such as IRS Form 8949 and Schedule D in the US. Non-US residents should comply with local tax regulations. Records should be well-maintained so that tax reporting becomes easy.
Internal Controls and Compliance
Implementing Internal Controls
Tight internal controls, such as
- separation of duties,
- regular account reconciliations, and
- security protocols to protect crypto assets,
ensure accuracy and prevent fraud.
Regulatory Compliance
The business must also comply with anti-money laundering (AML) laws, know its customers (KYC), and comply with other regulations that differ in detail from jurisdiction to jurisdiction.
Financial Reporting for Crypto Trading
Balance Sheet Presentation
Most cryptocurrencies are classed as current or non-current assets depending on whether you intend to realise the holding within one year of the date on your balance sheet.
Income Statement Presentation
Report trading income and expenses in the income statement, including
- trading gains and
- losses and
- related expenses.
Three types of disclosures provide information on accounting policies and transparency:
- thirty-two separate disclosures of significant accounting policies,
- analysis of prior year periods as deemed appropriate, and
- reconciliations of key financial measures.
Notes to Financial Statements
Detailed notes will put it in context. Disclosures should include how the valuations have been made, the major risks involved, and how they will be managed.
Conclusion
With the right rules and record keeping, your crypto trading will be compliant with regulations, and there will be no hassles with your accountant or auditor. You’ll be able to provide detailed financial accounts to the tax regulations. To stay on top of the latest trends, be it new coins or central bank digital currencies (CBDC), you can sign up for our free email newsletter. Learn the latest news, insights from industry experts, and how you can navigate this new world. By signing up for our mailing list, you’ll get the latest information, insights, and hacks sent directly to your inbox.