What is Virtual Currency? Tax Implications & More

In this guide, we’ll break down everything you need to know about virtual currencies — including what they are and how the IRS treats them for tax purposes! 

What is virtual currency?

Virtual currency is a currency that exists only in the digital realm. 

Virtual currencies do not take a physical form — like coins and notes. Typically, virtual currencies use blockchain technology for security. 

Examples of virtual currencies include Bitcoin and Ethereum! 

What is virtual currency for tax purposes?

The IRS uses the following definition of ‘virtual currencies’: 

A digital asset that has an equivalent value in real currency, or acts as a substitute for real currency, is referred to as convertible virtual currency, for example, a cryptocurrency. It can be:

• Used to pay for goods and services
• Digitally traded
• Exchanged for or into real currencies or other digital assets
  

Remember, ‘virtual currency’ is a term used by the IRS primarily to describe crypto-based assets. 

The US dollar and other fiat currencies are not considered virtual currencies for tax purposes. Even when you have dollars on a digital bank account or a platform like Venmo, it won’t be considered virtual currency. 

Do I have to report virtual currencies on my taxes? 

Income and capital gains from virtual currencies like BTC and ETH should be reported on your tax return. Remember, failure to report may be considered tax evasion — a serious crime with serious consequences. 

Will the IRS ask about ‘virtual currencies’ on my taxes? 

Prior to the 2022 tax year, the IRS asked about virtual currencies on tax returns. 

“At any time during (tax year), did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?”

After 2022, the IRS changed the wording of this question from ‘virtual currencies’ to ‘digital assets’. Digital assets include both virtual currencies as well as crypto-based assets like NFTs. 

If you sold, traded, or received a gift in virtual currency/digital assets, you should answer ‘Yes’ to this question. Intentionally lying on this question is considered tax fraud. 

Types of virtual currencies 

Let’s walk through two different types of virtual currencies: cryptocurrencies and stablecoins. 

Cryptocurrencies 

Cryptocurrencies rely on decentralized blockchains to record transactions. Here are some examples: 

• Bitcoin 
• Ethereum 
• Dogecoin 

Stablecoins 

Stablecoins are virtual currencies that are linked to the price of fiat assets like the US dollar. Examples include: 

• USDC
• USDT

Pros and cons of virtual currencies 

Pros of virtual currencies 

• Faster money transfers: Virtual currencies offer faster money transfers than traditional banks — with transactions finalized within seconds! 
• New applications: Virtual currencies can be programmed to open the doors to new types of applications — like DeFi protocols and NFTs! 
• Limited geographical restrictions: Virtual currencies make it easy to trade with people all over the world! 

Cons of virtual currencies 

• Highly volatile: Virtual currencies like Bitcoin and Ethereum can be highly volatile. Remember to invest with caution. 
• Subject to hacks: In the past, virtual currency holders have lost access to their coins due to hacks. 
• Frequent scams: Unfortunately, scams are common in the virtual currency space. 

Digital currency vs. virtual currency vs. cryptocurrency

Virtual currency, digital currency, and cryptocurrency are separate but related concepts. Let’s break down the differences between the three. 

Digital currency: Digital currency is an umbrella term that includes any monetary value represented in digital form, including both virtual currencies and fiat currencies like the US dollar that are stored digitally. 

VIrtual currency: Virtual currency is a type of digital currency that is not issued by a central bank and does not have a physical counterpart. 

Cryptocurrency: Cryptocurrencies are a specific type of virtual currencies. Cryptocurrencies use cryptographic techniques and a decentralized blockchain network to validate transactions.