What the Crypto?! A (very) basic guide to cryptoassets.

You are late for our trip, Clark!

Before finding them in your pocket I guess…?

At least it’s not the key to your digital wallet that you keep losing. Have you heard about that guy who lost £25,000 when his crypto key was stolen?

I wish…”x marks the spot” would be easier than a password of 40 randomly generated numbers and letters that you need to get into a digital wallet.

Not quite true. Admittedly there are substantial risks associated with cryptoassets and the current generation of cryptoassets don’t deliver clear benefits to consumers as yet.

But the reality is that crypto isn’t going away.

The UK government has set out an ambition to be the world’s most innovative economy and maintain its position as one of the leading financial centres globally.

It isn’t even one of the major markets for cryptoassets but there is increasing investment in them by mainstream financial services firms in the UK with many banks exploring how to engage with this market. And the big regulatory players (like the Financial Conduct Authority (FCA), HM Treasury and Bank of England) are actively exploring cryptoassets and issuing guidance.

OK. What we really need is a Captain Crypto but he’s on holiday so I’ll do my best.

Right…well, a (hopefully) simple definition is that a cryptoasset is a digital representation of: (i) value; or (ii) a contractual right that can be transferred, stored or traded electronically.

I think you have to first just get over it not being a physical object. A £10 note is a physical object we are comfortable with, but it’s really a contract with the Bank of England (which doesn’t make that much sense on inspection). All of these items are digital contracts. It is written in 1’s and zeros’ not a’s and b’s, and as are most things these days, it is stored digitally.

Great. And cryptoassets fall into three main categories which are referred to as “tokens”. Ready?

Exchange Tokens

Enable the holder to buy and sell goods and services from anyone who will accept them without the need for traditional intermediaries such as banks.

Despite not being backed by a currency or issued by a bank, exchange tokens have “value” and so can be used as a means of exchange or for investment.

Exchange tokens have similar characteristics to cash….although they are not yet recognised as legal tender or currency.

The obvious example is Bitcoin.

Security Tokens

Grant the holder rights of ownership, control, voting and/or dividends.

Similar characteristics to shares in a company but instead of a share certificate you get a digital token.

Security tokens can also operate like a debt instrument in that they represent money owed, like a debenture or bond.

Utility Tokens

Gives the holder access to current or prospective goods or services.

Unlike exchange tokens, holders can only access the specific goods and services that the utility token relates to.

Think crowdfunding. You receive a utility token for investing in a company which gives you first access to a new product release.

For example, you invest in a utility token issued by a band or theatre and get access to pre-sale tickets at a discounted rate in return for the token.

Great!

Of course. There are many potential risks and it’s important to be aware of them but the point is that crypto doesn’t necessarily mean bad…and it isn’t just a passing trend.

The aim of the UK Government and the big regulatory players is to maintain the UK’s reputation for:

• being a safe and transparent place to do business;
• ensuring high regulatory standards;
• protecting consumers; and
• guarding against threats to financial stability…

…but they also want to allow innovators in the financial sector that play by the rules to thrive.

So sticking your head in the sand could really mean missing the boat because there is huge potential for innovation, improving efficiency, access to capital and opening up a much wider customer base.

Correct. HMRC may not recognise cryptoassets as “money” or “currency” but they will still tax them.

Cryptoassets are - as the name suggests – assets.

People holding cryptoassets as an investment (as is often the case) will be liable to Capital Gains Tax on the sale for profit of the cryptoassets.

Inheritance Tax applies on cryptoassets as a form of property.

And where a person is buying and selling cryptoassets with such frequency, level of organisation and sophistication that the activity amounts to a financial trade in itself then they will be liable to Income Tax.

Yes. But it’s important to consider the tax implications of doing so.

Cryptoassets received as remuneration from employers are likely liable to income tax and National Insurance Contributions (NICs) on their value.

Granting options over cryptoassets to employees (as opposed to share options) are likely to create liability for Income Tax and NICs…and so EMI share schemes remain much more tax efficient at present.

Keeping a record of the type of cryptoasset, date of transaction, volume sold/bought/received, value, and information on bank statements or wallet addresses is important as well as a record of conversion values and methodologies to show any exchange rate values. In reality the real issue is the value of many of these things is so hard to determine, regardless of what it might say on some 3rd party exchange as there is often no liquidity - but we will need to leave that for another time.

Well, no. It’s complicated…and there’s much more to it…and it’s still evolving at a rapid pace…but that’s the basics, the very basics and it’s easier when you start to relate it to real world examples.

And the key take away is, do not be afraid of them, and realise they are a positive development in humanity. They were borne out of wanting to create a system outside of the banks that could survive another Crash, and indeed they are, and now they have a million uses people are realising, many extremely positive.