Assets of the Crypto Kind — Part 1
Key Takeaways:
Examining the intersection of currency and assets within the realm of cryptocurrency.
Insights into crypto's evolving status, market trends, and considerations for investors.
Navigating this dynamic landscape demands ongoing vigilance and strategic decision-making.
Note: This is a two-part guide into the world of cryptocurrency as it pertains to custody solutions, South African digital asset estate planning and passing on that wealth to future generations. View part 2
Part One – Understanding what it is.
The word “mining” has been heard in many-a-conversation in recent years.
But when one thinks about mining, at least to the average person, the “Gold Rush” often comes to mind. At least at first.
Hordes of fortune seeking men descending on a small town rumoured to be a source of gold. And a source of their future fortunes.
You imagine bright eyed and bushy tailed men (at least in the beginning), setting up camp (literally) along the riverbanks, waking up early every morning brawling and fighting their fellow “miners” to get the best spot in the river – the spot where other men had found their precious nugget(s) of gold.
According to the Sierra College Press, would-be gold diggers “placed some gold-bearing materials, such as river gravel, into a shallow pan, adding some water, and then carefully swirling the mixture around so the water and light material spilled over the side”. Revealing (they hoped) gold pieces or flakes. Referred to as “panning for gold” it was considered the most basic method of mining for gold. But it did prove successful for some.
In fact, it was estimated that “over the course of the gold rush 1,750 pounds (793.7 kilograms) of the buttery metal was unearthed” .These fortune seekers were optimistic and believed without a doubt, that they would strike it rich. No matter how many times they actually ‘struck out”.
As a result of the gold rush, so-called “Boomtowns” rose up offering every temptation under the sun. But despite the wanton temptations on offer, Boomtown’s did represent a significant uptick in political and economic development. Often leading to thriving communities. Cities like San Francisco as one example.
Gold had created a sort of evolution. Because gold had become the new currency. The new traded commodity. A way to buy whatever your heart desired.
And it has remained so.
In fact, according to Investopedia –
“Under a free market system, gold is a currency. Gold has a price, and that price will fluctuate relative to other forms of exchange, such as the U.S. dollar, the euro, and the Japanese yen. Gold can be bought and stored, but it is not usually used directly as a method of payment. However, it is highly liquid and can be converted to cash in almost any currency with relative ease”.
Ø A side note – it must be noted that (and truth be told) there has been value in gold as far back as the Ancient Egyptians. But the point here is more the idea that an everyday man could mine gold almost in their “back yard” and in turn become wealthy from it.
But that was then.
And this is now.
Times have most certainly changed. But what is clear is this - the Gold Rush and everything it brought with it, changed worldwide economies. It changed how people saw wealth – and how wealth could be created. It changed how traditional currency was viewed. And how it was valued.
The Gold Rush changed the world (the argument as to whether it was for the betterment of society is for a different day).
Understanding the Gold Rush and the change it wrought on societies (and economies) is important. Which is why we began there. Why? Because it sets the stage for what we are going to delve into next – a new and different kind of currency.
You see, the idea of what currency is has changed. Once again. Only this time, it is not sought out in a mineral or a metal or something that can be “held within the palm of your hand”.
Ø And this “holding in the palm of your hands” includes your VISA, Debit and Mastercard’s because whilst you cannot see your money physically you hold the key to your ‘vault” or bank account (which holds your money) and in that sense you can hold your money in your hands. Even if it is only “electronically”.
Rather this “modern age” currency and wealth is out in the ether. In a digital format.
And the idea of not really being able to see, hold or (often) understand what a digital currency is has left a lot of us stumbling –
· Do we rush in (just like the miners did during the Gold Rush)?
· Do we stake our sanity and our security on something we cannot see and don’t really (yet) understand?
Gold is one thing. You can hold it. And even if you don’t fully grasp how it is valued you still understand that it is valuable. Even if it is just from a jewellery perspective.
Ø In fact, and according to Investopedia “during multiple stock market crashes in the first decade of the 21st century, the price of gold began to rise again. The idea of returning to the gold standard became more popular at that time”. Gold withstood the test of time, it would seem. Despite market crashes. It retained its value. And that’s an important thing. Gold over cash?
But not being able to physically see your currency in order to understand its value, makes a lot of us a little nervous. And a little suspicious.
So, what is this crypto currency we hear about?
The Oxford Dictionary defines crypto currency as –
“a digital currency in which transactions are verified and records maintained by a decentralized system using cryptography, rather than by a centralized authority”.
Wait. What is Cryptography?
“Cryptography is the mathematical and computational practice of encoding and decoding data”.
Investopedia defines crypto currency as –
“a form of digital asset based on a network that is distributed across a large number of computers. This decentralized structure allows them to exist outside the control of governments and central authorities”.
Ø Ever heard of Bitcoin?
A stellar example of what crypto currency is, BDO USA describes Bitcoin as follows–
“While there have been several attempts to create cryptocurrencies since the 1990’s tech boom, Bitcoin is the first to gain widespread public notoriety. Leveraging opensource peer-to-peer technology, the transaction and issuance of Bitcoin is collectively managed by the network, effectively cutting out the middleman.
Introduced by an anonymous programmer or group of programmers under the alias “Satoshi Nakamoto,” Bitcoin has consistently dominated the crypto market since it became available to the public in 2009. It has remained relatively unchallenged until the introduction of the Ethereum platform in 2016. Cryptocurrencies, including Bitcoin and Ethereum, are more volatile than traditional fiat currencies. Fiat currencies are declared to be legal tender by a government and are not backed by physical commodities”.
Can crypto currency be considered money?
With the word “currency” in the description, the inevitable question is therefore – is crypto currency money?
According to the Crypto Assets Regulatory Working Group, the answer is NO –
In terms of the South African Reserve Bank (SARB) Act 90 of 1989, money is defined as legal tender, which in turn is defined as:
“A tender, including a tender by the [South African Reserve] Bank itself, of a note of the Bank or of an outstanding note of another bank for which the Bank has assumed liability in terms of section 15 (3) (c) of the Currency and Banking Act or in terms of any agreement entered into with another bank before or after the commencement of this Act, shall be a legal tender of payment of an amount equal to the amount specified on the note.”
“A tender, including a tender by the Bank itself, of an undefaced and unmutilated coin which is lawfully in circulation in the Republic and of current mass, shall be a legal tender of payment of money”.
In the South African context, legal tender (i.e. money) is limited to banknotes and coin issued by the SARB. From a legal perspective, crypto assets are therefore not recognised or viewed as money”.
The above is echoed by the Generally Accepted Accounting Practices or GAAP, which states (according to U.S. BDO) that
“Cryptocurrencies are not cash because they are not legal tender and are not backed by a government or other legal entity. For similar reasons, they are also not cash equivalents or foreign currencies under U.S. GAAP”.
Furthermore, the South African Institute of Professional Accountants or SAIPA in their paper on Accounting for Cryptocurrency, goes on to describe crypto currency as such –
“Cryptocurrency has no intrinsic value in that it is not redeemable for another commodity (such as gold), has no physical form (such as physical coins), is not legal tender and is not currently backed by the government or a legal entity.
Your cryptocurrency is not held by a bank or other entity; it’s stored in your ‘wallet’ on your computer, cellphone or in the cloud. Cryptocurrency, such as Bitcoin, is pseudonymous in that the cryptocurrency is not tied to a person, but rather one or more specific keys, and thereby the owner is not identifiable, while all transactions are publicly available in the blockchain”.
So, if crypto currency is not money, what is it?
Is it perhaps an asset?
The traditional definition of an asset as defined by SARS is follows –
“We define assets as including—
(a) property of whatever nature, whether movable or immovable, corporeal or incorporeal, excluding any currency, but including any coin made mainly from gold or platinum; and
(b) a right or interest of whatever nature to or in such property;
The definition of an ‘asset’ is of importance, as CGT is, with few exceptions, not triggered until an asset is disposed of. A wide definition has been ascribed to the term, which includes all forms of property and all rights or interests in such property. The exclusion of currency is dealt with below.
A few examples of assets are listed below:
Land and buildings, for example, a factory building, a person’s home, or holiday home;
Shares;
A participatory interest in a collective investment scheme;
An endowment policy;
Collectables, for example, jewellery or an artwork;
Personal-use assets, for example, a boat;
Contractual rights;
Goodwill;
A trade mark;
A loan;
A bank account;
Trading stock. In a going concern a disposal of trading stock will usually not give rise to a capital gain or loss because double deductions and double taxation are prevented in determining base cost and proceeds”.
Where does crypto currency fall under the above definition? Well, it doesn’t. Not entirely.
But if we again look to GAAP (and again as set out by U.S. BDO) –
“cryptocurrencies are generally accounted for as indefinite-lived intangible assets. Intangible assets under U.S. GAAP are “assets (not including financial assets) that lack physical substance.” Further, financial assets are cash, evidence of an ownership interest in an entity, or a contract that conveys to one entity a right to receive cash or another financial instrument, or a right to exchange other financial instruments on potentially favourable terms. Cryptocurrencies are not financial assets. They also lack physical substance. Therefore, they meet the definition of an intangible asset and would be recorded at acquisition cost (i.e. price paid, or consideration given)”.
This is again supported by SAIPA in their paper on Accounting for Cryptocurrency where they set out that –
“An ‘intangible asset’ [IAS 38] is an identifiable non-monetary asset without physical substance/form. So, cryptocurrencies appear to meet the definition of an intangible asset, as they are identifiable, can be sold, exchanged or transferred individually, are not cash, a non-monetary asset and have no physical form.
Intangible assets have traditionally been assets held for use in the production process, such as patents, trademarks, copyrights and other intellectual property. An intangible asset’s primary objective is to generate revenue from the company’s ordinary course of business. Cryptocurrencies are used to pay/exchange for goods or services, to incentivise or promote, and for investment purposes. An intangible asset feels very different from the use of cryptocurrencies.
It is generally accepted that fair value measurement is the most relevant measurement basis for a cryptocurrency, because it’s being used as a currency-equivalent or alternative investment vehicle. An intangible asset can be measured at fair value, but only if there is an active market. Fair value movements must be recognised in ‘Other Comprehensive Income’”.
So, if we assume the accounting principal that crypto currency is actually an intangible asset, the jump from currency to asset makes sense.
SARS definition of crypto currency supports this assumption –
“A crypto asset is a digital representation of value that is not issued by a central bank, but is traded, transferred and stored electronically by natural and legal persons for the purpose of payment, investment and other forms of utility, and applies cryptography techniques in the underlying technology.
According to the Explanatory Memorandum on the Taxation Laws Amendment Bill as issued on 20 January 2021 the word “cryptocurrency” was replaced with “crypto asset” in line with the proposed adoption of a uniform definition of crypto assets within the South African regulatory framework”.
If crypto assets are assets, are they taxed?
According to SARS, crypto assets would be taxed -
“normal income tax rules apply to crypto assets and affected taxpayers need to declare crypto assets’ gains or losses as part of their taxable income.
The onus is on taxpayers to declare all crypto assets-related taxable income in the tax year in which it is received or accrued. Failure to do so could result in interest and penalties.
Following normal income tax rules, income received or accrued from crypto assets transactions can be taxed on revenue account under “gross income”.
Alternatively, such gains may be regarded as capital in nature, as spelt out in the Eighth Schedule to the Act for taxation under the Capital Gains Tax (CGT) paradigm. Determination of whether an accrual or receipt is revenue or capital in nature is tested under existing jurisprudence (of which there is no shortage).
Taxpayers are also entitled to claim expenses associated with crypto assets accruals or receipts, provided such expenditure is incurred in the production of the taxpayer’s income and for purposes of trade”.
How does one acquire crypto assets?
Through a process called “Mining”.
Which brings us back full circle to the Gold Rush days. Except mining for crypto assets is not done by “panning for gold” but instead (and according to coinbase) by –
“Mining is the process that Bitcoin and several other cryptocurrencies use to generate new coins and verify new transactions. It involves vast, decentralized networks of computers around the world that verify and secure blockchains – the virtual ledgers that document cryptocurrency transactions. In return for contributing their processing power, computers on the network are rewarded with new coins. It’s a virtuous circle: the miners maintain and secure the blockchain, the blockchain awards the coins, the coins provide an incentive for the miners to maintain the blockchain”.
The process of “mining” is simplified by SARS who describe it as -
“Mining is conducted by the verification of transactions in a computer-generated public ledger, achieved through the solving of complex computer algorithms”.
You can also acquire crypto assets by exchanging local currency for a crypto asset (or vice versa), using crypto assets exchanges (markets for crypto assets), through private transactions as well as through bartering i.e. goods or services can be exchanged for crypto assets (normal barter transaction rules apply).
So, now that we have established that crypto currency is an intangible asset, is subject to tax as imposed by SARS and is acquired by means of mining, exchange controls or through a type of barter system, the next logical question would be – How does the South African Reserve Bank deal with crypto assets?
The South African Reserve Bank (SARB)
On the 23rd of February 2022, SARB released a statement which set out the following –
“We refer to Exchange Control Circular No. 4/2022 and the announcement made by the Minister of Finance in Annexure F of the 2022 Budget Review wherein it was announced that resident individuals may utilise the investment portion of their single discretionary allowance and/or foreign capital allowance to participate in online foreign exchange trading activities.
These online trading activities generally include one or a combination of options, such as trading global currencies against each other, trading a contract for difference, trading in foreign stocks, trading commodities including crypto currencies and trading foreign indices using the online trading platform of the broker concerned.
Residents should note that they may not fund their international trading accounts at registered brokers using South African credit, debit and virtual cards, but such trading accounts should be funded in terms of the single discretionary and/or foreign capital allowance, i.e. the Authorised Dealer concerned must convert the Rand into foreign currency and transfer such funds via the banking system as an Electronic Funds Transfer to a foreign bank account or the funds can be deposited in a foreign currency account at an Authorised Dealer”.
As such, (and already from 2021), South African residents are not able to use bank cards to buy crypto currency on offshore platforms, such as Bitcoin and Ethereum. This was extended (by the above statement from SARB) to include online international trading accounts on exchanges and trading platforms, foreign currency accounts at authorised dealers, trading global currencies, foreign stocks, CFD (contracts for difference), commodities including crypto currencies and foreign indices.
Funding online international trading platforms, including crypto currency and trading accounts, can be done by using Foreign Investment Allowance and Single Discretionary Allowance’s. Funds legitimately held offshore can also be used.
How is the South African Government viewing crypto assets?
In the Budget Review 2022, the South African Government proposed the serious notion that regulatory bodies need to be established to safeguard the crypto owner.
The South African Government has taken the interventions proposed by the Intergovernmental Fintech Working Group (“IFWG”) to heart.
The IFWG has set out the following (as set out in Businesstech) –
“Including crypto asset service providers as accountable institutions within the Financial Intelligence Centre Act (2001). This change would address concerns around money laundering and terror risk financing through crypto-assets and align the act to the standards set by the FATF for virtual assets and related service providers. The proposed amendments to the act were published in June 2020 for public consultation and are expected to be finalised in 2022.
Protecting consumers by considering the declaration of crypto assets as a financial product under the Financial Advisory and Intermediary Services Act (2002). According to this declaration, any person providing advice or intermediary services related to crypto assets must be recognised as a financial services provider under the act and must comply with the act’s requirements. This will include crypto-asset exchanges and platforms, as well as advisors and brokers. This work is expected to be finalized in 2022.
Enhancing monitoring and reporting of crypto asset transaction to comply with the Exchange Control Regulations of 1961. The process to include the crypto assets in the regulations is underway.”
The IFWG’s stance on crypto assets should come as no surprise though. In an article by BDO titled Crypto Assets: How you are taxed, the author Associate Professor David Warneke set out the following regarding the IFWG’s position –
“the Intergovernmental Fintech Working Group (IFWG) reiterated that crypto assets are not “money” in the sense of legal tender, although they perform some of the functions of money.
The IFWG identified various risks emanating from the fact that crypto assets and crypto asset service providers are still unregulated in South Africa and recommended that regulation be introduced. The objectives identified by the IFWG in regulating crypto assets include the combatting of tax evasion and of impermissible tax avoidance arrangements”.
And despite concerns to the contrary and according to Tax Consulting SA (as set out in the above article on Businesstech) this move by Government to regulate crypto assets is not entirely a bad thing –
“Crypto owners should see these proposed interventions as a proactive approach from the government to protect both the consumer and the South African fiscus.”
Crypto assets in summary?
There is a LOT to take in where crypto assets are concerned. But if we break it down into easily digestible pieces it becomes a little easier on the mind (and stomach) -
Crypto assets (and currency) are not money or legal tender, but due it being a currency-equivalent or alternative investment vehicle and therefore holding value (although not in physical substance) it is a digital representation of value (not issued by a central bank);
Crypto assets are taxable by SARS either as normal income tax (and therefore forms part of your taxable income) or through Capital Gains Tax;
Crypto assets cannot be acquired by means of bank cards, online international trading accounts on exchanges, trading platforms, foreign currency accounts at authorised dealers, trading global currencies, foreign stocks or CFD (contracts for difference) but instead through either Foreign Investment Allowance or a Single Discretionary Allowance as allowed by SARB, and
Government also seeks to regulate crypto assets by means of an accountable institution with the aim of protecting crypto asset owners.
Wondering how crypto assets will be dealt with in your Estate Planning process? In our upcoming (follow up) article, we will endeavour to explain the practicalities of Estate Planning (where crypto assets are concerned) as well as how you can deal with them in your Will.
Get in touch with Benaters today should you have any further questions about crypto assets. We would be happy to assist you.