The cryptocurrency market continues to make headlines in 2021. Read on for a basic understanding of cryptocurrencies and the current state of crypto payment processing.
What is Crypto?
Merriam-Webster defines cryptocurrency as a type of currency “that only exists digitally… has no central issuing or regulating authority but instead uses a centralized system to record transactions.” Forbes defines it as “decentralized digital money based on blockchain technology.”
Since it is a digital currency, there are no physical coins or notes received when you own crypto. Instead, there is a digital, public record of your transaction stored within a blockchain.
The blockchain is what makes this digital currency unique. A blockchain works as a digital ledger of duplicated transactions shared across thousands of computers, called nodes, around the world simultaneously. No one person or business controls these computers, making the blockchain completely decentralized.
How Cryptocurrency Transactions Work
When we buy something with a credit card, issuing banks approve transactions while acquiring banks accept transactions.
When exchanging cryptocurrency for a good or service, there isn’t a designated company or institution that confirms and completes the crypto payment processing. Instead, the node where the transaction happens broadcasts the transaction to all the computers in the network.
The thousands of nodes work simultaneously to validate the transaction by scanning the entire blockchain. If the majority of nodes find the transaction legitimate, then a consensus is reached. The transaction is validated and then included in a block of data. Because a majority is required to validate the transaction, it makes the transaction’s validity highly probable. It ensures cryptocurrency is safe and secure for transactions.
Then, there is a type of node called a miner, which increases the security of the blockchain. Miners take the data block with all the validated transactions and run each transaction through an algorithm to create a hash for each one. Hashes are a string of 64 letters and numbers; every hash is unique.
Hashing is similar to encryption in the payments industry, where sensitive payment information gets encoded into something unreadable. However, there are slight differences. Encryption in payments is a “two-way function”; if something is encrypted, it can be decrypted with a key to access the information. On the other hand, hashing is a “one-way function.” There is no way to “reverse” it to reveal what the data is.
Cryptocurrency Use Cases
There are several use cases around cryptocurrency, but we will focus on some of the financial-related cases for this post.
There is hope that cryptocurrencies can make international payments faster and cheaper. Since a cryptocurrency is not issued by a central authority and is effectively borderless, you can bypass the several intermediaries needed to process the transaction. Transactions can happen on the same day or the next day safely and securely through the verifications done on the blockchain.
In theory, a decentralized financial system democratizes finance and gives the unbanked access to services that a traditional financial institution would deny based on existing standards. In emerging markets, those outside the banking ecosystem are using mobile phones to access cryptocurrencies, as it’s a viable alternative to a bank account and a way to protect their money from hyperinflation.
Some cryptocurrencies have a limited and finite supply of coins, giving them the ability to keep inflation low. This stipulation encourages some retail and institutional investors to view crypto as a store of value and invest in it as a form of “digital gold.”
Still, like any investment asset, the value of a cryptocurrency can rise and fall at any time. Those who decide to buy in must understand the risks involved.
Cryptocurrency Payments in the U.S.
The world is slowly coming around to recognizing cryptocurrencies as an actual payment option. However, the adoption rate for cryptocurrency payments continues to lag within the United States.
The IRS currently views cryptocurrencies as property, making them subject to capital gains taxes like stocks, bonds, and other securities. That means there will be tax implications for businesses and consumers who choose to transact with crypto.
If a U.S. taxpayer pays for something using a cryptocurrency, the IRS views this transaction similarly to selling the crypto on a market exchange. The tax liability depends on how long the taxpayer held the crypto and whether they spent it at a profit or a loss.
U.S. businesses that accept cryptocurrency payments must report the gains and losses to the IRS. For example, let’s say a consumer buys a $10 item and pays for it in a cryptocurrency. Some time passes by, and the business owner decides to convert it to dollars.
However, the value of the crypto is now $15, which means the owner has a capital gain of $5. The owner will have to report this $5 gain during their tax filing. Due to the potential of these gains, some experts recommend businesses convert cryptocurrency into cash right away. Doing so avoids the need to record additional gains or losses.
The Future of Crypto
While we choose to refrain from making bold predictions about the state of cryptocurrencies at Global Payment Integrated, we continue to watch the space as it grows. Subscribe to our newsletter to stay on top of payments trends - and to be in the know should cryptocurrency payments gain traction in the marketplace.