Cryptocurrencies: Issues and Best Practices

Journal of Financial Planning: April 2019​​​​​



Ryan Firth, CPA, is the founder and president of Mercer Street Personal Financial Services | Business & Tax Services, which focuses on serving small business owners, young professionals, and growing families in the wealth accumulation phase of their lives.

As a financial planner, you may have tech-savvy, early-adopter clients who hold cryptocurrencies (also referred to as cryptoassets or cryptos for short) such as Bitcoin, XRP, ether, Litecoin, and many more. The purpose of this column is to inform you of some of the issues your clients might face from a tax compliance and financial planning perspective. It is not comprehensive; rather, it provides high-level information so you can identify the issues and advise your clients accordingly, or know where to go for further guidance, if needed.

Tax Planning for Virtual Currencies

IRS Notice 2014-21 ( gives taxpayers some guidance on the tax treatment of transacting in cryptocurrencies, or as the IRS refers to them, “virtual currencies.” The IRS treats virtual currencies as property, which means it’s extremely important that your clients track the cost basis of their crypto holdings, including the quantity, price (in U.S. dollars), and date of when they buy, sell, receive, spend, or exchange cryptos. Online basis calculators can help you and your clients keep track of their transactions.

Many of the more reputable crypto exchanges have developed, or are in the process of developing, tax-reporting features that help customers accurately track their cost basis (usually on a FIFO basis, but some also report on a LIFO basis), gains, and losses from transactions. The IRS requires crypto exchanges to issue a Form 1099-K to taxpayers who have received more than $20,000 of gross payments and more than 200 such transactions in a given calendar year. Be aware that these forms will only report the gross proceeds from transactions, so again, it’s important that your clients track their cost basis and account for expenses like trading and network fees. 

Another important aspect to consider: offshore exchanges and digital wallets that are operated by foreign third-party providers may be subject to FBAR and FATCA reporting requirements (be mindful of the $10,000 threshold). Finally, because of tax reform, as of January 1, 2018, section 1031 like-kind exchanges of virtual currencies are disallowed and, other than a couple of narrow exceptions, losses (for example, theft via a hacked wallet) are no longer deductible for tax purposes.

Correlation and Pricing

Cryptocurrencies are a highly volatile asset class that can experience extreme price fluctuations over short periods of time. Most cryptos are highly correlated with each other, although there are relatively new types of cryptocurrencies called stablecoins that are pegged to a fiat currency such as the U.S. dollar. While cryptos are not directly correlated with broader equity or commodities markets, there is potential for increasing correlation.

Several OTC investment vehicles and futures currently trade on the two Chicago exchanges. Intercontinental Exchange, or ICE, (the parent company of NYSE), NASDAQ, Fidelity, and TD Ameritrade have all independently announced institutional-focused offerings that are expected to be rolled out over the coming year. The SEC has not approved any ETF proposals, but that could change at some point in the near future. 

Public speculation is that if the SEC approves ETFs, then institutional investors will enter the space en masse, potentially leading to an increase in the price of many cryptoassets, but it remains to be seen how this will all play out. There is significant liquidity risk for some cryptocurrencies that are thinly traded, particularly tokens or coins that have been recently issued through an initial coin or token offering (ICO), the mechanics of which are similar to an equity IPO. There is no centralized exchange for cryptocurrencies, so investors are likely to encounter wide bid-ask spreads—this is how most exchanges make money—compared to more traditional assets.

Also, spot prices can often vary between exchanges depending on the cryptoasset and the depth of trading volume on that exchange for that particular asset. Most cryptoassets are deflationary because there is a limited supply of new coins or tokens that can be issued by the network over time (for example, Bitcoin), but there are some networks that are currently not, such as Ethereum. 

Theft and Digital Estate Planning

In theory, a cryptocurrency like Bitcoin could be used as an inflation hedge, much like traditional commodities such as precious metals. Cryptoassets held within an exchange or third-party digital wallet are susceptible to theft. It’s unclear which exchanges are adequately capitalized and insured to protect against loss due to theft, and indeed, many exchanges have been targets of cybertheft. Most property and casualty insurers do not write policies that cover consumers from loss or theft of crypto assets.

One of the most important but often overlooked considerations of cryptoassets is digital estate planning. Best practice would be to inventory the cryptoassets held by your client and ensure that instructions are left for the executor(s) on how to access the assets. Most crypto exchanges and third-party digital wallet providers control the private key to your client’s wallet, but for those clients who have access to the private key, it is extremely important that it be stored in a safe place offline, yet accessible to those who may need to access it in the event the client becomes incapacitated or dies.

A Few Best Practices

However you choose to advise your clients with respect to cryptocurrencies, it’s prudent that you communicate to them that they should only invest whatever they’re comfortable losing, because there’s a chance they might lose their entire investment. As a best practice, you should communicate this in writing to your client and have your client acknowledge in writing that he or she is aware of and understands the risks of investing in cryptocurrencies.

As another best practice, you should ensure that your clients understand how the cryptocurrency they are invested in, or would like to invest in, works. For example, do they have a basic understanding of the blockchain technology that underpins the cryptocurrency and what intrinsic features and/or functionality of the cryptocurrency make it a good investment in their eyes?

Some planners are hesitant to advise clients on cryptocurrencies, and for good reason, but some clients are comfortable with these types of assets and the risks inherent in holding them. As the technology matures and becomes more widely adopted, clients will increasingly expect their financial planner to know what’s happening in the crypto sphere, and they will seek guidance on how to best navigate this nascent asset class from a trusted adviser.

A version of this column was originally published by TXCPA Houston in their December/January edition of the Forum Magazine, available at​.

Investment Planning