Cryptocurrency trading can be like an emotional rollercoaster. When we present financial statements to clients, they are surprised to see their trading volume. It’s nearly always higher than they expected. They have transacted with cryptocurrency going back and forth, in and out, and around multiple activities, exchanges and platforms.
One of the most crucial risk factors for cryptocurrency clients is their record keeping: specifically, the lack of it.
Every single transaction, buying, selling, trading, LP, farming, loans, or reward tokens, must be captured, accounted for, and reported. It doesn’t matter if it’s only ’a little bit’. If one transaction is missing, the entire portfolio doesn’t reconcile.
If transactions history is missing, it raises questions about how you acquired or disposed of the token. It’s like money disappearing (or appearing) in your bank account and not having any record or recollection about what it is.
You can’t sell a token you never purchased, yet, some trading records will show taxpayers selling tokens that they have no record of acquiring. This is practically impossible and creates confusion, frustration, risk and exposure to IRD.
Prevent reconciliation issues and keep good cryptocurrency records. We recommend the following.
The linked article (a short 2-minute read) explains a mindset shift from being an amateur (making it up as you go along) compared to being a profession. Some of my favourites that I think relate to cryptocurrency activity:
- Amateurs have a goal. Professionals have a process.
- Amateurs don’t know what improves the odds of achieving good outcomes. Professionals do.
- Amateurs focus on identifying their weaknesses and improving them. Professionals focus on their strengths and on finding people who are strong where they are weak.
- Amateurs think good outcomes are the result of their brilliance. Professionals understand when good outcomes are the result of luck.
- Amateurs focus on the short term. Professionals focus on the long term.
Read further here: Hidden Complexities of Buying Cryptocurrency for Someone Else.
Implement a robust record-keeping system
We’ve outlined the information we need to prepare financial statements here. Knowing this information is required, what can you do to prepare and ensure you have all this information available?
The gold standard (for now) is a cointracking.info account that is linked to all your exchanges, wallets, and transactions. However, it’s only as good as the information uploaded and linked. Cointracking software can run a report of your closing quantities (based on the trading data), and you can compare them to what you are actually holding in your wallets. This is a fundamental check to ensure that all transactions are captured and should be completed regularly.
For some clients, we prepare quarterly (or monthly) management reports. Read further about the Benefits of Frequent Financial Reporting for your Cryptocurrency Activity.
Imagine you own a car dealership (sales yard) and have 20 cars for sale. Throughout the year, you buy ten more cars from suppliers and sell ten cars to customers. You have the invoices for the purchases and sales. But, at the end of the year, you only have 18 cars in the yard. Something isn’t quite right. You started with 20, purchased ten more, and sold 10. You should still have 20 cars on hand.
You only have 18 cars on hand, so you write off two cars (and claim a deduction for the cost price because you don’t have the cars in the yard) and file your tax return. IRD knows that the car price (or crypto) has increased during the year. Therefore, they are surprised that your profit isn’t as high as expected. IRD issue you a notice requesting information, ask questions and then go down a rabbit hole.
In the case of the two cars (the variance), maybe they were at the mechanic getting a service, or the cash wash getting cleaned up and ready to sell, or maybe they had been paid for and therefore included in the closing stock tally’s, but were still on the boat from the overseas supplier (therefore not in the yard).
It is this problem-solving that creates most of our difficulties trying to reconcile portfolios. We don’t know what we don’t know. We need clear information from you about your holdings.
Simplify your activity
Do you need to have seven different exchanges, 65 tokens, and thousands of trades to achieve your goal?
Our most successful clients (who own $10m+ of cryptocurrency) own less than 15 tokens, have less than 200 trades, and use one or two exchanges, plus a fiat on/off ramp. They stick to their bread and butter and let winners run. They don’t change their mind daily or go hunting for random tokens on random exchanges from a social media tip-off. They have a simple activity that results in their success.
- Be a professional,
- Don’t buy, sell, or transaction on behalf of someone else.
- Implement a system to record, maintain, and track your cryptocurrency holdings like a business.
- Complete regular reviews
- Consider frequent financial reporting
- Create checklists to ensure everything is completed, accurate, and documented
- Make notes about your activity. Especially one-off events that are unusual
- Simplify your activity
Contact Tim Doyle for a call or meeting to discuss any cryptocurrency tax or accounting questions. Our office is in Cambridge, Waikato, or we can arrange a video conference call.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.