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Cryptocurrency Fundamentals: How It Works, Risks and Taxes

Cryptocurrency is a digital asset recorded on a blockchain. The IRS treats it as property, so sales and swaps are taxable, and prices are very volatile.

Cryptocurrency Fundamentals: How It Works, Risks and Taxes

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What is cryptocurrency?

  • Cryptocurrency is a digital asset recorded on a shared ledger, a blockchain, and secured by cryptography, so it can move without a bank in the middle.
  • Networks validate transactions through consensus methods: Bitcoin uses proof of work, and Ethereum has used proof of stake since 2022.
  • Bitcoin was designed as peer-to-peer digital money with a supply capped at 21 million coins; Ethereum is a platform for programmable smart contracts.
  • Stablecoins aim to track a currency such as the dollar; the GENIUS Act of 2025 created a federal framework for payment stablecoins.
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Full Guide

What is cryptocurrency?

  • Cryptocurrency is a digital asset recorded on a shared ledger, a blockchain, and secured by cryptography, so it can move without a bank in the middle.
  • Networks validate transactions through consensus methods: Bitcoin uses proof of work, and Ethereum has used proof of stake since 2022.
  • Bitcoin was designed as peer-to-peer digital money with a supply capped at 21 million coins; Ethereum is a platform for programmable smart contracts.
  • Stablecoins aim to track a currency such as the dollar; the GENIUS Act of 2025 created a federal framework for payment stablecoins.

Main risks

  • Prices are extremely volatile; Bitcoin has fallen more than 70% from a peak more than once.
  • Crypto assets generally produce no cash flows, so value depends on adoption and demand.
  • Hacks, fraud and platform failures, such as the FTX bankruptcy in 2022, have caused large investor losses.
  • Laws and regulation continue to change, in the U.S. and abroad.

How can crypto be held?

  • On a trading platform that holds it for you, which adds counterparty risk; if the platform fails, customers may be treated as creditors.
  • In a self-custody wallet, where you control the private keys, and losing them generally means losing the assets.
  • Through exchange-traded products; spot bitcoin products began trading in January 2024 and spot ether products later that year.
  • Those products are not registered under the Investment Company Act of 1940, so they lack some protections that mutual funds and most ETFs have.

How is cryptocurrency taxed?

  • The IRS treats crypto as property, so selling it, swapping it for another token, or spending it can produce a capital gain or loss.
  • Staking and mining rewards are ordinary income when you gain control of them.
  • Brokers report gross proceeds on Form 1099-DA for 2025 sales, and cost basis for covered assets acquired in 2026 or later and held at the same broker.
  • Form 1040 asks every filer about digital asset activity, and records of basis matter most for assets moved between wallets or platforms.

Crypto in a broader portfolio

  • Position size is usually framed around how large a loss could be absorbed, given crypto's history of deep drawdowns.
  • Because prices move so much, crypto can drift far from its intended weight between rebalancings.
  • Donating appreciated crypto held over a year can avoid capital gains tax on the appreciation, but gifts over $5,000 generally need a qualified appraisal.
  • Estate plans need a way for heirs to access keys or accounts.

Key takeaways

  • Crypto is a volatile, cash-flow-free asset whose value depends on adoption and regulation.
  • Custody choice (platform, self-custody or ETP) changes the risks you take.
  • Nearly every sale, swap or spend is a taxable event, and 1099-DA reporting is phasing in.
  • Confirm crypto tax treatment and recordkeeping with a CPA.
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How Cryptocurrency Is Taxed in the U.S.

The IRS treats crypto as property: disposing of it can trigger capital gain or loss, and crypto received for work or staking is ordinary income.

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Crypto Tax Planning: Lot Selection, Losses, Staking, and Form 1099-DA

The IRS treats crypto as property: sales and swaps realize gains, and staking rewards are income. The wash-sale rule doesn't apply to crypto in 2026.

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Giving Crypto to Charity: Deductions, Appraisals, and Limits

Crypto held over a year and given directly to a qualified charity is generally deductible at fair market value, with no capital gains tax on the gain.

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