Crypto accounting is a practice of recording transactions that are to be done by crypto investors. There are different methods of crypto accounting used by investors, but what are they?
In this blog, we will talk about what crypto accounting is, its importance, different types of crypto accounting methods and implications for crypto investors.
What is crypto accounting?
Crypto accounting refers to categorising, recording and reporting cryptocurrency transactions for financial and tax purposes. You have to track all the transactions related to crypto like disposal, acquisition and exchange of digital assets along with calculating losses and gains resulting from transactions you did.
Cryptocurrencies work in a unique space between traditional currency and digital assets. They require specialized accounting approaches to reflect their tax implications and value as well.
Also Read: Snapshot In Crypto: What It Is And Why Matters?
Why do you need to do crypto accounting?
Here are the reasons for doing crypto accounting:
Portfolio management
Proper accounting helps in understanding your overall cryptocurrency portfolio status, allowing you to make more decisions for better investments to grow your portfolio.
Tax compliance
Many countries require reporting of cryptocurrency in their tax returns. So, proper accounting ensures you are accurately reporting your crypto-related transactions including all the gains and losses.
Audit preparedness
In the case of a tax audit, having proper crypto accounting details will help you show all your transactions without any issues.
Financial planning
By tracking all your crypto transactions, you can see where you can invest next what risk management precautions you should be taking and make better decisions related to your next buy and sell.
Legal protection
If you keep a record of all your crypto transactions it will help you only from any legal issues in the future related to tax or income.
Crypto Accounting Methods
There are different types of accounting methods for cryptocurrency transactions. Each has its own advantages and implications. Take a look at some:
First in, First out ( FIFO )
In first in, first out, it assumes that the first units of any cryptocurrency you buy are the first ones you sell as well. This method is very direct and widely accepted by tax authorities in plenty of countries.
Pros:
- Results in lower capital gains taxes for long-term holders.
- Simple to understand and very direct
- Simple to implement
- Accepted in different countries
Cons:
- It may not always minimize your tax liability
Last in, First out (LIFO)
The Last in, first out method assumes that the units you purchased recently are the first ones you sold. This method can be very advantageous in a market that is moving up where recent purchases are likely to have a higher price basis.
Pros:
- Useful for active traders who want short-term profits in a rising market
- It can potentially reduce short-term capital gains in a rising market
Cons:
- This method can lead to higher taxes in a falling market
- This method is not accepted in many countries
Highest in, first out ( HIFO )
In Highest in, first out it is assumed that all the units with the highest purchase price are sold first. It is designed to minimize capital gains taxes by maximizing the basis of sold units.
Pros:
- It is beneficial in highly volatile market conditions
- This method can slightly reduce your capital gain taxes
Cons:
- It is quite tough to calculate and track
- It is not accepted in all countries
Average cost basis methods ( ACB )
The average cost basis method calculates the average cost of all units purchased and it also uses it as a cost basis for all the sales done. By using this method you can simplify your record-keeping but you may not always get the result in the lowest tax liability.
Pros:
- It reduces the impact of price volatility on tax calculations
- It also simplified the calculations, especially for traders who trade almost daily
Cons:
- This method may result in higher taxes compared to other methods
- It is not accepted in many countries
Read More: A Comprehensive Guide On Crypto Copy Trade
Overall
Crypto accounting is a very important step every trader should take as it is an important part of participating in the digital asset ecosystem. By understanding the methods listed above you can ensure your tax compliance and maintain clean records of all your crypto transactions.
