The Taxation of Income from Cryptocurrencies in Various Jurisdictions (Part 1): Understanding Cryptocurrencies
By Santiago Lapausa, JC&A Abogados
Back in 2007, Satoshi Nakamoto (a person or entity whose identity is unknown as of today) who introduced a white paper called “Bitcoin: a peer-to-peer electronic cash system” in response to the financial crisis, believed that banks and institutions should not be exclusively relied upon to process transactions.
Cryptography is the science of codifying messages so that only the sender and receiver can read them. The easiest way to understand this concept is by using the analogy of public keys as a normal lock, private keys as the keys to the lock, and boxes as a way to store and transmit messages. When you want to convey a message securely, you send it in a locked box that only a private key can open.
Authentication is the act of ensuring a message is indeed from the sender.
Confidentiality guarantees that only the person who the sender addresses the message to is able to read it.
The same applies to transactions in the blockchain: money sent by someone can only be accepted by the person who is supposed to receive it.
A hash is a short description of compression of a piece of data created using a mathematical function and algorithm. It is a oneway function because it is impossible to go back as you can get the same output from multiple inputs.
The blockchain is like a digital ledger that stores transactions. This record verifies transactions by checking blocks of data in the digital ledger. Everyone in the network has a copy of the ledger as it is public and not owned by anyone. Thus, once a transaction is confirmed on the blockchain, it cannot be removed, modified, changed or reversed.
Each block of data has a reference to the previous block, and this is what places them one after another, leading to the term blockchain. It takes 10 minutes on average to add a new block to the blockchain. This confirmation time per block was chosen, and Bitcoin recalibrates it as more miners join the network, speeding up the process to ensure it takes 10 minutes at least to be solved. Each transaction is verified by solving mathematical puzzles with the help of computers. The so-called miners solve these puzzles by verifying the transactions, and receiving cryptocurrencies in exchange. Because the math problems involved in confirming a block on the blockchain are so hard, it is impossible for an attacker to fake a block or to verify fraudulent transactions. A hacker is not only facing a single user but the entire network. Transactions are replicated in the whole network, so for a hacker to modify a transaction, it has to be changed in every computer.
Therefore, mining is not about creating new bitcoins, but validating new transactions and recording them in the global ledger (the blockchain). When a block is solved, the transactions contained are considered to be confirmed. It secures the Bitcoin system by decentralising. The miner that can solve the problem gets the reward.
Santiago LapausaJavier Carretero y Asociados – Abogados, Marbella, Spain
T: +34 95 292 46 56, F: +34 95 286 41 62
JC&A Abogados is a firm based in the city of Marbella, Spain, comprised of lawyers and economists aimed to provide local, national and international professional advice. We speak Spanish, English, French, Russian, German and Dutch.
Santiago Lapausa is a partner of JC&A Abogados. With a Bachelor degree in Economics and Business Studies, he joined the firm in 2003 to found and develop the tax department. Santiago is involved in all areas of general tax practice and specialises in non-residents and international tax planning.
Published: Spring 2019 l Photo: NicoElNino - stock.adobe.com