What Are Virtual Assets & How Do They Work?

These digital forms of value are reshaping how transactions occur and how individuals hold and transfer wealth. As technology continues to evolve, these assets are gaining broader adoption and influencing various aspects of finance and commerce. This article aims to clarify what virtual assets are and how they function within this evolving landscape.

Defining Virtual Assets

Virtual assets represent digital forms of value that can be traded, transferred, or used for payments and investment purposes. They exist exclusively in digital form, meaning they lack a physical counterpart like traditional currency or commodities. This intangible nature allows for seamless digital interaction and movement across networks.

The Internal Revenue Service (IRS) generally treats virtual assets as property for federal income tax purposes, similar to how stocks or bonds are treated. This classification means that transactions involving virtual assets can trigger tax obligations, such as capital gains or losses, depending on the change in value from acquisition to disposition. For instance, if an individual sells or exchanges a virtual asset, any gain or loss is recognized as the difference between the asset’s cost basis and the amount received in the exchange. The IRS now specifically includes virtual currencies, stablecoins, and non-fungible tokens (NFTs) within its definition of digital assets. Taxpayers must accurately report income and gains from virtual asset transactions to avoid penalties and interest.

Brokers and virtual asset service providers are increasingly required to report transaction details to the IRS. Starting in 2025, new Form 1099-DA will be used to report the gross proceeds from sales and exchanges of digital assets. By 2026, this reporting will also include the cost basis, which simplifies the calculation of gains or losses for taxpayers.

Common Categories of Virtual Assets

The landscape of virtual assets includes several distinct categories, each serving different functions.

Cryptocurrencies

Cryptocurrencies are perhaps the most recognized type, operating as digital currencies secured by cryptography and typically decentralized, meaning they are not controlled by a central bank or government. Examples like Bitcoin and Ethereum allow for peer-to-peer transactions and can be used for payments or as a store of value. When an individual earns cryptocurrency, such as through mining or staking, it is generally considered taxable income at its fair market value upon receipt.

Stablecoins

Stablecoins represent another category, designed to maintain a stable value by pegging their price to a more stable asset, such as a fiat currency like the U.S. dollar, or commodities like gold. This pegging aims to reduce the price volatility often associated with other cryptocurrencies, making stablecoins potentially more suitable for everyday transactions and cross-border payments. While their value is intended to remain constant, stablecoins are primarily transactional tools rather than investment vehicles for capital appreciation.

Non-fungible tokens, or NFTs

Non-fungible tokens, or NFTs, are unique digital tokens that represent ownership or proof of authenticity for specific items, which can be digital or physical. Unlike cryptocurrencies, each NFT is distinct and cannot be replaced by another identical item, making them suitable for representing art, collectibles, or in-game items.

Tokenized traditional assets

Tokenized traditional assets involve representing real-world assets, such as real estate, commodities, or even company shares, as digital tokens on a blockchain. This process allows for fractional ownership, enabling investors to own a portion of an asset that might otherwise be indivisible or illiquid. The goal is to increase accessibility, liquidity, and efficiency in trading these assets by leveraging distributed ledger technology.

Key Characteristics of Virtual Assets

Virtual assets possess distinct characteristics that set them apart from traditional financial instruments.

Decentralization

Many virtual assets, particularly cryptocurrencies, exhibit decentralization, meaning they operate on distributed networks without a central authority like a bank or government. This structure fosters a peer-to-peer environment where transactions are processed and verified by network participants, rather than a single intermediary. This distributed control can enhance resilience and reduce reliance on traditional financial institutions.

Cryptographic security

Cryptographic security is another fundamental characteristic, employing advanced encryption techniques to secure transactions and verify asset ownership. This security helps protect against fraud and unauthorized access, maintaining the integrity of the digital ledger where these assets are recorded. Each transaction is cryptographically linked, creating a secure and transparent record.

Immutability

Immutability, especially in blockchain-based virtual assets, refers to the inability to alter or delete recorded transactions. Once a transaction is added to the blockchain, it becomes a permanent part of the ledger, which enhances transparency and auditability. This characteristic provides a verifiable history of ownership and transfers, making it difficult to dispute or reverse transactions. The permanent nature of these records contributes to the overall security and trustworthiness of virtual asset networks.

Global accessibility

Global accessibility allows virtual assets to be transferred across borders with relative ease and speed, often bypassing traditional banking hours and international transfer fees. This global reach can facilitate cross-border commerce and remittances, offering an alternative to conventional financial systems.

Programmability

Many virtual assets are programmable, meaning they can be embedded with specific conditions or rules that automatically execute when certain criteria are met. This programmability enables the creation of sophisticated financial applications and automated agreements, expanding the potential uses beyond simple value transfer.