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Tales from the Crypto Webinar Part 2: How Does Cryptocurrency Income?

Michelle O’Neil:


Hi, I'm Michelle O’Neil with OWLawyers and we are going to present to you the next part of the Tales From the Crypto webinar, dealing with cryptocurrency and the divorce in Texas. So this is a webinar or proof for 2.0 hours of credit. This is section number two and I am still joined by Andrew Speer who is known at our office as the smart lawyer because he knows all about these little technology issues that I really don't even understand. This portion of the webinar, we're going to talk about how cryptocurrency produces income, which obviously can be important if you're in the middle of a divorce litigation. So Andrew, how does cryptocurrency produce income?

Andrew Speer:


There's basically two or three main ways. You can do basic trading, get your capital gains. Bye low, sell high. That's the easy one, everyone can get that. The second most common is probably by mining cryptocurrency, like good old gold, silver miners, remember that? Except you're using a computer, you're using a graphics card for the most part. There is a new algorithm actually coming out that goes back to your CPU doing it. But regardless of what it is, you buy a computer part and you jam as many of them in there as you can, you install a program and it will actually validate the transactions. And so you get paid. Every validation creates a payment. It's called a block reward from mining. And so I have all my computers pointed at this one coin, doing all this work and over time, almost steadily, they will pay me out in a certain amount in that coin.

Michelle O’Neil:

Okay, so I am lost.

Andrew Speer:

Computers just sitting there making calculations.



Michelle O’Neil:


How are you earning money though? What is it doing to spin off income?



Andrew Speer:


So each transaction someone else makes has to be validated, right? And it has to show that two people didn't try to sell the same thing, right? I have something called my private address or my private key, which is the store value. The problem is you can just copy and paste that and so what if I try to sell it here and try to sell it there? To stop that you have to validate the transaction. And so you do that, every transaction is bundled into a block and these bundles, all the computers confirm that that is what occurred.

Michelle O’Neil:


Okay. So are you acting as the escrow agent for other peoples?

Andrew Speer:

No, you confirm. So for instance, on an exchange, they won't allow you to move those coins until 30 confirmations or something and so it'll be confirmed in different blocks in every single transaction in cryptocurrency ties to the previous one. And they're all one way. So you can almost go back to what's called the Genesis block, the first one that's split into two and then those went into two and so on and so on. And what you're doing with the mining is it's decentralized. It's a whole bunch of strangers all pointing their computers at the same program for a coin and that's called the network. Right? And you have a network hash rate and you are just confirming solving puzzles, which confirms that transaction is what occurred and there's a payment for doing so and that payment is how you make money. They pay you in Bitcoin. And so then you have to cash out somehow. That's one way, that's called mining. That's approved proof of work algorithm, a very simple view of it. If anyone out there is a big expert, that is the easy way of breaking that down by the way. And then there's another algorithm that is more common now called proof of stake.

Michelle O’Neil:

So what is a proof of stake? It’s not like the steak my husband cooks at home?

Andrew Speer:

No, unfortunately. Same idea, you got to validate the transaction but this one, you have to hold onto the coin. With a mining program, I don't have to own it. I can get rid of it right away. I have no vested interest in it besides selling it. With proof of stake, I have to own, it depends on the coin. Sometimes I need to own one or two or I can own very small amount. One currency is called Tron. And so I stake them, which is essentially I freeze them. I can't move them anywhere or do anything with them and by me having that many units, those units work together to essentially validate the transactions. They all agree this went through it. A good question you might want to ask. Speaking of Tron, so with Tron, I cast my vote, proof of stake. I have 10,000 of these things and I vote for team UK or something. Team UK gets however many votes, millions of them, right? And then they pay everyone who voted for them in either Tron, that same coin or sometimes they use a different coin called a Token. And that is a whole nother issue in itself. So you get paid for validating transactions, but you have to hold onto them. And they pay you essentially an interest rate, sometimes it's 5%, sometimes it's 2%, it's rather low. There is no really high yielding ones, but the trick is that doesn't show up anywhere for the most part, in certain situations. There's something called a node pool, I know this works with Dash. So if I don't have the required 10,000 units to do my own stake or have my own node, a whole group of people who don't have enough, can put all the resources together and then then they can validate it and they all share in that interest rate essentially. But to do that, I have to give them my coins, right? And I have the option of when I give him my coins, when I take it back, I can leave the interest in there, right?
I can take that same amount I put in and leave that interest in there and be like, here you go, you can have that's all I've got. And it's going to be very difficult to prove unless you have access to that node pool account. And so in a divorce case, let's say you've always had a hundred Dash right? And you moved it to one account and then it came back. Your public key for the most part would still show you can move it into that same old one. I've still got a hundred Dash everyone, right? But what really happened? You follow the chain around and you look at the preceding public key it was in and you see what does that public key do? If that public key has 40,000 transactions going in and 39,000 transactions going out, it's probably going to be a node pool or it's going to be an exchange. It's a red flag. If you go up the chain, you might be able to actually figure out, that was in a node pool and you know what? They never pulled out their interests. So there can be hidden money just sitting there and they just wait and wait and wait for the divorce to be done and pull it out. They've made their profit there, maybe they lose a little money in the process by dividing it, but they've never lost that interest. Right? If I pulled my a hundred out and I have to give you 50, I'm still keeping a hundred percent of that interest. You don't even have a clue it exists and so that's how it works. They normally pay out and specified periods of time. You can reinvest it to, you can compound it, which creates real big headaches for tracing.

Michelle O’Neil:

Goodness. I think my mind just blew up.



Andrew Speer:


Sorry. The staking is a new way of doing this that a lot of currencies are switching to because it gets rid of the whole, I just want to sell it for cash issue and people like receiving interest and I don't have to have all of these computers warring around wherever I'm at to make me money instead I can just freeze that amount of tokens and it's quiet and it's cool and no problem. But in both situations you will make a predetermined amount almost. It's going to be very close, it will change. The more people mining, the less each minor gets to an extent.

Michelle O’Neil:


So is this spinning off a lot of income or just a little bit?

Andrew Speer:

Depends.

Michelle O’Neil:

Okay, what does it depend on?



Andrew Speer:


Back in 2014, I think you could have had a six graphics card rig and you'd be making, I don't know with just six of them, maybe I'm going to ballpark here at $20 a day, $30 a day, which is a really high return. You used to be able to pay off the graphics card in three months. And then everything after that, and there were $300 or something, would be just pure profit after electricity costs. I would say with the mining, you might be able to make a few hundred bucks if you have a giant location, people make thousands. There's these things called mining farms, typically not in someone's house, but you can even,

Michelle O’Neil:

Because you have to have a computer that's doing all this generating.

Andrew Speer:

And you just, you need, sometimes they do it off site and if you didn't know about it, I can have my farm over there just churning away and I could pay the guy who's hosting the place in that coin. And you might not ever know if it's too late, if I've had it there for four years and you didn't have an inkling at the very beginning. I could have it offsite and you wouldn't know, you can remotely manage most of them now. But that's just for mining with this proof of stake, the income on there, it's just 5% of good rule of thumb, but then again, it depends on how much money you put in there.

Michelle O’Neil:


Right? Well obviously, I mean 5%, if you're getting 5% of $100, that's a certain amount. Or 5% of $1,000 is a different amount.

Andrew Speer:


So proof of stake is going to be percentage. Mining though, mining sometimes things fluctuate. So every now and then they cut down the mining reward. Your payment for doing the mining, those get halved and reduced. So early on when mining itherium was big, people were making, I wish I would have found this earlier, Michelle, I wish I'd talked to you. You could've told me to do this back when I was in law school.

Michelle O’Neil:


All I do is have the idea.

Andrew Speer:

I would have just been sitting there in my garage with a bunch of graphics cards and probably making like $100 a day just doing nothing or just maintaining it. And I'm not doing anything. Now you, you'll make a little less. But here's the thing, what a lot of miners did was they kept the coin. And if it's increased in price since then, you can't trace mining. It generates out of nowhere. It goes to a public address, but you can't link that to a bank account yet. It creates money from nothing. The only way to find it is by an electricity bill.



Michelle O’Neil:


Oh, okay. Because you have the computers sitting there genning all the time.

Andrew Speer:

And there will be very high.

Michelle O’Neil:

So could a internet company like know that you're doing in the internet a lot?



Andrew Speer:


No. Data is very low. Data, your smartphone is going to use a lot more than this cause you're just doing small little blocks. There's the block chain is what they're all on. The entire blockchain for any given coin is going to be gigabytes. It's going to be gigantic. Problem is you don't have to download the whole blockchain. We're just doing a little part and it barely uses any data. You can track it. It’ll be less. It'll probably use less than everything else in your house but it uses electricity. Electricity is going to be your red flag. Always pull the power bill. Request power bills in your request for production. I've started doing that more because if it is sky high and don't look at the dollar amount, always look at the kilowatt hours and look at it, you can track them over time cause sometimes they might have a flat rate power bill and it'll spike. It'll be obvious, that's how you check that.

Michelle O’Neil:

Obvious to you.

Andrew Speer:

Hopefully. Yeah.



Michelle O’Neil:


Maybe not obvious.



Andrew Speer:


Oh no, that's not right. Cause I know the kilowatt hour usage now. I know way too much about, I wish I never knew. I didn't ever pay attention to that. I just paid attention to dollar amount before. Now I'm actually watching kilowatts and monitoring them. But yeah that's something everyone needs to look for.



Michelle O’Neil:


And so you have these computers at your house that are doing this mining. And so if somebody looked at your electric bill, then they would say, Oh, he's mining.


Andrew Speer:

Or I'm running the AC at 50 degrees and have 10 Jacuzzi's going or something.

Michelle O’Neil:

Yeah. Well, right now that'd be a good thing because it's awfully hot outside. All right. So if they're paying for this work or whatever, if they're paying you in more cryptocurrency, then isn't that creating a problem with the PR pricing of cryptocurrency?

Andrew Speer:

Yeah, the inflation rate.

Michelle O’Neil:

So talk about that. How does that create the inflation and what do you do about it?

Andrew Speer:

So it's a double edged sword, right? All of the minors just want to keep mining and making money off of it and all of the people who actually are holding, the investors, they don't like that new units of cryptocurrency are being introduced all the time. So certain algorithms, for the most part, they go back to the having. Your reward for mining is reduced over time and by doing that, you slow down the inflation rate. I think right now they're aiming at a 2% inflation rate is there a goal with Etherium and Etherium is even taking the big leap. What they are trying to do or have been trying to do for years is moved to a proof of stake. Switch algorithms..

Michelle O’Neil:

From proof of work to proof of stake. I said that like I knew what I was talking about.

Andrew Speer:

Yeah you did, you nailed it. Everyone is very doubtful of this, but supposedly it's gonna start in January of 2020. Who knows, they’ve been trying for a long time and it hasn't happened, but that's how you stop the inflation is you reduce the reward. But then again, you're in a situation where you actually need people confirming your transactions or else it'll take two years to send someone anything.


Michelle O’Neil:


So is this income earned from mining or proof of stake or proof of work or whatever. Is the income earned from that? Is that something that you should report on your taxes income or does it go into the capital gains as a gross?



Andrew Speer:


I reported it, I believe as income. I don't remember, whatever my CPA said to do. I know that, so when I sold it, that's just pure profit to me. Or it was just as part of my income. I wouldn't count that as a capital gains unless



Michelle O’Neil:


Well the capital gain is the growth of one of the Bitcoins over time.

Andrew Speer:

Yes. I have to hold it for a very long time.

Michelle O’Neil:

Right. But then the payments for doing the mining would be income?



Andrew Speer:


That would just be income. That's just income, I guess if I held it for a long time.

Michelle O’Neil:

You have some capital gains on it.

Andrew Speer:

Mostly income from mining. Most people are mining to sell it cause you normally want to pay your power bill with that and so that's the big balance is.



Michelle O’Neil:


So do you really make a profit like because of the power bill, like if you pay your power bill and include that as a

Andrew Speer:


You make a profit and in the winter you actually save money because you don't need to use a heater.

Michelle O’Neil:

Oh because your computer generates a lot of heat.

Andrew Speer:

yeah, they're turning out a lot of heat. And so in the winter it's actually kind of great for me. Dog loves them. So in most cases you'd never mine if it profitable and you can track the wattage and things like that.

Michelle O’Neil:


So this seems a little bit different from how traditional stock works. I mean, a traditional stock grows in value and it may spin off dividends, but this seems to be a whole different category of income that you don't have with stock. Like you don't get to sit there with your stock and have it work and make money.

Andrew Speer:


I guess just the dividend. That'd be it. And that would be like the proof of stake almost. That'd be closest equivalent, but the mining is definitely a completely different beast.

Michelle O’Neil:


So the mining is like having your little stock certificates out there and doing a job.

Andrew Speer:

Yeah. And yes, it'd be like the employees, it would be like,

Michelle O’Neil:

You have to like boil it down to simple terms for me.



Andrew Speer:


If that little certificate was given me money on its own, I think a mining, you can fit a lot of them in a small area and it would be very hard for someone who doesn't know anything about this to tell you approximately how much money that machine should make. So that's something people should keep in mind. And also there's a resale value for every single one of the graphics processor, GPUs in a mining rig.

Michelle O’Neil:

So in your computer, when you say mining rig, you're not talking about like your little pick axe, right?


Andrew Speer:

Oh no, it's talking about the computer. Now all of these essentially cards lined up and each of those probably is going to be able to sell for at least half of what you purchased it for. And so you're going to make the money that you made mining, you can sell it off, make money there. Cause you will sell it. And so that's something people need to keep in mind in their inventories and appraisements. There's an actual very easy number that you can value a used mining computer at. And I mean on eBay you'll be able to see what the prices for this type of card. Or there's other websites too and you can see what each type of card should generate, how much revenue it should make and how much power it should use. I think its called whattomine.com. You can click it and enter it and so you can actually value, you can figure out how much they should be making off of that computer and if they tried to give you some wild guess.


Michelle O’Neil:


So does a mining computer look like just any other computer or is there a way to tell that you have a mining computer?


Andrew Speer:


So there's new cards out. You could have a computer or just with one in there and you wouldn't really be able to tell, but it won't make you much money. It'll make you two bucks a day or something. The way to make it profitable is you have six to eight cards. You can go up to 13 normally. It almost looks like a cage. It's like a metal box with just like tubes, like PVC pipe almost. And it will just literally be a whole bunch of these cards. It'll be loud.



Michelle O’Neil:


Maybe we can put a picture of that in the comment.

Andrew Speer:

Yeah, absolutely.

Michelle O’Neil:

So we'll know what one looks like.

Andrew Speer:

They're pretty obvious, they have closed off ones that will be harder to tell what

Michelle O’Neil:

If its closed off, does it look like a tower computer or a server?

Andrew Speer:

It'll look like a server. It'd just be a black box and those would be harder to distinguish. But if you see something like that, you want to look into it and they'll just be sitting there doing nothing. You normally don't have the monitor attached to it or keyboard, it'll just be a computer sitting there for some reason, just whirring away. And that's what you got to look out for because one, it's producing money and two, it's worth a lot of money. The newer cards you buy, the resale is even higher than 50%, and that's better than most assets in a house, right? When you try to do an estate sale on furniture and things like that, 50% if you're lucky I think. And so people need to keep that in mind when valuing estates.

Michelle O’Neil:


So that's going to be an asset to list in the inventory. And so is there a way to or maybe you already answered this, but is there a way to predict how much is earning from all of this process?

Andrew Speer:


So if I can log into it, I can tell. If I have the public address it delivers money to, I can tell. If I don't, I can look at each card and then write down the make model. It's like a car almost, make model and just stick with that and then I can plug them in and try to figure out what their hash rate should be. It's the hash rate is it's speed, like how many calculations it does. They measure them in per seconds. And then for each card in that computer, I should be able to say it can do 200 mega hashes a second or something like that. And then I'll know approximately what the power draw should be on each card. Some people tweak them. That's a whole nother story, but I should be able to estimate it. I need to know the specifics about it, but I should be able to, if I can log into whatever program they're using, that's even easier and then I can take their hash rate and use it by the block reward. You know how much you get per day, per hash, and then you can actually go per year, per day, per month, whatever you want, but it will be almost constant. There's some deviations, paying you in that coin and it should be predictable and work almost like a clockwork. You receive 0.05 every three days.


Michelle O’Neil:


And so then if this is producing income, that's something that ought to be reported on some tax returns somewhere. So if we're honest with the IRS…

Andrew Speer:

If you don’t then they're going to get you, that's my perspective.



Michelle O’Neil:


Well of course. I mean the universe has a way of working itself out, but what it sounds to me like the IRS is probably got some problems even learning that this income is out there. Cause it's not like they're filing a 1099 on it.

Andrew Speer:

I don't remember which part you filed, but yes, they're not.

Michelle O’Neil:

I mean they're not filing a form of any kind.

Andrew Speer:

And some people will run their mining rig through a VPN, a virtual private network, and I can make that VPN say that I am in Sweden. And all they see is a tunnel of data leaving. They have no clue what's on it and so it'll be even harder to trace in that aspect. I can receive it anywhere in the world that way, even though I'm just sitting here in Dallas. That's a bigger problem too, but the IRS would have no idea until I cash out. And then they're going to have to link back and back and back. And if you do it far enough, you might be able to find out that it came from a mining pool. There's also something called solo mining, where I basically plug straight into the network and it's just me alone going at it. And that's gonna be really hard to trace. That's even more difficult and in most cases when people are mining, they have enough minors or enough mining equipment to make it worthwhile and something significant. If it's not generating, $1000 bucks a month or something. If you sell it, it's going to be worth a few thousand. It should be. And that's kind of the takeaway with mining. There's a secret asset there that people like to forget they just think it’s a computer. It's got the multiple parts, the most expensive part of a computer in it.

Michelle O’Neil:

How much are we talking about? What does a mining cart cost?

Andrew Speer:

A good one? There's one, the most efficient one right now costs $670. Then there's other ones, typically $250 to $350. If you go buy used ones, a hundred something, $150…

Michelle O’Neil:

Do you buy them at Microcenter or?

Andrew Speer:

You could probably try a Microcenter. EBay is a great place. I would always, if you think they're mining, go check, ask them for their eBay transaction history because buying a used card is not bad when it comes to mining. And so if you see they're buying a whole bunch of used X, Y, Z cards, they're probably mining cryptocurrency cause there's certain cards that are very good at it and certain cards that are very bad at it. And so they keep on buying these certain ones that are very good. There's no other reason to have 20 radion RX 470s. You wouldn't, it's makes no sense. They're mining and their power usage is really low on those and their yields really high.


Michelle O’Neil:


So you talked about a little about tracing. So in the next segment we're going to move to tracing and so this wraps up the second segment of our Tales From the Crypto webinar. The next segment will be on tracing cryptocurrencies. We're going to take a real quick break and we'll be right back. Keep in mind that this is a webinar that's aimed at attorneys. This is for continuing legal education. If you're out there watching this webinar and you're not an attorney, we welcome you to watch it. But remember that we are not giving you any specific legal advice. We cannot comment on any specific case or situation without knowing all the facts. So if you need legal advice, this webinar is not a substitute for legal advice. Please, please seek the advice of a lawyer as to your specific situation and get specific advice to that. Because if you rely on just what we're talking about here, we're being general, we're talking about general legal principles that may not actually apply to your situation. This is for continuing legal education only and we cannot create an attorney client relationship just through the video camera. Okay. Thanks.