Cryptocurrencies: how do they work and what does Czech law say about them?

What are cryptocurrencies?

Cryptocurrencies are a kind of virtual money. They are digital assets that work on the principle of decentralized blockchain technology. This means that no central entity (such as a bank or government) controls the network. Instead, the management of transactions and their verification is distributed among many independent nodes (computers). These nodes work together based on predefined rules. This makes cryptocurrencies more secure, transparent and resistant to censorship or fraud.

One of the most famous cryptocurrencies is undoubtedly Bitcoin (BTC). It was created in 2008 and has been operating as a network since 2009. It was intended to serve as an alternative to conventional money. The aim of Bitcoin was to provide its holders with financial independence without intermediaries – i.e. banks in particular. Other well-known cryptocurrencies include Ethereum (ETH), which allows the creation of so-called smart contracts in addition to payments, and Tether (USDT), which is a stable cryptocurrency pegged to the US dollar.

Cryptocurrencies can be used by their holders to pay for goods and services, to invest and speculate, to provide decentralised finance (e.g. bank-free loans) and to protect their finances from inflation.

Other types of cryptocurrencies:

• Altcoins – Ethereum (ETH), Cardano (ADA), Solana (SOL), Polkadot (DOT).
• Stablecoins – USDT, USDC – their value is tied to traditional currencies.
• CBDC (Central Bank Digital Currencies) – digital currencies of central banks that may compete with cryptocurrencies in the future.
• Meme coins – Dogecoin (DOGE), Shiba Inu (SHIB) – often speculative assets.
• Utility tokens – used to exploit specific blockchain projects.

The main (dis)advantages of cryptocurrencies

One of the main advantages of cryptocurrencies is undoubtedly decentralisation. Cryptocurrencies are not controlled by anyone and are not controlled by any central authority in the form of a bank or a government. All transactions are traceable thanks to transparency. Compared to regular transactions, those with cryptocurrencies are faster and at lower fees. In addition, some cryptocurrencies allow private transactions, so payments can be anonymous. And the blockchain technology on which they operate is also secure and resistant to manipulation and fraud.

But then, of course, there are drawbacks. Perhaps the biggest one is volatility, the fact that the price of cryptocurrencies can fluctuate wildly. Furthermore, you have to deal with legal uncertainty when buying and trading them, as cryptocurrencies are not clearly regulated in many countries. And they are also at risk of losing access, as the moment you forget the password to your cryptocurrency wallet, you could lose your funds irretrievably.

How do cryptocurrencies work?

Cryptocurrencies work on the basis of blockchain technology. This ensures the aforementioned security, decentralization and immutability of transactions. You can think of the blockchain as a digital ledger that records all transactions made using cryptocurrencies on the network. Each new record (block) contains information about transactions and is also linked to previous blocks. This creates a chain of blocks. Thanks to this system, the data cannot be changed retroactively, which contributes significantly to the transparency and trustworthiness of the entire system.

In order for a particular transaction to be valid and to be entered into the chain, it must go through a verification process. There are several mechanisms that are used for this. The well-known Bitcoin uses the so-called Proof of Work (PoW). In this case, the entire Bitcoin network consists of miners (miners) who compete to be the first to solve a complex mathematical problem. This task is extremely computationally intensive, so you need to have a device with specialized hardware. Once one of the miners solves the problem, they create a new block of transactions and add it to the blockchain. Other nodes in the network then verify the correctness of the solution. The miner who successfully mined the block receives the newly mined cryptocurrency as a reward.

Critics of this system cite that PoW consumes a large amount of energy because mining requires a huge amount of power. This then has an impact on the environment. The disadvantages include the need for expensive hardware if one wants to be a miner.

What does the law say about cryptocurrencies?

In the Czech Republic and the European Union, cryptocurrencies are subject to specific legal regulation. This affects their use, taxation and obligations related to their exchange. Cryptocurrencies are not considered legal tender in the Czech Republic. Nevertheless, their ownership and trading in cryptocurrencies is legal. As cryptocurrencies are not considered an official currency or legal tender in the Czech Republic, they legally fall under the category of intangible assets. This means that they are treated similarly to other assets (e.g. shares or securities) and are subject to specific tax rules.

All service providers, exchanges and cryptocurrency exchanges must comply with anti-money laundering rules and identify their customers under European and Czech regulations. So if someone wants to buy cryptocurrencies through a regulated platform, they have to go through an identity verification. This process is to prevent cryptocurrencies from being used for criminal activities such as terrorist financing or tax evasion.

Mining cryptocurrencies is considered a business in the Czech Republic, so it is subject to social and health insurance.

Cryptocurrency exchanges and bureaux de change in the Czech Republic must keep records of their customers and their transactions. Banks can refuse to work with cryptocurrency entities if they fail to comply with anti-money laundering rules. In addition, under the new European regulation, cryptocurrency payments that exceed the €1,000 threshold may be subject to additional controls.

In addition, since last year, the European MiCA regulation has also been in force in the Czech Republic, which aims to unify the rules for cryptocurrency markets across EU member states and ensure a safer and more transparent environment for investors and users of cryptocurrencies. Among other things, MiCA requires exchanges and exchangers to obtain a license from the CNB or another EU regulator.

What about the taxation of cryptocurrencies

In the Czech Republic, you have to tax the profits you make from cryptocurrencies. The method of taxation then depends on whether the cryptocurrency trading is carried out by an individual or a company.

Individuals pay 15% income tax on cryptocurrencies (or 23% on income above CZK 1.582 million per year). In this case, the difference between the purchase price and the sale price is subject to income tax (if someone buys Bitcoin for CZK 500,000 and sells it for CZK 800,000, then they must tax CZK 300,000). This tax must be paid when the cryptocurrency is exchanged for another cryptocurrency and for goods or services.

In addition, the so-called time test has been in force since February this year. This means that cryptocurrencies held for more than 3 years no longer need to be taxed. If your crypto income does not exceed CZK 100,000 per year, you also do not pay tax. If you want to apply this time test, you need to provide proof of your cryptocurrency holdings – for example, a stock exchange statement. However, you will not apply this new feature until your 2025 tax return.

For legal entities, they must keep accounts in crowns and record cryptocurrency movements. Gains and losses from exchange rate differences must then be reported in the accounts. Businesses in the Czech Republic are allowed to accept payments in cryptocurrencies, but they must record them and convert them into koruna at the current exchange rate. If a merchant accepts Bitcoin for CZK 1,000, he must record it as CZK 1,000 income in his books. If the exchange rate of the cryptocurrency rises and the trader sells it at a higher price, he must tax the profit.

You will not be taxed when you pay for goods or services with cryptocurrency, for example, on an e-shop. In legal terms, this is an exchange of cryptocurrency for another “commodity”, so the difference between the purchase price and the price at the time of spending must be calculated. The exchange of cryptocurrencies (e.g. BTC for ETH) is also considered a taxable transaction. The income in this case is the market value of the cryptocurrency received in crowns at the time of exchange.

In the tax return, income from cryptocurrencies is reported in the Other income box.

Cryptocurrencies are usually not subject to VAT unless they are services related to exchange trading or mining.

Summary

Cryptocurrencies are digital assets that operate on a decentralized blockchain technology that provides transparency, security and resistance to censorship. This includes not only the well-known Bitcoin, but also other cryptocurrencies such as Ethereum and Tether, which offer various uses such as decentralised finance or inflation protection. Yet cryptocurrencies also have drawbacks, such as volatility and legal uncertainty. In the Czech Republic, cryptocurrencies are considered intangible assets and are subject to specific tax rules. Taxation varies depending on whether cryptocurrencies are held by individuals or companies. European MiCA regulation and Czech legislation provide a transparent and safer environment for cryptocurrency trading, with an emphasis on preventing money laundering and controlling transactions.