I'm not going to attempt to explain how the tax system works in its entirety because I don't know and it would be a horrible experience for both of us. However, comma, I know enough about our beloved Uncle Sam (because I have to pay taxes and all) to explain to the average Joe what the heck our warm and fuzzy IRS is going to do with folks whose Bitcoin and Ethereum have CENTUPLED (which means increased by 100x according to a guy on Yahoo! Answers). Let me say outright, it's kind of bs.
I don't know whether the IRS is unsure about how to handle cryptocurrency gains (because blockchain is still "new" technology) OR they're casually punishing cryptocurrency holders for valuing digital currency. Either way, the crypto-tax policy isn't playing very nice.
As it stands in the United States, we citizens can buy foreign currency as an investment and are only taxed when we convert that foreign currency to USD, regardless of whether it doubled (or centupled) in USD exchange value. The "gains" are simply treated as ordinary income.
For example, suppose I exchange $500USD for 5000 pesos. Twelve months later, the peso strengthens and now I can exchange it (for USD) with a $125 GAIN. The $125 is taxed as ordinary income. Suppose instead of exchanging pesos for dollars, I use the $125 to buy some expensive Tequila. The $125 is still treated as ordinary income. Suppose instead of the peso STRENGTHENING, it weakens in value and I lose $125. The $125 is now a loss and tax deduction.
Cryptocurrency on the other hand---despite every law of finance & commerce supporting it as a currency---is not considered a currency by the federal government. Cryptocurrency is treated as an asset, specifically "property." Now I'm not sure how many US citizens mortgage their homes in exchange for a Starbucks card or use a recreational boat to buy a trip to Vegas but apparently, the US government is convinced.
"Crypto as an asset" is just a little upsetting because cryptocurrency transactions are treated as "taxable events" AND crypto-holders have to pay long-term capital gains.
For example, suppose I exchange $500USD for 50000 altcoins. Twelve months later, the altcoin strengthens and now I can exchange it (for USD) with a $125 gain. The $125 is taxed at a 15-20% long term capital gain rate. Suppose instead of exchanging altcoins for USD, I use the $125 to buy a Starbucks card. The $125 gain is still taxed at 15-20% AND the action of purchasing a Starbucks card with the altcoin is considered a taxable event.
Bottom line: the IRS is punishing cryptocurrency holders with both extensive record-keeping rules AND significant taxes on the use of cryptocurrency. Which makes me really sad.