Bitcoin Cypherpunk

Bitcoin Threatens The Income Tax

How can the state levy taxation on that which they do not issue and cannot control?

As the age of cryptocurrency comes into full force, it will facilitate a subversively viable taxation avoidance strategy for many of the technically savvy users of peer-to-peer payment systems. In doing so, cryptocurrency use will act to erode the tax revenue base of national jurisdictions, and ultimately, reposition taxation as a voluntary, pay-for-performance function. In this post, I cover some of the benefits such a strategy will have for cryptocurrency investors, why our notion of taxation is ripe for disruption, and why cryptocurrency taxation is infact enabled by default.

The Siren Song of Tax Havens

Although investors have been lured by the siren song of tax havens for as long as governments have existed, none have existed with the legal and architectural characteristics found in cryptocurrency. By operating in a peer-to-peer nature, it is reasonable to forecast the impracticality of systemic taxation on these types of financial assets from national jurisdictions.

Although bitcoin operates behind a veil of cybersecrey, this pseudo-anonymity will not allow the subversion of national taxation. Rather, the principle reason that bitcoin will create a new form of tax haven, is that the State acts as an unnecessary third party in the conduct of payment within this system. From the perspective of bitcoin, recognizing the State as a legitimate entity is both cumbersome and unnecessary. What need is there for the State when business is conducted in a voluntary, peer-to-peer manner on a network which no one owns?

Running The Numbers on Cryptocurrency Taxation

It has been said that compounding interest is one of the most powerful forces in the universe. When we apply the black magic of compounding returns to the profit-maximizing actions of consumers, we see quite clearly why every user aware of the benefits of using cryptocurrency, even if only for the tax-savings, will opt to do so over traditional fiat money. The allure of avoiding the clutches of national taxation is strong enough that any rational consumer will make cryptocurrency a portion of their financial portfolio given they have the sufficient technical understanding.

“Each $5,000 of annual tax payments made over a 40-year period reduces your net worth by $2.2 million assuming a 10% annual return on your investments,” reports James Dale Davidson in The Sovereign Individual: Mastering the Transition to the Information Age, “For high income earners in predatory tax regimes (such as the United States), you can expect to lose more of your money through cumulative taxation than you will ever earn.”

James Dale Davidson, co-editor of Strategic Investment

Never before has there existed a tool that can preserve economic and informational assets with such a high degree of security combined with a near-zero marginal cost to the user. This revolutionary capability of the bitcoin network does, and will continue to provide, a subversively lucrative tax haven in direct correlation with its acceptance on a worldwide basis.

Government Response to Cryptocurrency Taxation

Many government agencies have already cued in to the tax avoidance potential of bitcoin and cryptocurrencies. However, it would seem that they misjudge this emerging threat looming over their precious tax coffers. The Financial Crimes Enforcement Network in the United States (FINCEN) for example, has already issued guidance on cryptocurrency taxation, yet makes a false distinction between real currency and virtual currency. FINCEN states that “In contrast to real currency, “virtual” currency is a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency,” and later “virtual currency does not have legal tender status in any jurisdiction.”

What these agencies fail to realize, is that cryptocurrency is not virtual in any sense of the word. Indeed it is as real, and perhaps even more real, than traditional fleeting fiat currencies. Currency is an abstract concept from the outset. If such currency is capable of purchasing real-world goods and services, then it is indeed real. Only the most careless investors would mistakenly believe money “does not have legal tender status in any jurisdiction” due to its digital makeup. Bitcoin, and cryptocurrencies as a whole, are creating a new jurisdiction entirely.

Bitcoin and cryptocurrency offer a near perfect alternative to traditional tax havens which are being tightly controlled by new laws associated with the Foreign Account Tax Compliance Act (FATCA). In his report Are Cryptocurrencies Super Tax Havens?, Omri Marian makes clear the pressure for financial institutions who interact with the US banking system to hand over account holder information, and for a collective crackdown on offshore tax havens with the enactment of FATCA in 2010. Such a legislative act, it would seem, is a boom for bitcoin’s antifragile position in the marketplace.

Tax policymakers seem to be operating under the faulty assumption that cryptocurrency-based economies are limited by the size of virtual economies. The only virtual aspect of cryptocurrencies, however, is their form. Their operation happens within real economies, and as such their growth potential is, at least theoretically, infinite. Such potential, together with recent developments in cryptocurrencies markets, should alert policy-makers to the urgency of the emerging problem.

– Omri Marian, Are Cryptocurrencies ‘Super’ Tax Havens?

Current bitcoin payment processors such as BitPay have recently revealed that government agencies are watching cryptocurrency transactions through the bottlenecks and exchanges where it can be tracked and traced with a high degree of transparency. It should not come to anyone’s surprise that governments are watching cryptocurrency nor that companies are complying with their laws, but understanding why national governments require users of an emerging digital economy to cut them a slice of the pie while they contribute nothing to it’s operation, and in many cases, hinder the adoption of this technology, remains a callus mystery.

Governments initially attempting to control cryptocurrency taxation through the businesses and bottlenecks which it can be monitored through will have as much success as they have limiting peer-to-peer file sharing.

Old laws seldom resist the trends of technology. The attempt of government agencies to levy taxation on cryptocurrency transactions directly is as futile as attempting to regulate the direction of the wind. No matter the tool of choice, state actors will be overrun by continuously expanding waves of cryptocurrency adoption.

Cryptocurrency Is Taxed By Default

What would you say if you were told cryptocurrency taxation occurs on every transaction by default? In the realm of digital currency, the transaction fee which the user decides to (or decides not to) attach to each payment represents the taxation. This user can decide to attach a large fee or no fee at all. In doing so, the miners of the network will choose preference for the transactions with a larger fee attached. Thus is the nature of the mining fee incentive. Miners work to confirm these payments sooner than those with smaller fees.

This transaction queue represents a voluntary, pay-for-performance taxation structure where the performance derived from the system is correlated with the willingness to pay of the user.

Algorithmic Regulation

Cryptocurrencies have an inherent regulation, the peer-to-peer architecture they are built upon. Truly, bitcoin is code as law.

Cryptocurrencies have regulation built into the very nature of their existence, just not through our conventional ideas of human intervention. Because of the technological nature of cryptocurrency taxation, judicial regulations bestowed upon these types of systems will always be, to a large degree, futile.

Bitcoin has established it’s own set of rules through the source code which it is built upon. Forcing legal frameworks on this type of 21st century innovation will only cause unnecessary friction during its adoption phase.

The only choice of regulation we have in terms of cryptocurrency taxation is not to try and fit it inside some existing doctrine, but to abide by their laws of voluntary exchange and information freedom. We must be the ones to conform to the regulation, not vice versa.

Bitcoin is a system which will only be governed effectively through digital law, an approach which functions solely through the medium of mathematical technology. It will not bend to the whim of those who still hold conventional forms of law-making as relevant today.

For a successful technology, reality must take precedence over public relations, for nature cannot be fooled.

– Richard Feynman

When we come to understand the systemic subversion to judicial intervention, it becomes quite clear that cryptocurrency taxation will remain a voluntary, pay-for-performance function. No longer will taxation be enforced through coercion, but become a voluntary act towards increased system performance.

Mass taxation on bitcoin is infeasible through judiciary law. You, or anyone motivated to maximize their net worth, will find a subversive tax haven in the realm of cryptocurrency.

By Travis Patron

Travis Patron is the founder of Diginomics Corporation and the author of The Bitcoin Revolution: An Internet Of Money. He was an early adopter of both bitcoin and ethereum technology, and continues to educate audiences on emerging opportunities in the digital economy.

8 replies on “Bitcoin Threatens The Income Tax”

Great article. Someone that actually understands the impact and ramifications of using crypto’s like Bitcoin. You cannot make a new technology fit old ways. The old ways must be changed to accept and adopt new tech. Taxing bitcoin in the “traditional” way (coercion) cannot be done. Those that are trying are only grasping at straws – When everyone realizes this – the regimes and tyranny in place right now will crumble.

Thanks Travis. It’s not going to happen overnight but it is well on it’s way. Anything that can empower the people of this planet to live a better and more free life I am behind. Let me know if there is more I can do to help out at Diginomics.

Taxation of crypto will always occur at the exchanges. Anytime crypto is exchanged for fiat it will result in a taxable event. Right now the IRS taxes BTC like a stock, it monitors the exchanges in order to verify you are reporting your transactions properly (and if they aren’t doing this yet, they soon will). In the future, it’s likely that governments will develop new taxes to further discourage participants from exchanging fiat into crypto and vice versa. This will have the effect of accelerating the development of pure crypto markets, since early adopters of crypto will not sit idly by as their investments depreciate due to government coercion. Over the long term this will have a profound effect on the economy, and it will reduce the power and influence of nation states as the world becomes increasingly global, and decentralized.

Yes Samuel. Taxation will always happen WHEN you exchange crypto coins for Central Banking Notes. The digital is NOT taxed, but the CBN’s will be based on there being an increase in the value of a bitcoin as compared to a Federal reserve Note. If you bought a bitcoin for $500 FRN’s and then sold it for $600 FRN’s, there are two ways you would be taxed.. 1) IF you wrote off the $500 purchase then tax would be owed on the full $600 FRN you received for it. If you did NOT write it off, then there is only a capital gain – an increase of FRN’s – of $100 and tax would be owed on that $100 increase. There is no tax on the coin itself. If youw ere to spend that coin on goods and services WITHOUT using an exchanger – i.e. you wanted to charter the Stone Age for a weeks sailing around the Caribbean, you would pay ME for the service – Not me via Bitpay.

This is where the tax and banking authorities are running scared. They see a fungible system that is capable of taking over their exclusive union shop. That means they will lose money.

The more Crypto Currencies take hold, the less their power over the people that use it effectively.

That is one way of looking at it, yes. But ONLY if you take your wages in cryptocurrencies OR use your tax paid Federal reserve notes (or central banking currency of your country) to purchase digital. That is also a write off on your taxes because you are putting your Central banking Notes into a business proposition that is intended to increase in purchasing power as compared to CBN’s.

If you earn your wages in Crypto’s and spend your crypto’s earned for items desired, the central banking authorities (namely the taxation side of them) cannot have any jurisdiction over that transaction.

I would like to believe in the claims made by the article but bitcoin itself is not anonymous enough to allow this to happen. First, as the US has done with banks all over the world, they will force the crypto exchanges to disclose buyer information including bitcoin addresses. Once they have this they can track the movement of your funds and will put the burden of proof on the customer to prove that any transfer did not amount to a sale of bitcoin. This is the crucial step. Sending your bitcoin to a mixer will be considered a sale and any gain will be taxed. Buying good and services again will be considered a sale of bitcoin and any gains will be taxed. If you transfer the bitcoins to another wallet you own it will be considered a sale UNLESS you prove that both wallets are yours. By putting the burden of proof on you and not the government I don’t see how you will avoid paying taxes. The interesting question is what will happen with a truly anonymous currency like Monero or Z Cash that the government cannot track.

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