Bitcoin, Taxes, and a Path to the Promised Land
Bitcoin is at an all time high today…again…as it was yesterday and the day before and the day before etc…for anyone who owns bitcoin…it’s pretty fucking exciting…so exciting that there’s only one thing that people want to do with their bitcoin: “hold.” Demand for bitcoin is fueled by 3 things:
1) idealism: those that want to believe there is a better way…those that rabidly consume information on the currency..that consider “what if” and are excited enough about a bitcoin future that they participate with their wallets.
2) speculation: curves like the one to the right don’t come along very often…people who own bitcoin as a pure investment are generating returns that you simply cannot find anywhere else…those returns are intoxicating and seductive and lure “double down” behavior…and…investors who generate those type of returns like to brag about it…causing viral spread of bitcoin as an asset allocation.
3) bad action: whether your laundering money, buying illegal goods and services, or trying to cover your tracks for some other reason…in it’s current form, bitcoin offers some cover if you’re transacting in bad faith…
I’ll start with Group 3 and say I’d assume this group is either flat or contracting as a % of volume in the bitcoin market. While providing much of the early liquidity in the bitcoin ecosystem, i believe that the group of bad actors who found this unregulated/unwatched channel is finite in size and a small portion of the overall addressable population/$ volume. So, as the other two groups grow in size…i believe this group will contribute a smaller portion of the volume in the market, and become less influential…further…i believe that the veil of true anonymity is starting to crack in this ecosystem, and when bad guys go down…other bad guys maybe back off…or find some other dark corner to transact in…
Groups 1 and 2 are more interesting to me…and I believe that for bitcoin to become really real…whatever that means…they are both going to have to start doing something that they aren’t really doing right now…and that’s spend. Let’s examine the incentive structure for each and figure out a path to this reality.
For the idealist, why spend?: “it’s simple…until bitcoin starts being exchanged for something other than dollars…the volatility puts your mission in jeopardy…crashes freak people out…some portion of the bitcoin in the world needs to become less liquid than it currently is…it needs to get locked up in places that won’t dump it back to the exchange when large holders sell…it needs to hold it’s value relative to a sweater or a carton of milk and move in value in a non-realtime way…so that when the “smart money” dumps…there is at least a lag in how that carton of milk gets “repriced” in bitcoin…(god i wish i took economics in college…this is straight intuition…but pretty sure it’s right)…until bitcoin goes into “circulation” in a real way…it’s value and legitimacy as a value store hang by a thread…a hope-filled, exciting, logical thread…but a thread none-the-less
For the investor why spend?: This one is trickier…why should I spend $100 worth of bitcoin instead of selling it back to the exchange for $100? Sure…maybe i could save the tiny fee in selling…but 1% or whatever isn’t a good enough reason…it’s still effort to spend my bitcoin…there aren’t very many place to do it…it’s an unfamiliar transaction…i don’t get to realize my gain all at once and see it on paper…it’s just more complicated than selling..so why? Well…at the system level, it is clear to me that a bitcoin spent vs sold helps to maintain the value of the remaining bitcoins i hold…but getting investors to think that way either requires them to be moving in volumes that are very large (market moving on their own)…or it requires them to think as a collective or a whole…to act together…that’s a flywheel that seems tough to get spinning…so why? It may be that the answer lies in something much more simple: TAXES.
I’m no accountant…and I’ve asked this question on twitter four or five times with no definitive answer…but I believe that the speculators who are earning insane gains on their bitcoin holding are eventually liable for short or long term capital gains tax when they sell their bitcoin back to the exchange…Short term capital gains in new york city I think can get up to 40% and long term capital gains I think are approaching 26% (inclusive of state and city tax…)…these numbers may be a few points off, but I didn’t feel like wasting the time on research…because in the scope of this argument…all you need to know is that it’s 20-40x the fees that the exchange takes for selling bitcoin back…
So these megagains for speculators are great, but the haircut to get out is quite singificant…unless…as a speculator you achieved liquidity through another means outside of selling…i.e. SPENDING…if you spend your bitcoin with merchants, buying ski jackers, and food, and anything else that you would normally use cash for…I BELIEVE (and please please please) correct me if i’m wrong…that you do not pay any tax on the appreciation of bitcoin currency…in the same way that you aren’t paying taxes on the dollars you hold in your checking account when the US$ rises in value…Getting to enjoy an extra 26-40% of the value you hold in bitcoin is a big fucking reason to spend instead of sell…and if this is true, i believe it’s how bitcoin will begin to circulate at scale…
So…this makes owning the merchant network in this ecosystem a pretty interesting layer…sure…but I think there is an even bigger opportunity as bitcoin matures into something people spend vs. hold…i’ll write about it another time…
oh…and if you own at least one bitcoin and want early access to Wildcard…send me a note with“beta” in the subject to jordan.cooper@gmail.com…Wildcard loves bitcoin so much that we’re going to open our doors a little early just to folks in the bitcoin community 🙂
p.s. as with everything i write…if i am understanding something wrong from an accounting or economic theory perspective…please correct me…
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I havn’t fully researched but ….not likely.. you cannot avoid capital gains taxes by swapping an item that has appreciated in value. For example, you buy a dusty old painting at a flea market for $10. You have it cleaned by a local antiques dealer and discover that it’s an original Rembrandt worth $5 million. Rather than sell the painting at Sotheby’s, you swap it with another collector for a Vermeer painting worth $5 million. While the “swap” in this case would be free from tax, you would not be able to avoid the capital gains tax on the $5-million market value of the Rembrandt (less, of course, the $10 you paid for it).
Richard
November 13, 2013
you’re not getting it…the point is that if you spend it on consumables…you never have to “sell the rembrandt” and recognize the gain
jordancooper
November 13, 2013
The IRS will view the exchange of the bitcoin for the item as a barter.
Richard
November 13, 2013
why doesn’t this apply to the US $? or any other currency that appreciates?
jordancooper
November 13, 2013
Note in the hypothetical, the painting was not sold. It was traded.
Richard
November 13, 2013
The answer is a little complicated.
Richard
November 13, 2013
The rest of the story: If you have a gain on a personal foreign currency transaction because of changes in exchange rates, you do not have to include that gain in your income unless it is more than $200. If the gain is more than $200, you report it as a capital gain. Also, You recognize a capital gain if you exchange currency into USD or another currency, or use it to purchase anything. If you held the foreign currency more than a year – the gain will be taxed at reduced rate – not more than 15%. If you held the currency less than a year – the gain will be taxed at your regular tax rate.
Richard
November 14, 2013
Ah…thanks for this research…super helpful. I wonder…is bitcoin a foreign currency?
jordancooper
November 14, 2013
For me, the biggest things that bother me about bitcoin are its deflationary nature and the 51% attack. I think these concerns will only grow as it becomes more popular and mining difficulty increases.
Okay, I lied, the biggest thing that bothers me is that I missed the boat on buying a bunch of bitcoin back in 2010 when I first read about it, and now I’m kicking myself.
But, since prices on other currencies are so cheap, I decided to snatch up a bunch of PPCoin at bargain basement prices. As a bonus, PPCoin addresses both of my above concerns about bitcoin. Woot!
…Now I just need to convince the rest of the world to do the same thing 🙂
Vinay Pulim
November 16, 2013
Nice to see this post! I had a comment for you: I think one of the major motivations for the implementation of BTC, will be the disassociation from traditional ideas on currency, tax and “appropriate” uses for ones money. BTC has been created by anarchists, and inherent in its success is that it will be undermining the current highly flawed centrally controlled monetary system, including the IRS. They should not be able to tax it, many BTC holders believe that taxation is theft, and we are investing in crypto currencies because we see the inevitable crash in the current monetary system coming. Of course the IRS and other governments will want to control and make money off the success of a functioning currency, but we should not let them. To me BTC is about freedom from the current system, I have no interest in paying taxes on it. You should not have to pay taxes on an alt-currency. I would also question your view on “bad-actors”- they are only ‘bad’ in the framework of the current system where there are so many laws around what you can and cannot do that literally everyone is a criminal. Using BTC for “illegal” activity shouldn’t matter, our current legal tender is being printed by way worse criminals than the ones shopping on the silk road. The point is that BTC is free from legislation, it is free, period. You don’t have to spend your BTC on illegal goods, but the fact that some people do does not make BTC any less relevant or useful, realizing that it has been created in response to the major limitations of our current financial system is VERY important to making this thing work!
heartandtooth
November 17, 2013
Some bitcoin tax discussion: http://www.bitcointax.info/
Sam
November 22, 2013
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