Source: IMF Authors: Katherine Baer, Ruud de Mooij, Shafik Hebous, Michael Keen Compiler: Zhu Juexiang
Since Bitcoin's debut in 2009, the number of encrypted assets that can be used as payment instruments has exploded to more than 10,000, with BTC being the first and largest. Their dizzying pace of growth and the pseudonyms they can afford have made it difficult for the tax system to keep up. This article discusses how governments can address the new challenges of taxing these cryptoassets while their use remains limited, in order to prevent tax revenue leakage and protect the integrity of the tax system. The Institute of Financial Technology of Renmin University of China compiled the core part of the research.
introduction
The controversial rise of crypto assets has been frantic, and the pace of innovation involved remains dizzying. The market capitalization of encrypted assets went from zero in 2008 to a peak (so far) of about $3 trillion in November 2021; starting with Bitcoin in 2009, thousands of other cryptocurrencies have now emerged. It is estimated that 20% of adults in the US and 10% of the adult population in the UK may hold or have held some crypto assets. Usage elsewhere may be more pronounced, including some emerging and developing economies: the number of users worldwide has exceeded 400 million. These developments need to be put into perspective: $3 trillion, for example, represents only about 3% of the value of global equities. But the power of crypto-asset development to disrupt traditional ways of doing business in finance, including taxation, and its potential to do more has become apparent.
Figure 1 Cryptocurrency market capitalization (total and selected currencies)
For some, these developments herald a brave new world in which people move away from government oversight and reliance on financial institutions to trust in cryptographically protected distributed ledgers, where transaction costs are ultimately much lower. Beyond that, cryptocurrencies are a harbinger of broader innovations in the form of decentralized finance that will extend these benefits across the financial system. For others, these developments make the crypto market a "Wild West," where criminal activity is facilitated and ill-informed investors face massive price volatility ($3 trillion has now fallen to less than $1 trillions of dollars), bankruptcy, scams, fraud (the demise of FTX in November 2022 is a microcosm). The worst deception to critics is that all of this is based on assets whose creation would cause severe environmental damage and, in many cases, have no intrinsic value. In response, proponents may point to the emergence of “green cryptocurrencies,” pointing out that fiat currencies also have no intrinsic value, arguing that cryptocurrencies have demonstrated their potential advantages in transaction speed and convenience in their support to Ukraine, and claiming that Gain agnostic benefits from continuous innovation.
Regulators face the daunting task of finding and striking a balance between promoting innovation, ensuring financial stability, and investor protection. For tax authorities, the first task is ultimately more mundane, if easier: integrating developments in the use of crypto assets into a well-functioning tax system. Despite its varying importance, this task will remain regardless of the future of cryptocurrencies: whether crypto booms or busts, the tax system will still need to deal with it.
Categorize cryptocurrencies
Opinions on crypto assets are varied and enthusiastic. The prospect of freeing financial transactions from government oversight and the involvement of financial institutions is a libertarian dream for some. El Salvador and the Central African Republic have even adopted Bitcoin as legal tender.
However, critics argue that crypto assets are not only inherently worthless, but also a front for crime, scams and gambling. They also point to dizzying volatility. Bitcoin, for example, soared from $200 a decade ago to almost $70,000 in 2021 before falling to around $29,000 today.
The debacle of FTX last year and the recent SEC lawsuits against Binance and Coinbase fueled user anxiety, while the appeal to criminal activity was reflected in high-profile multi-billion dollar seizures. These developments have sparked increased scrutiny from policymakers and calls for widespread regulation.
But whether cryptoassets end up booming or bust, there needs to be a coherent way to tax them.
A key question is how to classify cryptoassets - should they be considered property or currency? When selling cryptocurrencies for a profit, capital gains should be taxed like other assets. Purchases made with cryptocurrencies are subject to the same sales tax or value-added tax (VAT) as cash transactions.
An important task is therefore to ensure the application of these principles, which requires clarity on how cryptocurrencies are to be described for tax purposes: essentially, as currencies for VAT and sales tax purposes and as assets for income tax purposes. While it won’t be easy due to the ever-evolving nature of crypto asset trading, it is entirely possible. So the deepest challenge is law enforcement.
Income Considerations
Rough estimates suggest that a 20% tax on capital gains from cryptocurrencies would raise around $100 billion globally in the event of a price surge in 2021. This represents about 4% of global corporate income tax revenue, or 0.4% of total tax revenue.
But with the total cryptocurrency market capitalization down 63% from its peak in late 2021, tax revenue will shrink. If these losses were fully offset by other taxes, revenue would be reduced accordingly. In more normal times, with current market sizes, global crypto tax revenues could average less than $25 billion per year. In the broader scheme of things, that's not a huge number.
Figure 2 Cryptocurrency price fluctuations (Bitcoin price, denominated in USD)
There are also important issues of equity at stake. While the aliases of cryptocurrencies make it difficult to determine who actually owns them, there are signs that ownership is concentrated among the relatively wealthy — although holdings are also prevalent among low-income people. Existing surveys suggest that around 10,000 people hold a quarter of all bitcoins.
There is also VAT. Crypto transactions have similarities to cash transactions in that they have the potential to be hidden from tax administrations. Today, the share of purchases made with cryptocurrencies is still small. But without the tax system in place, widespread use could one day mean widespread VAT and sales tax evasion, leading to a significant reduction in government revenue. This may be the biggest threat to cryptocurrencies.
Handle execution issues
The most fundamental difficulty with taxing crypto assets is that they are "pseudonymous". That said, public addresses used for transactions are extremely difficult to link to individuals or companies. This can make tax evasion easier. Enforcement is therefore a core issue for tax authorities.
However, reporting obligations may encourage people to use centralized exchanges abroad to keep information on their asset transactions from tax authorities. To address this, the Organization for Economic Co-operation and Development (OECD) has developed a framework for the exchange of encryption-related information between countries. However, implementation is still some way off.
A more troubling possibility is that reporting rules (and the failure of some crypto intermediaries) could tempt people increasingly to trade through decentralized exchanges or directly through peer-to-peer transactions with no central authority overseeing these transactions Trading. These are still very impenetrable to tax administrators.
Given the complexity of the fundamental challenges posed by pseudonyms, the rapidity of innovation, large information gaps, and uncertainty about the future, the battle to properly integrate cryptocurrencies into the wider tax system has yet to turn. Some of the elements needed to do so - such as clarity of classification for tax purposes - are clear.
But the challenges are fundamental, notably the risk of VAT and sales taxes, which may be greater than people realize. As many (though far from all) governments are beginning to realize, policymakers need to develop clear, coherent and effective crypto taxation frameworks.
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Tax issues with cryptocurrencies
Source: IMF Authors: Katherine Baer, Ruud de Mooij, Shafik Hebous, Michael Keen Compiler: Zhu Juexiang
Since Bitcoin's debut in 2009, the number of encrypted assets that can be used as payment instruments has exploded to more than 10,000, with BTC being the first and largest. Their dizzying pace of growth and the pseudonyms they can afford have made it difficult for the tax system to keep up. This article discusses how governments can address the new challenges of taxing these cryptoassets while their use remains limited, in order to prevent tax revenue leakage and protect the integrity of the tax system. The Institute of Financial Technology of Renmin University of China compiled the core part of the research.
introduction
The controversial rise of crypto assets has been frantic, and the pace of innovation involved remains dizzying. The market capitalization of encrypted assets went from zero in 2008 to a peak (so far) of about $3 trillion in November 2021; starting with Bitcoin in 2009, thousands of other cryptocurrencies have now emerged. It is estimated that 20% of adults in the US and 10% of the adult population in the UK may hold or have held some crypto assets. Usage elsewhere may be more pronounced, including some emerging and developing economies: the number of users worldwide has exceeded 400 million. These developments need to be put into perspective: $3 trillion, for example, represents only about 3% of the value of global equities. But the power of crypto-asset development to disrupt traditional ways of doing business in finance, including taxation, and its potential to do more has become apparent.
Figure 1 Cryptocurrency market capitalization (total and selected currencies)
For some, these developments herald a brave new world in which people move away from government oversight and reliance on financial institutions to trust in cryptographically protected distributed ledgers, where transaction costs are ultimately much lower. Beyond that, cryptocurrencies are a harbinger of broader innovations in the form of decentralized finance that will extend these benefits across the financial system. For others, these developments make the crypto market a "Wild West," where criminal activity is facilitated and ill-informed investors face massive price volatility ($3 trillion has now fallen to less than $1 trillions of dollars), bankruptcy, scams, fraud (the demise of FTX in November 2022 is a microcosm). The worst deception to critics is that all of this is based on assets whose creation would cause severe environmental damage and, in many cases, have no intrinsic value. In response, proponents may point to the emergence of “green cryptocurrencies,” pointing out that fiat currencies also have no intrinsic value, arguing that cryptocurrencies have demonstrated their potential advantages in transaction speed and convenience in their support to Ukraine, and claiming that Gain agnostic benefits from continuous innovation.
Regulators face the daunting task of finding and striking a balance between promoting innovation, ensuring financial stability, and investor protection. For tax authorities, the first task is ultimately more mundane, if easier: integrating developments in the use of crypto assets into a well-functioning tax system. Despite its varying importance, this task will remain regardless of the future of cryptocurrencies: whether crypto booms or busts, the tax system will still need to deal with it.
Categorize cryptocurrencies
Opinions on crypto assets are varied and enthusiastic. The prospect of freeing financial transactions from government oversight and the involvement of financial institutions is a libertarian dream for some. El Salvador and the Central African Republic have even adopted Bitcoin as legal tender.
However, critics argue that crypto assets are not only inherently worthless, but also a front for crime, scams and gambling. They also point to dizzying volatility. Bitcoin, for example, soared from $200 a decade ago to almost $70,000 in 2021 before falling to around $29,000 today.
The debacle of FTX last year and the recent SEC lawsuits against Binance and Coinbase fueled user anxiety, while the appeal to criminal activity was reflected in high-profile multi-billion dollar seizures. These developments have sparked increased scrutiny from policymakers and calls for widespread regulation.
But whether cryptoassets end up booming or bust, there needs to be a coherent way to tax them.
A key question is how to classify cryptoassets - should they be considered property or currency? When selling cryptocurrencies for a profit, capital gains should be taxed like other assets. Purchases made with cryptocurrencies are subject to the same sales tax or value-added tax (VAT) as cash transactions.
An important task is therefore to ensure the application of these principles, which requires clarity on how cryptocurrencies are to be described for tax purposes: essentially, as currencies for VAT and sales tax purposes and as assets for income tax purposes. While it won’t be easy due to the ever-evolving nature of crypto asset trading, it is entirely possible. So the deepest challenge is law enforcement.
Income Considerations
Rough estimates suggest that a 20% tax on capital gains from cryptocurrencies would raise around $100 billion globally in the event of a price surge in 2021. This represents about 4% of global corporate income tax revenue, or 0.4% of total tax revenue.
But with the total cryptocurrency market capitalization down 63% from its peak in late 2021, tax revenue will shrink. If these losses were fully offset by other taxes, revenue would be reduced accordingly. In more normal times, with current market sizes, global crypto tax revenues could average less than $25 billion per year. In the broader scheme of things, that's not a huge number.
Figure 2 Cryptocurrency price fluctuations (Bitcoin price, denominated in USD)
There are also important issues of equity at stake. While the aliases of cryptocurrencies make it difficult to determine who actually owns them, there are signs that ownership is concentrated among the relatively wealthy — although holdings are also prevalent among low-income people. Existing surveys suggest that around 10,000 people hold a quarter of all bitcoins.
There is also VAT. Crypto transactions have similarities to cash transactions in that they have the potential to be hidden from tax administrations. Today, the share of purchases made with cryptocurrencies is still small. But without the tax system in place, widespread use could one day mean widespread VAT and sales tax evasion, leading to a significant reduction in government revenue. This may be the biggest threat to cryptocurrencies.
Handle execution issues
The most fundamental difficulty with taxing crypto assets is that they are "pseudonymous". That said, public addresses used for transactions are extremely difficult to link to individuals or companies. This can make tax evasion easier. Enforcement is therefore a core issue for tax authorities.
However, reporting obligations may encourage people to use centralized exchanges abroad to keep information on their asset transactions from tax authorities. To address this, the Organization for Economic Co-operation and Development (OECD) has developed a framework for the exchange of encryption-related information between countries. However, implementation is still some way off.
A more troubling possibility is that reporting rules (and the failure of some crypto intermediaries) could tempt people increasingly to trade through decentralized exchanges or directly through peer-to-peer transactions with no central authority overseeing these transactions Trading. These are still very impenetrable to tax administrators.
Given the complexity of the fundamental challenges posed by pseudonyms, the rapidity of innovation, large information gaps, and uncertainty about the future, the battle to properly integrate cryptocurrencies into the wider tax system has yet to turn. Some of the elements needed to do so - such as clarity of classification for tax purposes - are clear.
But the challenges are fundamental, notably the risk of VAT and sales taxes, which may be greater than people realize. As many (though far from all) governments are beginning to realize, policymakers need to develop clear, coherent and effective crypto taxation frameworks.