The debt-driven monetary system has reached a significant level of intensity. On one side, the US has surpassed the $35 trillion mark in national debt, imposing a burden of $104k on every American. Conversely, the Congressional Budget Office (CBO) forecasts federal spending for 2024 at 24.2% of GDP.
This stark contrast between excessive spending and increasing debt places the economy on a precarious path. It is highly improbable that the US government would choose to cut spending, most of which is allocated to social programs, entitlements, and the military, the latter being a crucial factor that supports the USD as the global currency.
This situation also implies further Fed balance sheet expansion, with three 0.25% rate cuts already anticipated for this year. Consequently, non-currency assets such as equities, gold, and Bitcoin are likely to experience renewed growth. Central to this phenomenon is the issue of information authenticity.
As the US Bureau of Labor Statistics is projected to revise down job figures by up to one million from April 2023 to March 2024, the distortion of information is evident even within central banking. If the Federal Reserve can increase the M2 money supply by 27% in 2020-21, the money itself begins to lose its informational integrity.
This is the reason why investors gravitate towards equities, gold, and Bitcoin. These assets become reliable stores of value as currency loses its ability to accurately communicate value. The drawback, however, is that they are also subject to taxation, which serves to reduce the pace of exiting the central banking system.
This is particularly relevant for Bitcoin, a distinctive asset that functions as both a store of value and a potential medium for daily transactions. This raises the question of whether a regulatory framework could exist where low-value Bitcoin transactions are exempt from federal taxation.
Bitcoin’s Usage and Currency Substitution Suitability
To navigate the regulatory landscape ahead, we first need to examine how Bitcoin is most commonly utilized. A contrast between Bitcoin use and fiat can clarify whether Bitcoin serves as a practical currency or poses a challenge to the existing monetary system.
Despite layer 2 scaling solutions like the Lightning Network, as Bitcoin usage increases, the load on the Bitcoin mainnet intensifies as miners work on processing transaction blocks. This heightened activity results in increased friction, showing up as rising fees for each Bitcoin transaction.
In developed nations like Australia, the use of cryptocurrency for payments has generally been low.
Image credit: Reserve Bank of Australia
This is predictable; strong incentives are needed for people to abandon existing payment options that are already instantaneous and convenient.
At best, Bitcoin transactions largely involve intermediaries facilitating Bitcoin transactions using fiat currency. For example, the Bitcoin onramp platform Strike had to sever ties with Prime Trust custodian after it declared bankruptcy, yet Strike continues to partner with banks like Lead, Cross River Bank, and Customers Bank.
In essence, Bitcoin adoption hinges on online payment systems linked to commercial banks, which are in turn connected to central banks. These establishments have effectively rendered money de facto digital, albeit stored on their own ledgers.
Even though these entities can manipulate the money supply, they do so to ensure maximum liquidity necessary for a debt-based monetary system, in which fiat currency functions primarily as a debt tracker.
Contrastingly, Bitcoin’s inherent scarcity makes it less attractive for such purposes. The downfall of gold serves as a pertinent example; it was abandoned due to its insufficient supply flexibility to support a growing (debt-based) economy, prompting mainstream economists to consider gold-backed currencies as outdated.
Moreover, Bitcoin is poorly suited as a daily transaction medium in comparison to feeless alternatives like Nano (XNO), which feature eco-friendly green hosting or forthcoming CBDCs. Instead, Bitcoin’s strength lies in its unchangeable scarcity, making it a suitable global reserve settlement layer.
While both network friction and flexible liquidity render Bitcoin less ideal as a true medium of exchange, they simultaneously mitigate its threat to the system. Does this mean, however, that adjustments to Bitcoin’s tax treatment are warranted?
The Impact of Current Tax Policies on Bitcoin Usage
Users on exchanges and platforms like Strike can freely purchase Bitcoin without concerns about triggering a taxable event; tax obligations arise only when BTC is sold for profit.
This is because the Internal Revenue Service (IRS) classifies Bitcoin as property. If Bitcoin is held for less than a year before selling, holders face ordinary income tax rates ranging from 10% to 37%.
If Bitcoin is held for over a year, it may be taxed at rates between 0% and 20%, depending on income levels across three brackets: 0%, 15%, and 20%. Consequently, Bitcoin holders must meticulously track the timing and price of their BTC purchases and sales, with the profit differential subject to capital gains tax.
Similarly, swapping Bitcoin for another cryptocurrency constitutes a taxable event, also subject to capital gains tax. If BTC is received as income, or acquired through mining, staking, or airdrops, it’s taxed as wage income, falling within the ordinary income tax bracket of 10% – 37%.
In addition to purchasing BTC, holding, or donating it to a registered non-profit, users can transfer bitcoins from exchanges to wallets without triggering taxable events. While BTC gifts are non-taxable when received, they could later be subjected to the same tax regimen.
In the event of selling Bitcoin at a loss, holders can deduct losses up to $3,000 per year, with any excess carried over to the following year. Currently, tax-loss harvesting is an option for Bitcoin holders to sell BTC at a loss to claim a tax break and subsequently repurchase it.
Unfortunately, this flexibility, which traditional shareholders do not enjoy, could be abolished by the proposed Lummis-Gillibrand Responsible Financial Innovation Act, which includes Section 1091, “Loss from wash sales of specified assets.”
However, even with this tax-saving strategy still available, it is evident that Bitcoin’s unique characteristics are not accurately represented in IRS regulations. The necessity to track every BTC transaction significantly discourages daily usage; even purchasing a pint of beer would require calculating the initial BTC cost to determine whether it resulted in a gain or a loss.
Additionally, merchants would face similar tax complexities since they technically receive property, not currency, which further complicates mass Bitcoin adoption by incentivizing long-term holding due to the previously discussed friction and liquidity challenges.
Moreover, Bitcoin’s entry into various innovative financial products is similarly hindered.
The Tax Burden on Bitcoin Derivatives
Despite Bitcoin’s status as the least volatile cryptocurrency, bolstered by its substantial $1.2 trillion market capitalization, holders still seek protection against its price fluctuations. Derivatives, including options and futures, offer such opportunities.
Furthermore, Bitcoin’s price volatility presents possibilities for traders who speculate on whether BTC’s price will increase (going long) or decrease (going short). This speculative market plays a crucial role in risk hedging and price discovery, yet it is also encumbered by the current taxation framework.
When an options contract is exercised or expires, it incurs capital gains tax. Most traders create trading alerts to notify them when BTC price reaches a certain threshold, enabling swift responses since capital gains or losses are determined based on the difference between Bitcoin’s fair market value and the strike price. Consequently, staying informed about Bitcoin’s fair market value is a challenge.
Calculating the fair market value of other cryptocurrencies used for Bitcoin contract settlements adds additional complexity.
Should the contract expire without acquiring BTC, the capital loss will be treated as the premium paid for that contract. Conversely, sellers of Bitcoin options premiums must also account for capital gains taxes.
For futures contracts, 60% of gains or losses are taxed as long-term capital gains or losses, while 40% are taxed as short-term capital gains or losses, regardless of the length of the futures contract.
While derivatives markets significantly enhance liquidity and trading volume, the prevailing Bitcoin tax regulations dissuade broader participation.
The Virtual Currency Tax Fairness Act and Bitcoin
The year 2024 has turned into a treasure trove of positive developments for Bitcoin, largely undeterred by the German government’s BTC selloffs. The most well-known cryptocurrency received institutional backing when the Securities and Exchange Commission (SEC) approved 11 exchange-traded funds (ETFs), reaching $48.13 billion in assets under management as of August 20th.
Not only did Bitcoin ETFs surpass all expectations, but their success also served as a launchpad for two presidential candidates, Robert F. Kennedy Jr. and former President Donald Trump, both endorsing the concept of a strategic Bitcoin reserve at the Nashville Bitcoin 2024 conference in late July.
At that time, Senators Ted Budd (R-NC), Krysten Sinema (I-AZ), Cynthia Lummis (R-WY), and Kirsten Gillibrand (D-NY) reintroduced bill S.4808, known as the Virtual Currency Tax Fairness Act.
As indicated by the title of the bill, cryptocurrencies would receive the same tax treatment currently designated for foreign currencies.
This means that for transactions valued under $200, cryptocurrency exchanges would only be subject to regular sales tax. While this does not match El Salvador’s approach of adopting Bitcoin as legal tender, it would effectively lower the barriers for small purchases at merchant outlets.
Previously, Sen. Cynthia Lummis, one of the bill’s co-sponsors, asserted her confidence that Bitcoin would be among the leading assets in a future global currency order.
In recent developments, presidential candidate Kamala Harris supports President Biden’s proposed 44.6% capital gains tax, alongside a corporate tax rate increase from 21% to 28%.
The Broader Implications for Bitcoin Adoption
Although to a lesser extent, the possibility of recession remains as we approach 2025. Should this occur, Bitcoin will face another test regarding its risk-off status. However, examining the long-term perspective, the framework of mass democracy does not favor austerity measures.
If austerity measures appear unlikely, the expansion of the Fed’s balance sheet will likely continue, further diminishing confidence in the USD. It remains uncertain whether competing factions will permit Bitcoin to develop as a potential escape route in this scenario.
Implementing a sales tax on BTC transactions below $200 instead of capital gains tax would significantly entrench Bitcoin further into the financial system. Considering that Blackrock’s IBIT is now the largest Bitcoin ETF, with $17.24B AuM, it seems accurate to state that the “threat” perception regarding Bitcoin has diminished significantly, if not entirely abandoned.
Conclusion
With Bitcoin valued above $60k, it is becoming increasingly apparent that only a small micro minority will ever possess more than 1 BTC. Consequently, such a limited demographic is unlikely to unsettle the central banking system.
What is more plausible is the emergence of a parallel, hybrid system where Bitcoin functions simultaneously as a commodity and a premium currency, both of which are tracked. This is reflected in the fact that even senators who are not explicitly anti-crypto advocate for expansive cryptocurrency surveillance.
Bitcoin’s transparent ledger is ideally positioned for this. This is a constructive development, especially as privacy-focused cryptocurrencies like Monero (XMR) have already been excluded from major exchange platforms.
Without the obstacles faced while navigating a fiat monetary system, Bitcoin has the potential to enhance financial inclusivity and promote innovation, despite the challenges related to onramps and offramp systems that include the taxation of appreciating assets. The Virtual Currency Tax Fairness Act is paving the way, yet it is likely to undergo further adjustments, particularly regarding how $200 transactions are aggregated.
This is a guest post by Shane Neagle. The views expressed are solely his and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.
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