Someone has to change: Why you can’t tax crypto as assets

David Siegel of the Pillar Project shows how systems break down when cryptocurrency is taxed as an asset.

"A token can represent almost any kind of value, different people can purchase the same token for different purposes, and tokens can change their "type" or purpose over time. A crypto-token can represent your gym membership or a ride-sharing credit. Yet most governments tax them as if they were investable assets," David Siegel, CEO and founder of the Pillar project says.

Australia is one of the countries where cryptocurrencies are taxed as an asset. Users are required to keep records of every single cryptocurrency transaction, including the date, the purpose of the transaction, the recipient (even if it's just a wallet address) and the Australian dollar value of the transaction. Net profits are then somehow hammered into the shape of capital gains to be taxed.

This makes some kind of sense in a world where all tokens are simply held and occasionally traded as a speculative asset, but it immediately breaks down when tokens are used for even simple transactions.

Siegel gives the example of using Pillar ERC20 tokens to buy a shirt.

"You want to buy a Pillar t-shirt in the store in the wallet. The shirt is priced in ether. You pay a certain amount of ether for the shirt, plus you pay an extra amount in PLR tokens, which are required to use the system. The current fee for an Ethereum blockchain transaction is 40 cents. So here’s your breakdown:

1. Pay the ether for the shirt.
2. Pay the sales or VAT tax, probably in ether.
3. Pay the ether fee to settle the shirt/tax transaction.
4. Pay the PLR to the system.
5. Pay the ether fee to settle the PLR transaction.

...ALL of these transactions are taxable events. This is the nightmare we find ourselves in as we try to reinvent the world of finance."

In Australia, you would run into a similar situation with the exception of VAT tax, which might be GST instead and included in the total transaction amount.

Two ways forward

In the long run, it's reasonable to assume that digital assets will not be given a blanket status as assets because it's simply unfeasible. It doesn't help that cryptocurrencies themselves still lack a unified functional definition.

For example, would frequent flyer points (generally non-taxable although redeeming rewards may be a taxable event) suddenly become cryptocurrency if they were distributed on a blockchain rather than a central airline system? Maybe. Who knows.

A blanket status as taxable, appreciating assets doesn't fit cryptocurrency. In the long run, a more nuanced tax approach will be needed that better encompassing different token taxonomies. But in the short run, Siegel suggests a few ways forward for cryptocurrencies to more easily meet tax obligations.

"There should be no transaction tokens," he says. "Charging some amount of tokens for each transaction incurs a blockchain settlement cost and triggers two separate tax events per transaction."

Siegel proposes three alternative models that could be used.

• Coupon model. "The user pays in advance for a number of internal bookkeeping units that then pay for transactions. For example, she would purchase a "booklet" of ten transaction credits and then spend them as she uses the system. Because they are internal units of account and not blockchain-based assets, purchasing the coupons is a single taxable event but spending them is not."
• Subscription model. "The user purchases a time-based subscription fee for your system's services, so she would pay a certain amount every month, and all her fees are covered. There would be a fee to settle the subscription payment, which would produce two taxable events. It may be better to charge people once a quarter than once a month. No one wants extra Ethereum fee charges or taxable events."
• Staking model. "Reward users who maintain a certain minimum balance of your tokens with free use of the system. There are economic advantages and incentives for this, but it probably shouldn’t be the only way to charge for access. I think you would want to encourage it but use a monthly pay-as- you-go model as a back-up."

It's slightly ironic that cryptocurrencies can deliver a system of monetary transactions with negligible or non-existent fees, but that the most practical way of using it might involve carefully minimising the number of transactions one performs to avoid a tax headache.

Right now cryptocurrency regulation is a mess on an individual country level because disparate agencies are all viewing these ambiguous digital things through their own lenses, and it's a mess on an international level because individual countries are similarly viewing it through the lens of their own interests and agendas. Unfortunately, there doesn't seem to be any satisfactory solution on the horizon yet.

Disclosure: At the time of writing, the author holds ETH, IOTA, ICX, VEN, XLM, BTC and XRB.

Picture: Shutterstock