Free Money, But Not Tax-Free: A Proposal for the Tax Treatment of Cryptocurrency Hard Forks

Cryptocurrency has attracted extraordinary attention as one of the greatest financial innovations in recent years. Equally noticeable are the increasingly frequent cryptocurrency events, such as hard forks. Put simply, a cryptocurrency hard fork happens when a single cryptocurrency splits in two, which results in original coin owners receiving free forked coins. Such hard forks have resulted in billions of dollars distributed to U.S. taxpayers. Despite ongoing regulatory efforts, to date, the Internal Revenue Service (IRS) has yet to take a clear position on the tax treatment of cryptocurrency hard forks. The lack of useful guidance when filing tax returns has left taxpayers genuinely confused in the past few years. To fill this regulatory gap, this Note proposes a framework for cryptocurrency hard fork taxation. It explains the underlying technology of cryptocurrency hard forks, examines the recommended guidelines from the American Bar Association and the Association of International Certified Professional Accountants on cryptocurrency hard fork taxation, and references the current practices in Japan and the United Kingdom to lay a solid foundation for the proposed framework. Ultimately, this Note proposes a two-pronged tax on cryptocurrency hard forks. The first tax is levied on the profit made from the receipt of forked coins, and the second tax is levied on the profit made from the disposition of forked coins. A concrete proposal is provided for the applicable coin valuation, tax basis, holding period, and tax rate for the two prongs. Aiming to propose a tax treatment that is closest to the nature of cryptocurrency hard forks, this proposal considers various practical concerns, such as the inefficiency of the cryptocurrency market, the indirect possession of forked coins through third-party exchanges, and the fluctuating trading prices of forked coins when determining the valuation, tax basis, and holding period. This proposal not only provides clarity for taxpayers in filing tax returns and fulfilling tax obligations, but it also relieves the potential tax deferral and tax evasion problems that arise after a cryptocurrency hard fork

Cryptocurrencies Are Taxable and Not Free From Fraud

In this report, the authors discuss cryptocurrencies — especially bitcoin — and argue that because the IRS lists them as property, they are taxable, and because they are not as anonymous as once thought, they are not free from fraud. Cryptocurrencies are digital assets used as a medium of exchange, but they are not really coins. They can be sent electronically from one entity to another almost anywhere in the world with an internet connection. There are many cryptocurrencies in the market, including bitcoin, ethereum, ethereum classic, litecoin, nem, dash, iota, bitshares, monero, neo, and ripple. Many of the cryptocurrency networks are not controlled by a single entity or company; instead, a decentralized network of computers keeps track of the currency using a token ID. A ledger maintains a continuously growing list of date stamped transactions in real time called “blocks.” This technology is known as blockchain, which records, verifies, and stores transactions without a trusted central authority. The network instead relies on decentralized autonomous organizations (DAOs) with uncertain legal standing

The Theory of Money

Fiat money(1) is a creation of both the state and society. Its value is supported by expectations which are conditioned by the dynamics of trust in government, the socio-economic structure and by outside events such as wars, plagues or political unrest. The micro-management of a dynamic economy is not far removed in difficulty from the micro-management of the weather. However, money and the financial institutions and instruments of a modern economy provide the means to influence expectations and bound behavior.(2) Paper money emerges as a virtual commodity. The dynamics of the economy permits it to serve as an imaginary gold.Although it is an abstraction, it is meaningful to talk about its quantity. Closely related to but basically different from fiat money is credit.(3) Credit, unlike fiat money is not a virtual commodity but a two party contract. The fact that it is a two party contract set in a dynamic context implies that there are chances that the economy may reach a state where a debtor is unable to meet his or her obligations. When this happens the laws and customs of the society must provide default, bankruptcy and reorganization rules. These rules are usually denominated in terms of fiat and socio-economic penalties such as the confiscation of assets, garnishing of salary or time in debtors' prison. Thus the value of paper gold is determined in two ways by the dynamics of the system. First by acceptance in trade, based on the expectation that it will remain valuable and second by its role in the discharge of debts where failure to repay has unpleasant consequences. When taxes are present a third valuation appears in the penalties for failure to pay taxes. The control of the fiat money supply together with rules on the granting of credit and the bankruptcy, default and reorganization rules,in essence, provide lower and upper bounds for the price level in the economy. They also determine the innovation rate of the economy. An innovation may be regarded as an economic mutation; the less costly failure is, the more likely an innovation will be risked. The rates of interest for loans combined with the harshness of the bankruptcy and reorganization laws help to determine the rate of innovation in a society. Government controls only one among many interest rates. A host of institutional details involving risk and transactions cost determine the others. The velocity of both money and credit may vary. Even though velocity may vary, human decision-making takes a finite amount of time. This implies that velocity will remain bounded. Beyond some speed of circulation expectations will degenerate and the economy will break down. In order to appreciate the intrinsic dynamics of a high information and communication mass economy at least three agents must be distinguished. They are the highly visible government; other largely visible legal persons, such as banks and corporations and real persons. Their differences are characterized by their relative power and the size of their communication networks. The contrast between a market economy and a state economy is not a clean contrast. The distinctions are on a continuum. Among modern democratic market economies the size of the government sector is roughly anywhere from 15% to 50% of the economy. Thus the control description of virtually any modern economy is of one extremely large and visible player; at most a few hundred large corporate entities of reasonably high visibility and a mass of small agents known by and in direct communication with only a few others. The reconciliation of a dynamics oriented macro-economics with an equilibrium oriented micro-economics lies in the understanding that the economy is embedded in the polity and society. The institutions, customs and laws are the carriers of process and provide bounds to process. They limit the dynamics.The role of macroeconomic policy is to bound the dynamics of an evolving society. Individual behavior is local and necessarily myopic. Myopic local optimization is consistent with global evolution. An elementary understanding of history and the decision and game theory proliferation of strategies is enough to indicate that the search for a unique or even stationary economic dynamics is an essay in futility.In contrast the search for the correct carriers and bounds on process is feasible.The monetary structure provides the sufficient loose coupling to permit mass independent behavior to take place even somewhat chaotically within institutional bounds.(4) 1. I use the term fiat or abstract paper money interchangeably to stand for a government supplied means of payment of no intrinsic worth. 2. Phrasing this somewhat more technically they provide the bounds on the state space. A state space is the set of all feasible states which can be achieved by the system. 3. Credit such as bank credit from a well known bank may be referred to as "inside money" in the sense that it is a contract between two legal persons in the economy other than the government. Yet the bank credit, because of the visibility and reputation of the bank, may serve as a substitute in transactions for fiat money. 4. Technically the institutions and the monetary and financial structure fully define the state space, but do not describe the dynamics. There is a robust collection of local individual rules of behavior which are all sufficient to provide the dynamic support of expectations that money will be accepted as having value. The control system may be sufficient to guide or at least limit the overall macroeconomic behavior without necessarily providing for a precise or unique dynamics. Money is the only financial instrument without an offsetting instrument. This nonsymmetry appears to be critical in the introduction of time into the model of the economy.Money, macro-economics, strategic market games, general disequilibrium, bankruptcy

Taxation of Virtual Assets

The development of vast social networks through Massively Multiplayer Online Role-Playing Games has created in-game communities in which virtual assets have real-world values. The question has thus arisen whether such virtual assets are legal subjects of taxation. This iBrief will detail and discuss the various exclusions to taxable income, and analyze their application to the possibility of creating potential tax liability based on in-kind exchanges of virtual assets

Trends in crypto-currencies and blockchain technologies: A monetary theory and regulation perspective

The internet era has generated a requirement for low cost, anonymous and rapidly verifiable transactions to be used for online barter, and fast settling money have emerged as a consequence. For the most part, e-money has fulfilled this role, but the last few years have seen two new types of money emerge. Centralised virtual currencies, usually for the purpose of transacting in social and gaming economies, and crypto-currencies, which aim to eliminate the need for financial intermediaries by offering direct peer-to-peer online payments. We describe the historical context which led to the development of these currencies and some modern and recent trends in their uptake, in terms of both usage in the real economy and as investment products. As these currencies are purely digital constructs, with no government or local authority backing, we then discuss them in the context of monetary theory, in order to determine how they may be have value under each. Finally, we provide an overview of the state of regulatory readiness in terms of dealing with transactions in these currencies in various regions of the world

The Five Indicia of Virtual Property

[Excerpt] “Many Americans use “it” every day. Although it is intangible, it may be worth thousands of dollars. Because we can both control it and prevent other people from controlling it, we assume, without much thought, that we own it. Sometimes we pay someone a monthly fee to hold it for us. Sometimes, simply by using it, we increase its value. When we finish using it, we often sell it. “It” is virtual property, and it may take the form of an email address, a website, a bidding agent, a video game character, or any number of other intangible, digital commodities. If it were to be damaged or stolen, the immediate questions would be: (1) how should a court identify it; and (2) what degree of legal protection should it receive? Because no court or legislature in the United States yet has recognized virtual property interests, a combination of contract and custom currently controls the relationship between Internet users and service providers. […] The question therefore becomes, how should courts identify protectable virtual property interests? Partially due to the dramatic success of Massively Multiplayer Online Games (MMOGs)9 and the rise of secondary markets for virtual characters and treasures from those games, a recent frenzy of legal scholarship has struggled to resolve this question. This note supports the legal recognition of virtual property interests, as already convincingly justified by the legal analogy to traditional property interests set forth by Professor Joshua Fairfield, buttressed by the practical reality that virtual property has significant economic value. Building on these rationales, this note proposes five indicia, common to most forms of virtual property, which a court should use to identify legally protectable virtual property interests on the Internet. These indicia are: (1) rivalry; (2) persistence; (3) interconnectivity; (4) secondary markets; and (5) value-added-by-users. This note cautions, however, against applying this newfound definition indiscriminately against the interests of the very entities without whom the property would not exist: the businesses hosting the remotely accessed computer resources (i.e., the service providers). […] Part III of this note applies the five indicia to the well-established framework of traditional property to illustrate this balancing process. Throughout the development of the law in this area, courts must retain the freedom and flexibility to craft appropriate equitable remedies on a case-by-case basis, and special attention should be directed to the practical issues commonly faced by Internet service providers. The ultimate purpose of virtual property jurisprudence should be to strike a balance that provides legal redress to users whose legitimate virtual property interests have been violated while simultaneously reducing liability and disincentives to service providers who promote and sustain the growth of the Internet.