As the age of cryptocurrency comes into full force, it will facilitate a subversively viable taxation avoidance strategy for many of the technically savvy users of peer-to-peer payment systems. In doing so, cryptocurrency use will act to erode the tax revenue base of national jurisdictions, and ultimately, reposition taxation as a voluntary, pay-for-performance function. In this post, I cover some of the benefits such a strategy will have for cryptocurrency investors, why our notion of taxation is ripe for disruption, and why cryptocurrency taxation is enabled by default.

The Siren Song of Tax Havens

Although investors have been lured by the siren song of tax havens for as long as governments have existed, none have existed with the legal and architectural characteristics such as those found in cryptocurrency. By operating behind a veil of cybersecrecy, it is reasonable to forecast the impracticality of systemic taxation on these types of financial assets from national jurisdictions. Individual enforcement of taxation is likewise impractical due to ideological backlash governments would receive for targeting individuals who avoid national taxation via information technologies. Even so, many jurisdictions have already declared digital currency transactions (something which occurs between consenting parties on a network which no one owns) to be taxable under current legal frameworks.

Yet how can the state levy taxation on that which they do not issue and cannot control?

Running The Numbers on Cryptocurrency Taxation

It has been said that compounding interest is one of the most powerful forces in the universe. When we apply the black magic of compounding returns to the profit-maximizing actions of consumers, we see quite clearly why every user aware of the benefits of using cryptocurrency, even if only for the tax-savings, will opt to do so over traditional fiat money. The allure of avoiding the clutches of national taxation is strong enough that any rational consumer will make cryptocurrency a portion of their financial portfolio given they have the sufficient technical understanding.

James Dale Davidson, co-editor of Strategic Investment

“Each $5,000 of annual tax payments made over a 40-year period reduces your net worth by $2.2 million assuming a 10% annual return on your investments,” reports James Dale Davidson in The Sovereign Individual: Mastering the Transition to the Information Age, “For high income earners in predatory tax regimes (such as the United States), you can expect to lose more of your money through cumulative taxation than you will ever earn.”

As we explained in the report Bitcoin May Become A Global Reserve Instrument, never before has there existed a tool that can preserve economic and informational assets with such a high degree of security combined with a near-zero marginal cost to the user. This revolutionary capability of the bitcoin network does, and will continue to provide, a subversively lucrative tax haven in direct correlation with its acceptance on a worldwide basis.

Government Response to Cryptocurrency Taxation

Many government agencies have already cued in to the tax avoidance potential of bitcoin and cryptocurrencies. However, it would seem that they misjudge this emerging threat looming over their precious tax coffers. The Financial Crimes Enforcement Network in the United States (FINCEN) for example, has already issued guidance on cryptocurrency taxation, yet makes a false distinction between real currency and virtual currency. FINCEN states that “In contrast to real currency, “virtual” currency is a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency,” and later “virtual currency does not have legal tender status in any jurisdiction.”

What these agencies fail to realize, is that cryptocurrency is not virtual in any sense of the word. Indeed it is as real, and perhaps even more real, than traditional fleeting fiat currencies. Currency is an abstract concept from the outset. If such currency is capable of purchasing real-world goods and services, then it is indeed real. Only the most careless investors would mistakenly believe money “does not have legal tender status in any jurisdiction” due to its digital makeup. Bitcoin, and cryptocurrencies as a whole, are creating a new jurisdiction entirely.

Bitcoin and cryptocurrency offer a near perfect alternative to traditional tax havens which are being tightly controlled by new laws associated with the Foreign Account Tax Compliance Act (FATCA). In his report Are Cryptocurrencies Super Tax Havens?, Omri Marian makes clear the pressure for financial institutions who interact with the US banking system to hand over account holder information, and for a collective crackdown on offshore tax havens with the enactment of FATCA in 2010. Such a legislative act, it would seem, is a boom for bitcoin’s antifragile position in the marketplace.

Tax policymakers seem to be operating under the faulty assumption that cryptocurrency-based economies are limited by the size of virtual economies. The only virtual aspect of cryptocurrencies, however, is their form. Their operation happens within real economies, and as such their growth potential is, at least theoretically, infinite. Such potential, together with recent developments in cryptocurrencies markets, should alert policy-makers to the urgency of the emerging problem.

– Omri Marian, Are Cryptocurrencies ‘Super’ Tax Havens?

Current bitcoin payment processors such as BitPay have recently revealed that government agencies are watching cryptocurrency transactions through the bottlenecks and exchanges where it can be tracked and traced with a high degree of transparency. It should not come to anyone’s surprise that governments are watching cryptocurrency nor that companies are complying with their laws, but understanding why national governments require users of an emerging digital economy to cut them a slice of the pie while they contribute nothing to it’s operation, and in many cases, hinder the adoption of this technology, remains a callus mystery.

Governments initially attempting to control cryptocurrency taxation through the businesses and bottlenecks which it can be monitored through will have as much success as they have limiting peer-to-peer file sharing and Tor operations. Cryptocurrencies have an inherent regulation, that from the law of number.

Truly, bitcoin is code as law.

Old laws seldom resist the trends of technology. The attempt of government agencies to levy taxation on cryptocurrency transactions directly is as futile as sweeping back waves of the ocean. No matter the size of broom, state actors will be overrun by continuously expanding waves of cryptocurrency adoption.

Cryptocurrency Is Taxed By Default

What would you say if you were told cryptocurrency taxation occurs on every transaction by default? In the realm of digital currency, the transaction fee which the user decides to (or decides not to) attach to each payment represents the taxation. This user can decide to attach a large fee or no fee at all. In doing so, the miners of the network will choose preference for the transactions with a larger fee attached. Thus is the nature of the mining fee incentive. Miners work to confirm these payments sooner than those with smaller fees.

This transactions queue represents a voluntary, pay-for-performance taxation structure where the performance derived from the system is correlated with the willingness to pay of the user.

Algorithmic Regulation

Cryptocurrencies have regulation built into the very nature of their existence, just not through our conventional ideas of human intervention. Because of the technological nature of cryptocurrency taxation, judicial regulations bestowed upon these types of systems will always be, to a large degree, futile. Bitcoin has established it’s own set of rules through the source code which it is built upon. Forcing legal frameworks on this type of 21^st century innovation will only cause unnecessary friction during its adoption phase.

The only choice of regulation we have in terms of cryptocurrency taxation is not to try and fit it inside some existing doctrine, but to abide by their laws of voluntary exchange and information freedom. We must be the ones to conform to the regulation, not vice versa.

Bitcoin is a system which will only be governed effectively through digital law, an approach which functions solely through the medium of mathematical technology itself. It will not bend to the whim of those who still hold conventional forms of law-making as relevant today.

For a successful technology, reality must take precedence over public relations, for nature cannot be fooled.

– Richard Feynman

Conclusion

When we come to understand the systemic subversion to judicial intervention, it becomes quite clear that cryptocurrency taxation will remain a voluntary, pay-for-performance function. No longer will taxation be enforced through coercion, but become a voluntary act towards increased system performance.

Make no mistake, in a crypto-anarchist jurisdiction where there is no means to confiscate or control property on behalf of another individual, the need for the state will cease to exist. You, or anyone motivated to retain their net worth, will find a subversively lucrative tax haven in the realm of cryptocurrency. Mass taxation on bitcoin is infeasible through judiciary law.