Cryptocurrency Regulation: The Light at the End of the Tunnel

News | February 3, 2019 By:

It’s generally accepted that taxes must be paid on cryptocurrency gains, but few seem to understand exactly what’s owed and how to calculate it. Software solutions that keep track of price fluctuations and trades made by integrating with exchanges exist, but the uncertainty surrounding taxation of the emerging asset class can only be attributed to lack of clear guidance on behalf of regulators.

In the U.S., initial advice from the IRS classified cryptocurrency as property, and traders were simply expected to pay tax using the ‘realization’ method, depending on their profits/losses (which complicates itself when a trade is crypto-to-crypto, as opposed to crypto-to-fiat). This is generally accepted as the appropriate approach, but recent developments may see this change: IRPAC has recently issued a report to the IRS, prompting it to reconsider the position in light of the growing popularity of cryptocurrencies.

There are certainly a number of nuances to digital assets requiring guidance that cannot be found in existing regulation, chief among these, is what happens when a blockchain is forked and suddenly a participant in one becomes a participant in several without ever opting in?

In the case of a hard fork, where a new chain diverges from an existing one, holders of assets from the original chain find themselves now in possession of two sets of UTXOs (Unspent Transaction Output) – one from the old chain, and one from the new chain.

Regulation does not address the fact that the coins of holders, at the time of a chain split, are effectively doubled. Nor do they address a holders inability to opt-out of the event. One of the most prominent examples is that of Bitcoin Cash (from Bitcoin), which continues to be highly contentious. I believe, in this case, that the cost basis should not be the price of Bitcoin Cash on the day of the fork, but rather zero.

Forcing people to pay income on value they never had a choice in receiving and were unable to reject, is illogical. If the recipient chooses to dispose of the forked coins, then and only then should tax be accessed. It should be a gain of 100% of the asset’s value at the date of disposition. This is a critical point that needs to be addressed because the openness of blockchains in general could open the flood gates to unreported income that no one actually considers income.

Another nuance that has been left entirely to interpretation is airdrops, a marketing tactic that was widely adopted in 2018 by blockchain startups, where an investor or holder of a given cryptocurrency, is given a nominal amount of tokens without taking any action. In the absence of guidance it’s not clear how airdrops should be treated, but if you received coins in an airdrop, particularly if you claimed them, you need to report something on your tax return.

Many are anticipating the IRS’ response on some of these matters, especially as the existing IRS Cryptocurrency taxation guidelines haven’t been updated since 2014. More detailed guidance that demonstrates in-depth knowledge of blockchain networks’ efficiencies is of utmost importance so that investors can keep on top of their taxes.

About The Authors

Sean Ryan and Perry Woodin, are the Founders of NODE40. NODE40 Balance is a robust cryptocurrency reporting software that integrates directly with major cryptocurrency exchanges. Members of the blockchain community transacting in, trading, or mining digital currency, have likely triggered a taxable event and can be unaware of how to properly disclose these transactions to the government.