As the crypto industry inches closer to the $2 trillion market cap mark, its refreshed hype cycle is all but certain to capture the attention of regulators.
Coming on the heels of a global pandemic, which sent global markets into a tailspin, 2021 has ushered in a Democrat led administration, the rollout of the long anticipated COVID-19 vaccine, and skyrocketing bitcoin (BTC) prices.
While many crypto enthusiasts love the crypto market’s “wild-west” nature, a turbulent season of increased regulation and taxation will certainly be a growing pain for the industry.
IRS sets a trap
As Benjamin Franklin famously said, “The only two certainties in life are death and taxes.” Without letting its reputation precede itself, it shouldn’t be any surprise to see the Internal Revenue Service (IRS) take a more proactive role in carving out its share of profits from bitcoin’s explosive growth.
It was recently reported that the IRS could be setting its sights on as much as $40 billion in revenue from crypto alone — enough to make up 5% of its total gap of revenue lost due to the pandemic — assuming a 50% compliance rate at a market cap of $830 billion.
The market cap has since doubled, meaning that, with full compliance, the IRS could be pocketing as much as $80 billion to $160 billion in tax revenue, closing the gap on up to 20% of its deficit.
This is low hanging fruit which you can be assured is on the government’s radar. How are we so sure? In December 2020, a question was added to the 1040 form:
The line reads, “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?,” and is followed by a “Yes” or “No” checkbox.
Many in the crypto community believe that this line is more or less a trap set by the IRS to catch coy crypto holders in the act. In a recent post, Tax expert Edward Zollars said:
“The reason for those questions is to catch someone who answers ‘No’ where the agency later obtains information that they did, in fact, have such currency that they had received, sold, sent, exchanged, etc., in 2020.”
This addition came just one month after the IRS sent over 10,000 warning letters to Coinbase users, in November of 2020, warning them that they may have underreported their cryptocurrency earnings.
And the confirmation that the government has opened hunting season on the crypto community was confirmed by Don Fort, former head of the IRS’s criminal investigation division, who said that “the IRS has been not so quietly positioning itself for a smooth transition from education to enforcement in 2021 and beyond.”
The moral of our story being Uncle Sam is coming for his piece of your gains, sure as the sun will rise and set. And the IRS will be hyper focused on this who hide their earnings.
What goes around comes around?
This isn’t the IRS’s first rodeo. It’s just the latest iteration of the internet shaking up the way we think about money. The whole situation is reminiscent of the IRS’s major crackdown of the previous decade — offshore bank accounts.
As far back as 2008, Foreign Bank and Financial Accounts (FBAR) filings have been thoroughly vetted, aimed at those tech-savvy enough to hide their money in tax havens like Switzerland.
Now all foreign bank accounts became vulnerable to IRS scrutiny, with many viewing the agreement between Swiss Bank UBS and the IRS to name United States account holders as the moment that the tide turned.
At the time, only about 20% of taxpayers who had foreign accounts actually reported them, spurring the crackdown. And did enforcement uncover any whales in the process? Just ask H. Ty Warner
Current data, as recent as 2017, shows that only .04 percent of taxpayers have reported crypto holdings while an estimated 7% had actually engaged in trading or holding virtual currency.
Years of poor compliance in the financial industries have surely taught the IRS when the optimal time to investigate a financial market and the government to implement to new regulations surrounding said market: we are living that moment.
Signs of future legislation?
The Biden administration so far has shown signs of openness to the crypto industry. As a progressive approach to money and finance, such openness is fitting. Janet Yellen, Biden’s Treasury Secretary, has shown mixed signals expressing concerns about money laundering, while also showing optimism at the technology’s potential for innovation.
He has also picked heads of the Securities and Exchange Commission (SEC) and other institutions that have expressed support, such as the former chief legal counsel of Coinbase Brian Brooks who left his job to become the acting chief of the Office of the Comptroller of the Currency for eight months.
But despite the administration’s seemingly favorable stance toward the blockchain, it would require legislation to seriously reshape the industry.
Regulation: good or bad?
Right now it’s the wild west, and while some of the more libertine crypto-junkies think no regulation is the best regulation, this isn’t always the case.
Keep in mind that the industry is still rife with exit scams, rug pulls, and Ponzi schemes. It’s a well-known fact that money launderers and drug traffickers use crypto to conceal their shady business dealings. But these do not make the industry inherently evil, nor do they outweigh the positive innovations that have been created using blockchain.
Regulation has certainly been a force to stymie growth and innovation in the past, but it is not always the case. While it may cause the price of bitcoin and other cryptocurrencies to fall in the short term as government agencies shake out bad actors, data-driven regulation could actually stimulate the crypto economy in the long run.
For example, regulation could lead to an increase in bitcoin’s growing credibility with established players in the financial industry, bringing about a whole new wave of money that could make the current price discovery look miniscule.
Remember that this isn’t the first time markets have been in this position. Harvard University’s Timothy Massad — the former head of the CFTC — said that “digital asset innovation has outpaced our regulatory framework,” but that, “regulation won’t stop innovation […] unless it’s done badly.”
This is the mark that the Biden Administration and Congress must meet: to implement positive regulation that protects investors while preserving innovation, and to do so in a timely manner. Waiting for a crisis and then responding after-the-fact is how over-regulation happens, and that won’t be pretty.