Why Capital Gains Tax does NOT work for Cryptocurrency

We are off to a bad start when the ATO gets the basics wrong… [1]

Spending your crypto to purchase items

Let’s say you bought a Bitcoin in 2017 and withdrew half of it to your hot wallet with the intent to purchase items. You buy a computer for 0.5 BTC 6 months later and start making small purchases for 0.00X BTC.

Little help from the tax department and accountants run for the hills at the sound of Bitcoin

I have called the ATO on many occasions to clarify rules around cryptocurrency. While guidelines are published, they become muddied by all the nuance of blockchain technology.

Crypto to Crypto transactions using an exchange

Let’s say you want to buy coin x but to get it you must first acquire some BTC and then swap it for coin x.

Stable coins are treated all the same

Stable coins are tokens on the blockchain that represent various fiat currencies like the US dollar. Despite this, the tax office regards them as all the same.

Crypto to crypto transactions on a DEX

This starts to get even more tricky than the scenario above. If you try to acquire coin x on a smart contract exchange like Uniswap, your crypto currency can go through many conversions before it gets to the final result.

Airdrops, a potentially unintended taxable event

Airdrops are basically tokens that are deposited into your wallet for free. These airdrops can be dropped into your account without your knowledge/consent but still incur a tax liability, even if they drop sharply in value after they are received.

Indeed. [2]

Transaction fees for the network

Every time you use a decentralised cryptocurrency like Ethereum or Bitcoin, there is a transaction fee paid to the network, denoted in the native cryptocurrency.

transaction gas fees are also a taxable event… [3]

Converting your ether into L2 ether or side chains

Ethereum plans to migrate to a L2 solution to increase its scalability. To do so you must deposit your ether into a smart contract to get minted the same ether on another network. Is this a taxable event? It shouldn’t be, but the tax office might have other ideas.

Using dApps on Ethereum, a compliance nightmare

Now we start to get to the real meat of the issues with these tax rules. When you use dapps on Ethereum, such as the MakerDAO CDP platform to generate DAI, you start to get into very complicated territory.

Ouch [4]

If Crypto fulfils its potential, the capital gains tax on Cryptocurrency will have to be abolished

As you can now see with the above examples, the capital gains tax becomes far too onerous as soon as you start using crypto as it was intended to be used, especially on smart contract based blockchains like Ethereum. These are still the early days and the technology will only get more complex with time.

Some alternative solutions to the capital gains tax

Before you dismiss me as being a stupid libertarian who doesn’t want to pay his taxes, hear me out. Here are a list of alternatives that would make this scenario much more simple so that we can focus on productive work rather than wasting our time trying to figure out our tax returns. We can’t all afford to have a massive accounting team to manage our personal affairs.

No capital gains on base cryptocurrencies

This is the most simple and ideal alternative. Simply don’t tax crypto gains except for those that are securities e.g. a token on ethereum that represents a company share.

Wealth tax on cryptocurrencies

This tax is already levied in countries like Switzerland and actually works very well for cryptocurrencies like Ethereum and Bitcoin because they are very liquid.

Only tax crypto to fiat transactions

Again, a much simpler approach. Simply calculate the gain at the time that it gets converted to fiat. France has taken this approach.

Why I am optimistic that reform will come

I am optimistic change will come in the long run as it is in the self interest of the tax department to eliminate these onerous taxes as the industry matures. When crypto becomes a mainstream affair, the amount of value creation from the technology will be massive and the tax issues I outlined here will be magnified as more and more people join the network and more services are created.

Good advice for everyone, especially government…

Photo references

[1] https://www.ato.gov.au/general/gen/tax-treatment-of-crypto-currencies-in-australia---specifically-bitcoin/

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