21/12/17: Of Taxes and Whales: Bitcoin's New Headaches

I have recently mused about the tax exposures implications of Bitcoin 'investments', and in particular, my suspicion that many today's BTC enthusiasts (retail investors speculating on BTC and other cryptos) are likely to be caught out with unexpected and un-covered tax liabilities arising from trading in currencies pairs that involve cryptos and regular currencies (e.g. BTCUSD pair). Normally, every trade in BTC that involves sale of BTC for USD is subject to capital gains tax. This is a nasty side effect of the BTC trading.

And here comes a new and a worse one: the GOP tax plan will make even trades between cryptos (e.g. BTCETH pair) subject to capital gains (https://www.bloomberg.com/news/articles/2017-12-21/tax-free-bitcoin-to-ether-trading-in-u-s-to-end-under-gop-plan). The GOP plan removal of the like-kind swap tax deferral provision for everything other than real property sweeps cryptos put of the deferral cover because back in 2014, the IRS designated cryptos as non-currency property-type assets, like gold.

In addition to catching many investors off-guard and leaving them facing potentially explosive tax bills, the new change induces more liquidity risk into the system: removal of the deferral imposes a de facto transaction tax on BTC and other cryptos. This is likely to reduce frequency of trading conducted by investors. Which, in turn, reduces liquidity of the BTC and other cryptos.

This tax change, in part, likely explain why the BTC and other cryptos concentration is falling: the whales, who used to control up to 40% of the entire BTC issuance to-date, are selling, and selling at speed (https://www.bloomberg.com/gadfly/articles/2017-12-21/bitcoin-whales-are-cutting-back).  Ordinarily, this would be a good thing (lower concentration risk, increased liquidity), but cryptos are not your ordinary assets. The problem with whales selling is that one of the key arguments in favor of cryptos is that crypto-enthusiasts and pioneers are market-makers who prefer mine-and-hold strategy. In other words, to-date, the argument has been that the whales simply will never sell their holdings before BTC issuance reaches its bound of 21 million units.

That reasoning is now going, like the proverbial hot air out of a punctured balloon: