The IRS Decision: What Does It Mean?

On March 25th, the United States’ Internal Revenue Service (IRS), issued a statement saying that bitcoins (and presumably other cryptocurrencies) are to be treated as property for tax purposes. Basically, this means that all capital gains and losses made from holding or using bitcoins must be reported for tax purposes. While many see this as an encroachment of the government into a decentralized system, others think that the ruling shows that bitcoin is becoming more mainstream.
Ideally, the ruling will affect all transactions made in bitcoin. Among other things, workers paid in bitcoin must report it as income on a Form W-2, any payment for goods must be reported, and any capital gain or loss from buying or selling bitcoin must also be reported. In order to pay the required taxes, everyone who gets (whether mining, buying, or earning) bitcoins must record the price of the bitcoins when they were acquired and the price when they are sold, in order to record a capital gain or loss. In theory, almost every transaction may involve a gain or loss that must be reported, even buying a cup of coffee, because of the volatility of bitcoin’s price. Jeffrey Hochberg, a tax attorney in New York, said that the ruling “would obviously create an accounting nightmare for taxpayers and may cause taxpayers to avoid using virtual currency.” Essentially, bitcoins will be treated like stocks and bonds. Taxes can be applied for gains made with bitcoin and up to $3000 can be deducted for losses. The ruling also affects miners, technically any income from mining should now be reported as income for tax purposes. They would also have to declare capital gains like everyone else should they sell the coins.
Many think this ruling represents too much government intrusion and the death of bitcoin as a currency, but others believe that this ruling will improve bitcoin’s standing in the mainstream view. While the ruling says bitcoin is property not a currency, the ruling may actually help investors, allowing a sense of certainty and security. The property ruling was also the lesser of two evils. Had bitcoin been ruled as a currency, the taxes for investors would’ve been much greater. Some also believe that because the IRS has recognized bitcoin, its credibility will be increased in the public eye, and it will see wider adoption.
While the announcement was certainly big news to the bitcoin community, some were quick to point out that such a ruling would be nearly impossible to enforce. Steven Rosenthal, senior fellow with the Tax Policy Center said on the IRS ruling that “Nobody in their right mind would ever comply with that,” and that “The IRS can’t even get the information they need from normal consumer purchases.” The pseudo-anonymous nature of bitcoin would make it extremely difficult for the IRS to track all purchases and catch tax evaders. Essentially, small time bitcoin users likely have little to worry about. The IRS is simply trying to catch big time tax evaders. Alex Daley, a technology investment analyst for Casey Research, said that “This ruling is a warning shot across the bow, mostly to business and large traders, that you’ll have to deal with the income tax evasion consequences.” He doesn’t think that the ruling is “a signal to consumers that we’ll take away the anonymous nature of Bitcoin.”
Regardless of whether the IRS’s ruling will be beneficial in the long run or not, the announcement in conjunction with rumors about a ban in China have driven prices down to about $450, from the $500-600 prices found just a week before.

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First Bitcoin Derivative On Tera May Bring Regulation

On Monday, March 24, TeraExchange, a trade execution platform that deals in numerous types of cleared OTC swaps, announced that it had constructed the first derivative swap involving Bitcoin. Two U.S. firms had privately negotiated the swap, which is a mult-million dollar transaction of funds to hedge the value of Bitcoin. If the swap is transacted, it would bring Bitcoin under the scrutiny of the U.S Federal Government for the first time in its history. The contract would need to be reported to the U.S Commodity Futures Trading Commission (CFTC), which regulates futures and swaps.
TeraExchange said that it had been communicating with the CFTC and is using all of the features available on its Swap Execution Facility (SEF) but, that because Bitcoin is not regulated and not authorized to be traded on a SEF, the transaction will not actually occur on the SEF. However, if the CFTC determines that their jurisdiction covers digital currencies, then they may authorize Bitcoin being traded on the SEF. TeraExchange received permission to operate an SEF last year, which allows for more transparency and reportability.
For the most part, the fate of Bitcoin in terms of regulations is still relatively unknown. Recently the exchange Kraken.com completed an audit of its reserves, in an attempt to improve credibility after recent debacles with Mt. Gox and Vircurex. The cry for regulation has only increased in the wake of the Mt. Gox collapse, and many wish for the government to become involved as evidenced by the class action lawsuit in the U.S against Mt. Gox, and the company’s assets being frozen.
Other attempts at regulations for Bitcoin have also appeared recently. Ben Lawsky at the State Department of Financial Services in New York promoted a need for oversight which recently led to established application procedures for Bitcoin exchanges. Many believe that regulation would be a good thing. Tera President and Co-founder Leonard T. Nuara, in the press release regarding the new Bitcoin swap, said that, “Regulatory approval is crucial to the long-term growth of the market utilizing bitcoin.” The press release also said that Tera plans to make Bitcoin swaps available to eligible contract participant.
While the future of Bitcoin regulation remains uncertain, it is certain that it will continue to remain in the discussion and, if the TeraExchange development is any indication, will become more and more accepted in mainstream finance. While this new development may bring more government oversight, it is also certain to bring more widespread acceptance for Bitcoin.

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