Without going into the specifics of Bitcoin and other cryptocurrencies, but to provide a brief background, Bitcoin is a cryptocurrency that was created in 2009 as a form of electronic cash. It is a decentralised digital currency without a central bank or single administrator. Bitcoin’s / cryptocurrencies can be sent from user to user on the peer-to-peer Bitcoin network directly, without the need for intermediaries. Transactions are verified by network nodes through cryptography and recorded in a public distributed ledger called a blockchain. Bitcoins are created as a reward for a process known as mining, which is undertaken to maintain the network and supply is limited to 21 million Bitcoins (the supply is different for each cryptocurrency).
Whilst in simple terms cryptocurrencies are a form of electronic cash, their mainstream emergence through the 2017 calendar year, spurred an interest in emerging markets, not seen since the dot-com boom of 1995-2000. Between 30 June 2017 and 31 December 2017, the market capitalisation of cryptocurrencies went from $102bn to $568bn. Everyone was rushing to the table, a new 1% was being created and the regulators were struggling to catch up.
Fast forward to June 2018 and 17.2 million Bitcoin is in circulation and north of 1,500 alternate cryptocurrencies have been developed, each one with a different use case.
Part A
Market participation is continuing to increase and global regulators and governments, including the Australian Government and the Australian Taxation Office (ATO), have commenced a coordinated push to develop a framework for dealing with the emergence of the Cryptocurrency market.
As it currently stands 1 unique bitcoin can be held as trading stock, held for investment purposes and held for personal use. The ATO has determined that a different tax treatment will apply to each of these scenarios, notwithstanding the fact that the same unique Bitcoin could be performing 3 separate functions at the same time, given it can be broken into 1 million Satoshis (equivalent to cents).
This is further complicated should you want to utilise your local currency to purchase a cryptocurrency that is not available on an exchange that accepts Australian dollars, as you are required to purchase bitcoin (or another cryptocurrency that can be purchased with your local currency) and convert that cryptocurrency into the desired cryptocurrency. This process may result in the purchaser undertaking a further 3 to 5 transactions to facilitate this outcome and give rise to a gain or loss on each transaction, even though the intention of the transactions is merely to purchase the end cryptocurrency.
Notwithstanding a taxpayer’s desire to acquire the end cryptocurrency, the ATO has advised that the disposal of one cryptocurrency to acquire another cryptocurrency is equivalent to the disposal of one CGT asset to acquire another CGT asset. Because you receive property instead of money in return for your cryptocurrency, the market value of the cryptocurrency you receive needs to be accounted for in Australian dollars.
A disposal can also occur when you:
- sell or gift cryptocurrency
- trade or exchange cryptocurrency (including the disposal of one cryptocurrency for another cryptocurrency)
- convert cryptocurrency to FIAT currency like Australian dollars, or
- use cryptocurrency to obtain goods or services.
Dealing with cryptocurrencies is further complicated by the following:
- cryptocurrencies have characteristics that result in them being similar to a number of different financial instruments, but not the same as any;
- each major unit of a cryptocurrency can be measured to one hundred millionth of a single Bitcoin;
- each unit of cryptocurrency is paired with a particular Blockchain platform (similar to an FX pair). The Common pairs are Bitcoin, Ethereum and Neo;
- Cryptocurrency transactions are measured in Satoshis, not FIAT;
- each transaction raises fees that, whilst tax deductible, are not always clearly identifiable and are often concealed in the price of the cryptocurrency that has been acquired or sold;
- that there are dozens of decentralised exchanges that largely record transactions based on a USD: BTC pairing; and
- the decentralised exchange might give you a transaction price based on USD, but any conversion to a local currency will need to be facilitated by the taxpayer.
As you can see, the administrative burden on the taxpayer based on the current ATO guidance is not difficult, it is arguably impossible.
Accordingly, until the coordinated global push for greater regulation delivers a solution to this problem, perhaps a simpler solution would be to tax profits in the hand of the tax payer once converted to FIAT currency in their country of residence, subject to any personal use exemption that may apply.
Part B
So as outlined in Part A, both the taxpayer and the tax regulator have some significant hurdles to overcome. In the Insolvency, we have similar issues as well.
Consider the following:
Mr and Mrs Smith lent Mr Jones $500,000, and in consideration for the advancement of funds, Mr Jones allows Mr and Mrs Smith to register a Security Interest over his cryptocurrency portfolio which has a value in excess of $500,000 at the time of the loan. In this example, Mr Jones has no other assets.
After about 6 months, Mr Jones has defaulted on his repayment obligations and in an effort to recover the $500,000, Mr and Mrs Smith have appointed a Receiver pursuant to the terms of the Specific Security Deed entered into between the parties.
Assuming the Receiver has the necessary working knowledge of the cryptocurrency environment and has a “wallet” which can hold Mr Jones’ cryptocurrencies, the Receiver contacts Mr Jones and requests that he transfer his portfolio to him.
Mr Jones advises that he is happy to assist the Receiver, however, due to significant market volatility and some poor investment decisions, his portfolio has been reduced to about $5,000.
Unbeknown to the Receiver, Mr Jones has transferred 90% of his holdings to another wallet or exchange and given the nature of cryptocurrencies, the Receiver is unable to trace or identify the fraud.
This is a real-world risk for parties considering lending in this space and as such, non-bank lenders who consider accepting cryptocurrencies as collateral, should consider its potential change in value and also whether the collateral can be disposed of without the secured party’s knowledge and consent.
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