Last week's guidance from the IRS on tax treatment for bitcoin transactions may have temporarily impeded one avenue in a single jurisdiction, but it has opened up another more significant avenue.
An IRS "property" classification for bitcoin reaffirms its status as "digital gold" because it tacitly encourages one type of monetary activity (store of value) over another (medium of exchange).
If bitcoin is digital gold, then gold is analog bitcoin. Both commodities have a significant economic role to play going forward because one is a consensual store of value based on chemical properties and the other is a consensual store of value based on mathematical properties.
This ruling was a lose-lose scenario for the IRS because an alternative tax ruling for treating bitcoin as a currency would have placed it in direct transactional competition with the US dollar. The Department of the Treasury was loath to do that at least from a tax perspective.
The big picture
In the big picture of so-called monetary transactions, economies support three basic types of transactions: person-to-business (P2B), business-to-business (B2B), and person-to-person (P2P). One could also include business-to-person (B2P), but I tend to leave that in the category of P2B.
These classifications hold up whether transactions are physical or digital and also whether transactions are domestic or international.
“Even prior to the Internet, practical monetary transactions demanded easy divisibility and reasonable carry costs.”
Regarding tax treatment in various jurisdictions, the only transaction classes affected would be P2B and some B2B in the jurisdictions enforcing merchant compliance for customer identity reporting. Hence, merchant compliance becomes a point of enforcement for authorities.
This is important because any tax rulings that bestow preferential treatment on bitcoin as a commodity will tend to nudge bitcoin (XBT) in the direction of a store of value perhaps backing alternate types of currency issuance or handling predominately large cross-border transactions – exactly the role played by gold (XAU) today.
Since gold and bitcoin are both monetary commodities that don't represent another party's liabilities, they become a medium of last resort for transactions without counterparty risk.
The two most prominent monetary metals in the world are gold and silver and while they might have established themselves initially in physical hand-to-hand exchanges, their usage has evolved beyond that. Even prior to the Internet, practical monetary transactions demanded easy divisibility and reasonable carry costs.
Bitcoin has the advantage of being both a potential long-term store of value and a useful medium in ordinary day-to-day transaction settings. The fact that bitcoin accommodates both makes its ultimate outcome more a function of jurisdictional treatment than commodity properties.
Remember, two of bitcoin's medium-of-exchange advantages over gold are its near-infinite sub-divisibility and its near-zero transportation cost over long distances.
Cypherpunk hacker juno moneta tweeted:
— juno moneta (@firstecache) March 29, 2014
What does this statement mean? Who wants to transform bitcoin?
To understand the answer to that, one must understand how PayPal willingly transformed itself in the regulatory sphere to get mainstream adoption. If the bitcoin innovators end up with a PayPal-like system saddled with third-party choke points, what has really changed in the payments world? Our twitter commentator states that the current IRS ruling happily steers bitcoin in the opposite direction.
Whereas PayPal never had the capability to evolve in the opposite direction, the distributed bitcoin network and its corresponding unit of value bitcoin certainly does. This is where the really big boys play.
The IRS ruling is also likely to elevate digital gold bitcoin into some form of reserve currency status and the vehicle of choice for large cross-border transactions. It would not be unusual to see this emergence as different jurisdictions will undoubtedly have varying treatments for "official" bitcoin classification.
Additionally, this outcome would support the thesis that larger international exchanges operate like bitcoin clearing houses while the domestic or regional exchanges satisfy the local markets.
About reserve currency
Reserve currency status refers to the use of a favored monetary instrument or commodity that is commonly held by nation-states and institutions for foreign exchange reserves and large cross-border transactions.
Reserve currencies, like gold, can also be used for the ultimate backing of a government's own monetary regimes as in the currency substitution cases of Panama, Barbados, Bermuda, and Uruguay.
Bitcoin as a reserve currency asset has appeal because it is non-governmental and global in nature. Its sustainability will not be affected by regional political instability and it has the potential to outlast certain countries and their form of government. Bitcoin is governed by the laws of mathematics.
In the case of large cross-border transactions, bitcoin has appeal because it knows no political boundaries nor is it hampered by capital controls, orchestrated payment blockades, and foreign exchange restrictions. As these transactions are typically performed by sovereigns or large institutions, the jurisdictional tax treatment will probably not be a concern. Possible use cases include closed-loop diamond brokers settling intra-network trades or even partner countries within a trading bloc seeking a pricing and settlement unit other than USD.
Institutional and sovereign transactions fall under the B2B payments category and they also could provide the valuable underpinning for bitcoin price discovery absent sufficient retail price discovery. Just as end-to-end encrypted email messaging, on-network P2P bitcoin transactions exist in a world of their own.
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