Most tax authorities see cryptocurrencies and crypto-tokens as commodities. As we know, there are several types of crypto-tokens:
- Assets (land, metals, gemstones, antiques, etc.)
A token can represent almost any kind of value, different people can purchase the same token for different purposes, and tokens can change their “type” or purpose over time. A crypto-token can represent your gym membership or a ride-sharing credit. Yet most governments tax them as if they were investable assets.
Suppose you go to an exchange and want to trade bitcoin for Pillar tokens. This trade breaks down as:
- Sell bitcoin to exchange, pay blockchain settlement fee in bitcoin (1 taxable transaction)
- Receive Pillar tokens from Exchange. In this case, someone has to pay the gas (blockchain settlement) fee on the Ethereum blockchain (2 taxable transactions)
That trade has three taxable transactions. In each case, the seller has to calculate his net gain/loss on each. When were these tokens purchased and for how much? What was the gain/loss at the time of sale? Which tokens get long-term capital gains treatment and which are short-term gains?
Now suppose you use those Pillar tokens in your Pillar wallet. You want to buy a Pillar t-shirt in the store in the wallet (this should be possible by September). The shirt is priced in Ether. You pay a certain amount of ether for the shirt, plus you pay an extra amount in PLR tokens, which are required to use the system. The current fee for an Ethereum blockchain transaction is 40 cents. So here’s your breakdown:
- Pay the ether for the shirt.
- Pay the sales or VAT tax, probably in Ether.
- Pay the ether fee to settle the shirt/tax transaction.
- Pay the PLR to the system.
- Pay the ether fee to settle the PLR transaction.
In this case, it’s likely that the PLR charge (4) is less than its blockchain settlement fee (5). ALL of these transactions are taxable events. This is the nightmare we find ourselves in as we try to reinvent the world of finance. Using dollars or euros, we don’t have any tax consequences, but using blockchain-based tokens, we do. Neither side – 1) those of us designing and using cryptocurrencies/tokens and 2) those charged with collecting tax – is prepared for this unintended battle.
How Should Systems Charge for Access?
There are some things we can do to limit the damage. These tactics apply to groups that have systems that use tokens to “power” the system, as advertised in most white papers.
There should be no transaction tokens. Charging some amount of tokens for each transaction incurs a blockchain settlement cost and triggers two separate tax events per transaction.
Any system using tokens on a per-transaction basis should switch immediately to one of the following models …
Coupon model: the user pays in advance for a number of internal bookkeeping units that then pay for transactions. For example, she would purchase a “booklet” of ten transaction credits and then spend them as she uses the system. Because they are internal units of account and not blockchain-based assets, purchasing the coupons is a single taxable event but spending them is not.
Subscription model: the user purchases a time-based subscription fee for your system’s services, so she would pay a certain amount every month, and all her fees are covered. There would be a fee to settle the subscription payment, which would produce two taxable events. It may be better to charge people once a quarter than once a month. No one wants extra Ethereum fee charges or taxable events.
Staking model: reward users who maintain a certain minimum balance of your tokens with free use of the system. There are economic advantages and incentives for this, but it probably shouldn’t be the only way to charge for access. I think you would want to encourage it but use a monthly pay-as-you-go model as a back-up.
DAVID SIEGEL is CEO of the Pillar Project, a nonprofit Swiss foundation building the world’s first smart wallet for crypto-assets. He is the author of Pull, business strategy in the age of the semantic web, and The Token Handbook, the first book on Tokenomics.