Around the time of the American Revolution, whiskey was a medium of exchange in Western Pennsylvania. Farmers used their grain as a store of value, thus satisfying the most important requirement of a sound money. Whiskey was also portable, non-perishable, and universally valued, and had high value relative to weight. The only problem was its lack of uniformity, but this was solved with brand recognition.
Unfortunately, Alexander Hamilton tried to promote the sale of government bonds to support the fledgling federal government. He convinced Congress to put a tax on whiskey, essentially a tax on money. The tax not only raised revenue for the government, but gave federal money a comparative advantage over free market money. Any history book will tell you the conventional story of the Whiskey Rebellion, in which Hamilton convinced George Washington to send in a federal army to force farmers to pay their taxes. We might speculate that the tax revenue was secondary to eliminating competition in the market for money.
During Hamilton’s time, the dollar was defined as a specific weight of silver. Today, it is purely fiat, backed only by the force of law. “Fiat” actually means a decree, sanction, or order. Specifically in this case, legal tender laws decree that dollars must be accepted as payment of both public and private obligations. The dollar has the major legal advantage that transactions in alternative media, such as gold or bitcoins, are subject to the law on federal tax reporting, just as the sale of stocks and bonds are. Until these two laws are repealed, neither gold nor bitcoins have a decent chance of competing with fiat.
According to the IRS, every bitcoin transaction must be reported by tracking gains and losses. IRS Notice 2014-21 specifically names bitcoins as an example of a “convertible virtual currency.” Any exchange of bitcoins for goods and services may result in a tax liability for U.S. citizens. For a nice example of this, see here.
The first step is to determine whether the transaction produced an ordinary gain or loss, or it created a gain or loss on sale or exchange as a capital asset. If bitcoins are used to pay employees or contractors, their value gets reported as W-2 or 1099 ordinary income. Bitcoin miners must report any mined coins as gross ordinary income. Otherwise, the acquisition and sale of bitcoins has the same tax-reporting requirements as that of other capital assets, like stocks, bonds, and investment properties.
Every bitcoin transaction, no matter how small, carries a legal obligation to track capital gains and losses. A bitcoin exchange may help keep track of tax data, but this is still a significant disadvantage to using bitcoins compared to dollar-denominated credit cards or cash for payments. Bitcoin transactions are preserved forever on the blockchain, making them available for a tax audit at any time.
Requiring that citizens track transactions in gold or alternative currencies and pay taxes on gains and losses relative to the dollar is just another mechanism for keeping the monetary playing field unbalanced in favor of government fiat.
How many people think blockchain anonymity can shield them from the need to report? (In reality, the degree of anonymity is much weaker than most people realize.) I don’t know, but one thing is certain: bitcoin transactions are archived forever, so the potential for tracking them never goes away.
Just like Hamilton’s attack on whiskey, taxation and legal tender laws give today’s fiat dollars an unfair advantage versus both gold and bitcoins. The fiat dollar has a legalized monopoly. Most freshman economics students can recite the evils of monopoly, and the government itself has many antitrust statutes ostensibly aimed at preventing monopoly in other sectors of our economy. Perhaps it is time to apply those statutes to the government’s money monopoly.