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Montreal Economic Institute: Bitcoin Adds Value, But Legal Realm Lags

By: Contributor - Jan 27, 2014, 8:00 am

The Montreal Economic Institute (MEI) recently released a report on bitcoin’s status in Canada. It praised bitcoin for a few benefits: easier international payments, lower transaction costs, and faster successful transaction confirmations. The report did raise some concerns, though, particularly regarding illegalities: fraud, money laundering, and tax evasion.

These concerns are not unfounded. Bitcoin developer Jeff Garzik has admitted that criminal use of bitcoins is “inevitable,” seeing that bitcoin transactions are more difficult to trace than those made with fiat currency. Bitcoin’s roles in the Silk Road — an online black market — and the assassination market have led to widespread misunderstanding that the cryptocurrency is primarily an anonymous means for questionable transactions.

While bitcoin users enjoy the pseudonymous privacy that comes with a number address, and higher levels of security due to advanced encryption, bitcoin is not entirely anonymous. As with most digital systems, footprints can be traced, and bitcoins can eventually be linked with their owners. Since bitcoin transactions are completely nonrefundable, fraud is also a possibility.

Given these footprints, Cameron Keng at Forbes disagrees with the concern over tax evasion, calling bitcoin’s meticulous public records “an accountant’s wet dream.” According to Keng, the digital currency is taxable when a “taxable activity occurs,” such as when bitcoin is exchanged for fiat currency, or used for trading. By explaining how bitcoin would fit into the current US tax structure, Keng inadvertently highlights how the “uncertain world of tax” may hinder progress of this cryptocurrency — be that in the United States, Canada, or elsewhere.

The “uncertainty” is, according to Joe Harpaz at Forbes, caused by the question of how to categorize bitcoin in the formal tax structure, and how the government can grab “its fair share of your gains.” The US Internal Revenue Service, for example, is still deciding how it will categorize and tax bitcoin. Gains under the capital assets category face a tax of up to 24 percent, but if bitcoin is treated like fiat currency, gains could be looking at tax rates as high as 43 percent.

The Canadian Revenue Agency issued a release back in May 2013 in which it outlined the tax rules applicable to bitcoin transactions: parties paying for goods with the digital currency must declare the value of the goods traded in their income for tax purposes — not that it is likely to happen. Those who buy and sell bitcoin like a commodity are also supposed to declare any gains or losses for tax purposes. If a buyer needs any guidance in classifying his bitcoin gains as capital gains or income, he is welcome to refer to a 23-paragraph segment in Interpretation Bulletin IT-479R, Transactions in Securities.

Despite the frustration that comes with trying to squeeze innovation through bureaucratic knotholes, the fact that the US and Canadian governments alike are working to include bitcoin in the tax structure speaks volumes about how far bitcoin has come. Governments skimming value from the surface of the bitcoin pool is an unsavory signal, but it is a signal nonetheless that the currency has accumulated substantial value.

Government endorsement could lend more legitimacy to the cryptocurrency, which would be good news for merchants interested in accepting bitcoin, and for banks like Wells Fargo that have shown interest in providing services to bitcoin users. However, a comment on a Reuters article about the Wells Fargo bitcoin meeting cautioned that “The banks have no more influence over bitcoin than the recording industry does over torrents. And that’s by design.”

Another complication arises, though, from the January 16 ruling from the Canadian government that bitcoin is not legal tender. This puts the country somewhere between China, which has officially banned bitcoin from use by third-party providers, and the United States, whose former Federal Reserve Chairman Ben Bernanke believes that bitcoin “may hold long-term promise.”

This ruling is a nice formality, and it might be useful to businesses that haven’t made a final decision about whether or not to accept the currency. However, bitcoin’s still-pseudonymous founder hardly felt the need to ask governments for their blessing back in 2008 — nor do bitcoin users, whose vast international presence can be viewed in CoinMap. So such a proclamation will likely go ignored.

Bank of Canada spokesman Alexandre Deslongchamps even said last week that “Smaller, stand-alone payment systems for which there are many substitutes — like bitcoin — should generally require much less intensive oversight, and regulation because they pose much less risk to the Canadian financial system as a whole.” In briefly outlining his hopes for bitcoin, he added, “these payment systems should be designed and operated to meet the needs of Canadians which would include convenience, and ease of use, price, reliability, safety, and effective redress mechanisms.”