• Margaret Ryznar

Regulating Bitcoin: A Tax Case Study


International companies have been cross-listing their shares on American exchanges for decades. Although cross-listing has traditionally been explained as an attempt to break down market segmentation and to increase investor recognition of the cross-listing firm, Professor John C. Coffee Jr. offered a “bonding” theory: issuers migrate to U.S. exchanges because by voluntarily subjecting themselves to the United States’s higher disclosure standards and greater threat of enforcement (both by public and private enforcers), they partially compensate for weak protection of minority investors under their own jurisdictions’ laws and thereby achieve a higher market valuation. In other words, a firm’s decision to cross-list on a U.S. exchange subjected it to a set of new disclosure and legal requirements that benefited it. Firms thus were choosing to “rent” the securities laws of other countries under the bonding theory for the benefits of legitimacy.

While this Coffee theory arose approximately two decades ago in the context of international cross-listing, it has implications for the modern context of bitcoin that I consider in my paper Regulating Bitcoin: A Tax Case Study. From its beginning, bitcoin has suffered from legitimacy concerns stemming from lack of regulation. Nonetheless, the lack of regulation has been attractive to many of its users, who have resisted regulation. However, the Coffee bonding theory offers reasons for regulation that include the benefits of legitimacy.

A tax case study illustrates this point. The anonymity of bitcoin can facilitate tax evasion, which has attracted illegitimate users among legitimate ones. This has undermined bitcoin. Much involuntary noncompliance with the U.S. tax laws on bitcoin stems from confusion on the taxation of bitcoin, and tax authorities will need to issue better guidance.

More so than involuntary noncompliance stemming from confusion, however, bitcoin’s use to evade taxes undermines its legitimacy. While there is an incentive to report bitcoin losses to claim tax deductions, the same is not true of bitcoin gains. As a result, some bitcoin users intentionally do not report their gains to tax authorities. Despite the existence of penalties for under-reporting tax liability in the United States, they are difficult to apply due to the anonymity of bitcoin. This has led to bitcoin’s ability to function like Swiss banks. Voluntary noncompliance with the tax laws costs the U.S. Treasury billions of dollars each year. The IRS has started to address this issue, including through establishing its authority to summon records from a virtual currency platform through a “John Doe” anonymous summons in U.S. v. Coinbase, Inc.

This voluntary noncompliance, in particular, has given bitcoin the reputation of facilitating tax evasion, undermining the legitimacy of bitcoin. Despite the novelty surrounding bitcoin and other virtual currencies, traditional tax compliance methods can be adopted to address many of these noncompliance issues. Such tax regulation would increase bitcoin’s legitimacy, as the Coffee bonding theory would hold. Thus, while concerns regarding regulation no doubt hold true in the bitcoin context, they must be considered alongside the benefits of regulation, including those predicted by the Coffee bonding theory.

The full paper can be downloaded here.

Margaret Ryznar, Indiana University McKinney School of Law


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