The Breakdown - This Overlooked Crypto Tax Provision Would Be a Disaster

Episode Date: October 2, 2021

This episode is sponsored by NYDIG.   On this edition of “The Breakdown’s Weekly Recap,” NLW looks at: Hidden crypto tax provision 6050I  Chilling language from British lawmakers around using CBDCs to control citizens’ spending  The Compound political gaffe    - NYDIG, the institutional-grade platform for bitcoin, is making it possible for thousands of banks who have trusted relationships with hundreds of millions of customers, to offer Bitcoin. Learn more at NYDIG.com/NLW. Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Join the discussion: https://discord.gg/VrKRrfKCz8   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW “The Breakdown” is written, produced by and features NLW, with editing by Rob Mitchell and additional production support by Eleanor Pahl. Adam B. Levine is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsor is “Tidal Wave” by BRASKO. Image credit: Overearth/iStock/Getty Images Plus, modified by CoinDesk.

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the Big Picture Power Shifts remaking our world. The Breakdown is sponsored by Nidig and produced and distributed by CoinDesk. What's going on, guys? It is Saturday, October 2nd, and that means it's time for the weekly recap. And today we are talking about a story which has been floating on in the background, but feels very important to highlight. It is an overlooked crypto tax provision that could be an absolute disaster for the industry.

So to give a little bit of background, the story starts with the infrastructure bill. If you remember, the infrastructure bill fight came to us when at the last minute, the 11th hour, a provision was added as a way to pay for the infrastructure bill that set out to close what they claimed were $28 billion of taxes that were avoided through loopholes in crypto. The language of the provision was extremely broad and would have forced basically everything. every actor in the crypto ecosystem from centralized exchanges who make sense to be called brokers to miners, to node validators, etc., to act like quote-unquote brokers, and report information that frankly wasn't available to them about users of the network. It basically would have made it illegal effectively to be a minor or a validator because as decentralized actors in the system

as non-custodial actors, they don't have any of the required information that the government was seeking about the people who are actually using the network. It was so egregious that at first people in D.C. like Jake Chervinsky, who I had on the show a few weeks ago to explain and recap the whole thing, thought it was a mistake. Turns out it wasn't. It was a direct assault attack that seemed to be specifically focused on defy and as we would later find out, was being driven by and large from the not-so-invisible hand of the U.S. Treasury Department, led by Janet Yellen. There is a lot to this story, but in short, the crypto industry was able to put an incredible amount of pressure on the political process incredibly quickly.

We made mainstream media for actually holding this infrastructure bill up, and we found a number of new allies on both sides of the aisle. Senator Pat Toomey, who I frequently reference on this show, Senator Lummis from Wyoming, but then also Senator Ron Wyden of Oregon, a Democrat who was in many ways to linchpin to keeping this thing from going off the rails even more quickly. The big bad, the person who put the provision in the bill was Senator Rob Portman from Ohio, but as I mentioned, it seemed in retrospect that a lot of this was coming directly from the Treasury Department. Indeed, one of the biggest frustrations for those in the crypto industry was why the Senate was ceding its lawmaking authority to unelected officials.

Either way, an extraordinary effort of lobbying and negotiation went into trying to take the rough edges off of this provision. And after a couple weeks, we had actually made a lot of progress. However, due to procedural issues, Senator Chuck Schumer decided to not let any provisions be voted upon. The only path to implementing a compromise provision with bipartisan support from both those who had originally been behind the original provision, as well as those who had tried to write something new and entirely less burdensome, was to be a full unanimous vote. If you've ever wondered if the U.S. Senate has ever done anything unanimously, you kind of get a sense of how this played out. It was looking pretty good until Senator Richard Shelby decided that he objected, not because he was against

the crypto provision. In fact, he was for it, but because he had a different provision, a provision which would spend $50 billion of extra money on military spending, mostly in his home state of Alabama, and because he couldn't get his provision voted upon, he wasn't going to vote on any provision otherwise. The bill has now moved to the House, and in fact, on Thursday night they were supposed to vote on this bill, but there are many, many things going on in the U.S. political environment that have made it more complicated, particularly negotiations around the debt ceiling. What I want to point out is that while we were all focused on the specific pay-for provision around this $28 billion of crypto money that they wanted to get that would have such huge

implications for miners, there was another thing that was lurking that could be equally as bad. Here's a thread from Abraham Sutherland of the Proof-Stake Alliance. He wrote, the infrastructure bill passed by the Senate and now pending in the House contains an overlooked digital assets provision that would be a disaster if it becomes law. An amendment to Section 6050I of the tax code imposes a new surveillance and reporting requirement on users of digital assets. This is not the much-discussed broker provision, tax code section 6045, that provoked opposition in the Senate. This provision requires recipients of digital assets, including NFTs, to verify the sender's personal info and record their

social security number, nature of transaction, etc. Then the recipient must sign a under penalty of perjury and send a report to the government within 15 days. All other tax code reporting violations are misdemeanors, but violation of 605.0.0 can be a felony, up to five years in prison. So far, this proposal has escaped attention because it uses an old law that doesn't fit with digital asset technology. This old law applies to in-person transfers of cash, physical currency, and presumes you can inspect the payer's ID documents. The law's relative clarity and limited applicability in the case of old-fashioned cash does not translate to digital assets. Compliance can be impossible. Exemptions involving financial institutions mean that

digital assets are stigmatized, and use of banks, etc., is entrenched. Why risk fines are a felony under Section 6050I? We need to draw attention to this issue. Congress should not vote on this without debate. If the consequences are debated openly, the amendment to Section 6050I would be voted down. Now, pretty quickly, Coin Center took up the cause as well, and they themselves wrote a blog post about it, which isn't too long and I want to read in full. Typically, we don't object to equal treatment of cash and cryptocurrencies, but the 60505OI reporting provision is a draconian surveillance rule that should have been ruled unconstitutional long ago. Extending it to cryptocurrency transactions would further erode the privacy of law-abiding Americans.

6050I would also be anachronistic and therefore difficult or impossible to obey in the context of cryptocurrency transactions. CoinCenter previously published an extensive report on the constitutionality of the Bank Secrecy Act. The BSA and its mandated reporting from banks and other financial institutions is a warrantless surveillance regime that hovers up the banking details of every American, irrespective of any suspicion of crime, and hands that deeply personal information to law enforcement and intelligence agencies without any checker balance from the judiciary. The only reason that kind of privacy invasion is

tolerable under the Constitution is the fact that banks are a third party to the transactions of their customers. Bank users willingly hand transaction information over to a bank as a condition of using banking services, and banks retain that information for legitimate business purposes. This is the essence of the so-called third-party doctrine, which obviates the otherwise applicable Fourth Amendment warrant requirement. Why is a review of BSA constitutionality relevant to our discussion of 605OI? Because 605OI reports are also deputized surveillance, but there is no third party. One person to a two-person transaction is obligated to collect a load of sensitive information from her counterparty and hand that to government officials without any warrant or

reasonable suspicion of wrongdoing. In the case of two persons exchanging two different cryptocurrencies, they each would have to report on the other. The law literally asks one American citizen to inform on another if the transaction in which the two are engaged are business and if they take place using cash, and if the infrastructure bill passes as drafted, cryptocurrencies too. Section 60505.0 has seldom been challenged despite the seemingly obvious constitutional infirmity. A case in 1991 made it to the Second Circuit Court of Appeals, but the judge in that case egregiously failed to explain how the third-party doctrine operates in this context. An obvious question remains,

why does the third-party doctrine described in the BSA cases apply when there are literally only two parties involved? Why is it constitutional for the police to force one American to collect information from their fellow citizen when they could not collect that information themselves directly without a warrant? The infrastructure bill remains in limbo. The broker provision is still a big problem, but our most difficult battles may be yet to come,

including fighting the blatant denigration of our constitutional rights embodied in 6050I cash and maybe cryptocurrency reporting. If this provision becomes law, it will be ripe for a constitutional challenge, and Coin Center is prepared to take on that challenge. So we've talked a lot about alt seasons, NFT seasons, Bitcoin seasons. Smells to me like Fourth Amendment challenge season, unreasonable search and seizure season, is upon us. This podcast is sponsored by Nidig,

an institutional Bitcoin firm that sees Bitcoin as a gateway to financial security for people around the world. Find out more at nightig.com slash NLW. That's NYDIG forward slash NLW. Since we're kind of on this tip, let's talk about more disasters in the making around CBDCs. Here's a little gem of an article from the Telegraph this week. Bank of England tells ministers to intervene on digital currency programming. Here's the chilling subtitle of this article. Digital cast could be programmed to ensure it is only spent on essentials or goods which an employer or government deems to be sensible. It continues, the Bank of England has called on ministers to decide whether a central bank digital currency should be programmable, ultimately giving the issue

or control over how it is spent by the recipient. So basically, in short, what they're talking about, what they're discussing actively as a free society, is whether the government should be able to control what people spend their money on programmatically, as in the government could say, you can't buy porn because we say it's not good, and the way that we enforce this is with your money itself. This is an absolute. insane notion to me. Rory Murray Murray tweets taxes on unrealized capital gains, deducted automatically because your CBDC cuckbucks are programmable to tell you where and most importantly where you can't spend them. I'm telling you, you're not going to like where this is going,

even if you think you are. Now, this is one of those things that seems so implausible it's easy to ignore. And I hate slippery slope arguments as a general principle. However, I will just remind us that when it comes to power and when it comes to giving authorities more power, it's not about whether the current group of authorities will use that power in the ways that they say they will, and not in the ways that they could by the letter of the law, but commit not to. It's about structurally limiting that power in the first place. There are battles to be fought around things like the Bank Secrecy Act and anti-money laundering rules and all of those good, delicious KYC regime things that have some major questions around how much more safe they've actually

made us. They are still night and day different from the capacity of central banks to program what money can and can't be used for in the first place. Anyway, on the tip of CBDCs, Visa also had CBDC news this week. They're creating something called the Universal Payments Channel, and this is basically their way of being a bridge between crypto to crypto, between CBDC to CBDC. They're clearly positioning themselves for this new digital currency era. The interesting thing pointed out by people like Maya as a hobby is that it's very easy to see how this could quickly become a conversation for bankers and approved parties only.

You have Visa, one of the biggest payments monopolies in the world, who are now getting deeper and deeper into this cryptocurrency game. By the way, all the people at Visa who are working on crypto are awesome, so this isn't about them. But still, what happens if and when the government decides that only approved parties, like Visa, are able to interact with the infrastructure of digital currency because they're the only ones that can comply with the rules and regulations? It's not that farfetched to think that this might be a real conversation that comes in the future, and this is certainly at odds with the permissionlessness that's such an important

part of all of these systems. Finally, last one, and whoo, rough Saturday, huh? But I've been bullish for two days, so I think it's okay. Let's talk about the compound gaff. Compound co-founder Robert Leshner tweeted, if you received a large, incorrect amount of comp from the compound protocol error, please return it to the compound time lock. Keep 10% as a white hat. Otherwise, it's being reported as income to the IRS, and most of you are doxed. Boy fucking howdy was that not the thing to say to the crypto industry. Here's a quick sample of responses. The Crypto Lark says,

threatening to docks and report people is a pretty damn bad strategy, dude, makes people more likely to keep it, and makes money a lot less likely to come into your platform in the future. Multi-coins-Touchard Jane says, have you also been filing all the other activity on compound with the IRS? And then All-Coyne Psycho put it best when he said, arguably the worst way I can imagine to handle this, congrats. This is staggeringly bad.

Like, staggeringly bad. First of all, it's your fault, or at least it's the fault of the protocol. Here's the way that CoinDest describe what happened. Compound had a liquidity mining program that rewards depositors and borrowers, but often at a rate of a single digit APY. The botch payout sums indicate a flaw in the Comptroller contract, which disperses the Comp liquidity mining rewards, possibly related to a recent upgrade.

So you're getting all high and mighty and huffy when it was an airman. error of your protocol that was producing this problem. Second, whether you're a decentralized company or not, do not talk to your users like that. It will not work. It will not engender any sort of trust or goodwill or anything good in business. Don't do it, period, full stop. But third, and most importantly, let's talk about the complete lifting of the veil of decentralization. It is an absolute tightrope that decentralized protocols are walking when they're trying to credibly say to the government, who is super suspicious and skeptical of them, yes, we started this, but no, we can't control it. It's its own new type of thing, and you need to

treat it on its own new terms. They are in effect by default, and I don't think that every protocol founder really appreciates this, asking for a new type of policy consideration for a new type of thing. Now, on the one hand, compound was out there saying that they can't fix this because of decentralization. Again from CoinDesk. Leshner also noted that, quote, are no admin controls or community tools to disable the comp distribution. Any changes of the protocol require a seven-day governance process to make their way into production. Labs and members of the community are evaluating potential steps to patch the comp distribution. But then in the same breath, at the same time, he's aggressively threatening users with information some centralized party seems

to hold and going straight to the IRS with it? I will be 100% shocked. If this exact tweet isn't paraded in front of Congress at some point in hearings on Defi in the years to come. This is the fifth biggest protocol by total value locked with over $10 billion, threatening their users with doxing to the IRS. You can't do that. It destroys any pretense of decentralization that you might have had. Now, from a human perspective, I understand Robert is going through it and everyone who's working on compound is going through it.

To his credit, he followed up and said, I'm trying to do anything I can to help the community get some of its comp back. And this was a boneheaded tweet and approach. That's on me. Luckily, the community is much bigger and smarter than just me. I appreciate your ridicule and support. That's great. A good learning moment.

I certainly don't hold anything against Robert. But fucking A. If you don't get, as a D5 founder, the seriousness of the game you're playing as it relates to the future of the way that regulators are going to look at this industry and that you can't just toss off the idea of decentralization when it's convenient for you, you're absolutely going to get wrecked. I hope that doesn't happen, but that's my take.

Anyways, guys, I hope you're having a great weekend. I appreciate you listening. Until tomorrow, be safe and take care of each other. Peace. Hello, listeners. If you're a financial advisor, manager, or CFA looking to learn more about Bitcoin, investment strategies, and tools to share with your clients, then you're invited to attend CoinDesk's Bitcoin for Advisors event on our

October 6th. It's a fully virtual event experience designed for advisors by advisors who have found ways to get compliance ready in order to add Bitcoin advising to their practices. You can head over to coindesk.com slash events to secure your complimentary registration today. That's coindesk.com slash events where you can register for free. We'll see you on October 6th and thanks for listening.