Regulating Bitcoin

Bitcoin and the crytocurrency world need some regulation. I am all for taking risk and prefer the Wild West to Cuba, but when you are at extremes it’s not good for anyone. Having the Wild West will lead to anarchy. When there is anarchy, despots and dictators insert themselves into the middle of it to bring calm-then go about their business of eliminating competitors and consolidating power until you have a totalitarian state.

If we want crypto to be totally decentralized with assets flowing into the hands that can make the most efficient use out of them, we need some guidelines.

Both the crypto world and the government world are struggling with it. I think part of the reason why is the crypto world would like to be left alone. The government because they don’t exactly know what sort of animal this is and what regulations to apply. Government regulators are not the most creative in general.

If there is one thing I learned as a trader it was to manage risk. Every day I put my jacket on and walked on the floor, I was managing risk. I knew exactly what to do when it was 30 seconds before a number and some order filler stuffed me. I knew what to do when a position went against me. Every day, there was a chance I could lose everything.

When I was on the board of directors at CME, we had a lot of discussion about managing risk. You will notice in 2008 it was the Wall Street guys that had the problems. Chicago firms did really well. It’s because we know how to manage risk here.

Currently, I see lots of risks in the crypto marketplace. If I was a benevolent dictator, I’d do a few things.

First, I would not let ICOs go off with some of the very basic simple white papers that are being circulated. I’d have a lot more detail in them. I’d have a nice large section on the risks of the investment, similar to what would circulate in an IPO. I might have an actual PhD economist look at the use of the coin and make an economic case for it being issued and implemented.

Second, you have to pay taxes on gains. Crypto is not a tax-free haven. If you buy Bitcoin and sell Bitcoin you pay a tax on the gain. Even if you roll into another crypto. How much tax? That’s a totally open question. I’d be very comfortable applying the current tax system of either the SEC or CFTC to the marketplace, but choose one.

Here is one way. If you hold it for less than a year, you pay the top tax rate. If you hold it for more than a year, you pay capital gains rates. Here is another. You pay a blended 60/40 tax rate on crypto trading. 60% at the highest rate, 40% at cap gains. On December 31 of every year, you pay that same tax on open positions in your portfolio based on the settlement price of December 31. You get to write off losses.

There is a twist. What if you generated crypto without using fiat currency? What if you mined it?

In that case, you have to organize as either an LLC or a Corporate entity. The business could fall under GAAP and FASB principles that are currently applied to companies that mine ore, minerals or other natural materials. I am not a CPA, but if you hold your coins as inventory, you probably would not be taxed on them. However, as soon as you sold you would have to pay tax. If you converted them from one coin to another, there would be a transfer price and you would owe tax.

The fact that there are two highly regulated futures exchanges trading Bitcoin futures is a good thing. Having more regulated cash and futures exchanges trading crypto would be good too. The other day, the market experienced first hand how inefficient the current technology powering a lot of the exchanges is. I sense a lack of confidence in the marketplace. Trade confirmations take too long and the fees to trade are escalating. Clearing and settlement at many of these exchanges is a joke. I don’t think it’s even critically thought about or understood. How to charge and arrive at a price for margin is a relatively misunderstood concept.

Yes, there are gatekeepers on Wall Street and they get to charge outsized profits because the market structure they set up gives them a massive edge. But, at least the game is highly organized. I agree that in crypto it would be a very good idea to have a level playing field with no gatekeepers. Except, you are going to need at least a couple to keep order in the market when things go crazy.

  • efalken

    “If you buy Bitcoin and sell Bitcoin you pay a tax on the gain. Even if you roll into another crypto.”
    Why do you think so? Why could it not be classified as a 1031 exchange, which is applied to art and real estate investments? On many exchanges you can sell BTC directly into ETH, etc., so there’s no USD nexus as when one trades from one stock to another.
    As the new tax bill contained an explicit provision that mandates 1031 exchanges can only apply to real estate starting in 2018, this implies that the 1031 rule has been applied to digital currencies previously, why it needed an explicit mention.

    • I think you need to recognize that while crypto is a “technology” it’s also a medium of exchange. Once you buy and sell in the same crypto, a trade has been made.

      • efalken

        It’s also an asset, an investment, like art or real estate, and thus relevant to a 1031 exchange, which the new tax law suggests is potentially applicable through this year. Potentially, because I haven’t seen an explicit judgment on this either way.

        • Sorry, Bitcoin isn’t art.

          • efalken

            Neither is real estate. Art is not under 1031 because of its art-like qualities, but because of its investment-like qualities. Obviously, you haven’t read any of this tax law, because the tax law on this explicitly makes this distinction on why and how art gets this treatment.

  • Robert Zeh

    If you include the bailouts that followed 2008 the Wall Street guys come out as reasonably good at managing risk.
    And a note on the bitcoin exchange’s technology stacks: some of their APIs leave a lot to be desired.

    • Ha, if you include the crony capital bailouts, you are correct.

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