The Paradox of Cryptocurrency Valuation in America

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The White House just devoted an entire chapter to the value of digital assets in its 2023 President’s Economic Report. The diversity of views on the subject is alive and well.

Crypto critics and advocates can’t even agree on a name. Labels such as “digital asset”, “virtual currency”, “tokens”, “decentralized currency” and “digital gold” are floating around in the industry. Critics choose colorful artistic terms such as “rat poison squared” and “pet rock” and call for the crypto to be banned for its lack of value.

To the dismay of the crypto industry (full disclosure: I am an adviser to the North Carolina Blockchain Initiative), the White House analysis – presented as a contrast between the purported benefits of crypto and the realities of it what cryptography actually achieved – was largely critical. Unsurprisingly, almost all of the benefits have supposedly been debunked. The report concluded that, from an economic perspective, many crypto assets lack fundamental value.

There are myriad ways to value something, and the report’s economic analysis for some cryptocurrencies seems objective. However, the findings are puzzling. The global criticism is in tension with government actions that have relied on – even exploited – the implicit or inherent value of cryptocurrency. Additionally, policymakers have seen an extraordinary expansion of regulatory and enforcement power in recognizing the value of crypto.

Take the extraordinary power acquired by the Securities and Exchange Commission (SEC). As early as 2017, the SEC published the DAO report, which explained why the tokens issued by DAO were securities and therefore subject to its jurisdiction. Although there are other security tests, the SEC relied on SEC c. WJ Howey Co., a Supreme Court case that outlined a four-factor test to analyze whether a potential transaction is a loosely defined type of security called an “investment contract.”

The first factor of the test asks if there was a “money” investment in the specified transaction. In the DAO report, ETH, the native digital currency of the Ethereum blockchain, was used. The SEC didn’t exactly conclude that ETH was money, but it did argue that ETH was a “contribution of value,” thus meeting the criteria for the test.

Since 2017, the SEC has relied on this test and the perceived value of crypto to launch – and win – numerous enforcement actions against digital asset companies. Questioning the value of cryptocurrency could undermine the perceived authority of the SEC on this issue.

The Internal Revenue Service (IRS) also benefits from recognizing the value of crypto. As early as 2014, it published an opinion defining virtual currency as “a digital representation of value that functions as a medium of exchange, a unit of account and/or a store of value”. This should sound familiar: this is how money is defined. The 2014 Notice also clarified that virtual currency would be treated as property and that general tax principles would apply to virtual currency transactions.

The idea played a significant role in the $1.2 trillion Infrastructure, Investment and Jobs Act when the White House noted that closing the tax gap by taxing crypto would help pay for historically costly legislation. The Cut Inflation Act also provided the IRS with $80 billion, which it plans to use to hire numerous officers whose duties will include pursuing crypto-related tax enforcement.

According to the IRS, regardless of the fundamental value of crypto, it can be taxed if there is an increase in the basis of a crypto-related investment. But if the crypto has no value or looks like a worthless asset, will the IRS be able to collect short-term and long-term capital gains taxes on crypto-related transactions? Otherwise, expensive congressional bills could quickly fall behind schedule.

There are other examples of the crypto valuation paradox within the federal government. In 2015, the Commodity Futures Trading Commission found that “[b]itcoin and other virtual currencies are encompassed in the [commodity] definition and properly defined as commodities. The Federal Reserve effectively bailed out crypto-related deposits held at Signature Bank during the recent banking crisis. As the White House Economic Report notes, “Bank deposits can also be used as currency.” Additionally, the government has “maintained parallel agitation” by auctioning bitcoin and other cryptocurrencies seized by law enforcement during criminal investigations. Proceeds go to the Treasury or Department of Justice where they can be spent on individual expenses.

What conclusions can we draw from this?

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First, given how the crypto industry has expanded the power and reach of the US federal government, a nationwide ban seems far-fetched and counter-intuitive. Second, the industry must continue to exist in a constant state of confusion about its perceived legitimacy by those who wield immense political and regulatory power. Third and least surprisingly, no matter what we think of it, crypto remains a huge source of profit and potential tax proceeds.

A coherent “whole of government” policy would be wise, if only for clarity and to avoid biting the hand that feeds you. Also, if crypto has no value, why tax and regulate it in the first place?

Agnes Gambill West is a Visiting Senior Scholar at the Mercatus Center at George Mason University. She is an advisor to the North Carolina Blockchain Initiative and a member of the North Carolina Innovation Council.

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