Why Crypto Should Modify the Section 6050i Tax Change, Not Fight It

Last week, a four-decades old law about cash was modified to incorporate cryptocurrency. Buried deep inside President Biden’s thousand-page Infrastructure bill was an amendment to an arcane section of the U.S. Internal Revenue Code, which sets reporting requirements for payments made with cash. The definition of “cash” was amended to include crypto. Rather than celebrate the law’s ratification of crypto, many in the cryptocurrency community are furious.

Over the centuries a large body of law has evolved pertaining uniquely to cash.

J.P. Koning, a CoinDesk columnist, worked as an equity researcher at a Canadian brokerage firm and a financial writer at a large Canadian bank. He runs the popular Moneyness blog.

One of society’s oldest cash-specific laws is legal tender. Other ancient laws cover counterfeiting. A newer law, one from the 18th century says that “currency cannot be followed.” If a stolen banknote is innocently accepted by a merchant, the merchant gets to keep it. Stolen goods, however, must be returned to their original owner.

More recent laws governing cash tend to specify due diligence and reporting requirements. Since 1970, U.S. banks have been required to submit currency transaction reports for cash deposits or withdrawals in excess of $10,000.

Into this thicket of laws governing cash, Satoshi Nakamoto kickstarted a novel “electronic cash system.” Since then a whole slew of other bitcoin-inspired cash systems have emerged including Ethereum, Dogecoin and Tether.

Fans of these systems have spent the last decade clamoring for mainstream legitimacy. “Bitcoin fixes this!” they say. And this legitimization seems to be happening. Usage is growing. In some cases, crypto has gone mainstream.

But the second-half of gaining legitimacy is integration with the body of existing laws. Electronic cash somehow has to be spliced into our centuries’ old rules about cash, coins and other bearer instruments.

It’s at this point of the legitimization process that many cryptocurrency advocates who coveted mainstream cash status for their tokens suddenly balk. Legitimization also involves, yikes... extra responsibilities?

This “balking” is precisely what is happening with the recent amendment of Section 6050i of the U.S. Internal Revenue Code to include crypto, passed last week as part of the Infrastructure Investment and Jobs Act.

A brief explanation of Section 6050i

On its face, the amendment provides cryptocurrency advocates with the legitimacy they’ve always craved. Cryptocurrency is being included in the definition of cash alongside banknotes and coins.

Being classified as cash, however, brings an associated set of burdens. Section 6050i imposes reporting requirements on cash users that non-cash users don’t face. If you own a jewelry store, for instance, and someone buys $10,000 worth of jewelry from you using banknotes, you need to report their purchase. Not so if they pay with a debit card. It is these new requirements that are causing cryptocurrency fans to balk.

Let’s look a bit closer at the law.

Section 6050i requires people engaged in “trade or business” to collect information about those who make purchases in excess of $10,000 using banknotes and coins. They must report this information by filling out what is known as a Form 8300 and filing it with the IRS or the Financial Crimes Enforcement Network (FinCEN). A Form 8300 must also be filled out when purchases are consummated with cashiers’ checks, money orders or traveler’s checks.

And now with the amendment, a purchase in excess of $10,000 made with bitcoin or any other types of crypto will require a Form 8300, too. The changes don’t take effect immediately, though. Reporting won’t become necessary until l 2024.

Lawmakers introduced the Form 8300 requirement in 1984, almost 40 years ago.

The motivating idea was to address tax evasion and laundering of the proceeds of crime. Moving criminally-derived cash into the banking system had already been targeted in 1970 by requiring banks to report cash withdrawals or deposits of $10,000. But criminals can also clean dirty cash by buying goods and services, say cars or real estate. And so the Form 8300 requirement, which extends reporting duties to cash accepting businesses, came to life.

There’s no crypto exemption

Cryptocurrency users may not like the amendment, but requiring Form 8300 reporting for cryptocurrencies is a perfectly reasonable extension of the law. The application of law to cash should be technologically-neutral. That is, irrespective of the form or medium on which it is instantiated, cash is cash – it should be treated equally. If Tesla dealers are obligated to report purchases of Teslas consummated with banknotes, they should have to do the same with bitcoin.

However, I agree with several of the criticisms that members of the cryptocurrency community have aired concerning the amendment to 6050i, particularly those made by Abraham Sutherland, an adjunct professor at the University of Virginia School of Law and advisor to the Proof of Stake Alliance. Although the amendment has already passed, it probably deserves to be revisited.

Here are some suggestions.

The main weakness is the way that crypto has been absorbed into Section 6050i’s definition of cash.

In determining what is to be defined as cash, the law uses a catch-all term “digital assets.” It defines a digital asset as “any digital representation of value which is recorded on a cryptographically secured distributed ledger.”

But as Sutherland points out – and I agree – “digital assets” is an overly-broad category. A non-fungible token (NFT) is very different from a centralized stablecoin like USD Coin. Bitcoin isn’t the same as what regulators refer to as LTDA, or legal tender digital assets (i.e. a blockchain-based central bank digital currency). Nor are dogecoin and dai equal. Yet by bracketing them all under the same category, they have all become “cash” in the eyes of 6050i.

Digital assets shouldn’t be bucketed together because they don’t function the same way. Some digital assets are more like cash than others. Some are more like property, or collectibles.

The best way to resolve this problem would be to break the category “digital assets” up into three types: stable digital assets (stablecoins and LTDA), non-stable fungible coins (bitcoin, ether, dogecoin, etc) and non-stable non-fungible coins (NFTs). The monetary threshold for triggering a Form 8300 reporting requirement, currently set at a flat $10,000, should be indexed to the type of digital asset.

The more “moneylike” a digital asset is – i.e. the more that it gets used as a medium of exchange – the more likely that it is useful for moving the proceeds of crime. Purchases made with these assets should face the lowest, and most stringent, thresholds. The less money-like the digital asset, the higher the threshold.

Stable digital assets such as stablecoins are the most likely to be used for payments, and should therefore face a similar $10,000 reporting threshold as cash. The argument can be made that stablecoins merit an even higher, and looser, threshold than cash, say $30,000, since blockchains provide a degree of traceability – cash and cashier’s checks don’t.

The threshold for payments made with non-stable fungibles like bitcoin should be even higher, say $50,000. This is because their volatility makes them less conducive for payments, and so the money laundering risk they present is lower than cash or stable digital assets.

Lastly, payments with non-stable non-fungibles such as NFTs should not be included at all in the category “digital assets.” If they are included, they should be subject to an even higher ceiling, say $100,000.

I’m using these thresholds for illustrative purposes only. The point I’m trying to make is that some combination of exemptions and staggered reporting thresholds would constitute a fairer way of bringing digital assets into the ambit of 6050i.

Majore compliance challenges will also crop up in decentralized finance, or DeFi. Section 6050i applies to “persons” engaged in trade. But is a truly decentralized protocol a person? Can a smart contract that accepts a $100,000 deposit of USDC be obliged to file a Form 8300 with FinCEN?

I’d suggest that a genuinely decentralized protocol should be exempt from the law’s definition of person. But fakely decentralized protocols – those protocols which are controlled by a person or corporation – should be obliged to report.

Regulated DeFi protocols (such as Swarm Markets) would also be exempt from Form 8300 requirements. So would their users. These gated protocols make an effort to know who is using their protocol, so a Form 8300 requirement would be redundant.

DeFi users who regularly receive digital assets from senders through the intermediation of genuinely decentralized protocols, say decentralized exchanges, may also incur reporting requirements. Compliance will be difficult since the receiving person cannot be linked to the sender. Higher thresholds for non-stable digital assets such as Ether would help reduce the reporting burden. Builders of decentralized protocols may want to consider developing 6050i compliance tools that connect receivers back to the original source of funds.

Lastly, stablecoins can help with compliance. Until now, centralized stablecoin issuers like Tether and USD Coin have taken a hands-off approach to identifying owners of stablecoins. If they were to adopt universal customer due diligence, only known parties would be able to own stablecoins. This would absolve DeFi users of the constant hassle of submitting Form 8300s.

Enjoying the fruits of legitimization means bearing the legal responsibilities that come with that legitimization. But at the same time, one also hopes that lawmakers do a better job of fusing crypto into Section 9050i than their current iteration. Reporting purchases made with crypto won’t take effect until 2024. We have a few years to resolve this.