The paradox of valuing cryptocurrency in America

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

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

To the dismay of the crypto industry, (full disclosure: I am an advisor of the North Carolina Blockchain Initiative) the White House analysis — framed as a contrast between crypto’s purported benefits and the realities of what crypto has actually achieved — was largely critical. Unsurprisingly, almost all benefits were supposedly debunked. The report concluded that, from an economic view, many crypto assets do not have fundamental value.

There are myriad ways to value something, and the report’s economic analysis for some cryptocurrencies seems objective. However, the conclusions are perplexing. The overarching critique is in tension with government actions that have relied on — even exploited — cryptocurrency’s implied or inherent value. Moreover, policymakers have experienced an extraordinary expansion of regulatory and enforcement power by recognizing crypto’s value.

Take the extraordinary power gained by the Securities and Exchange Commission (SEC). As early as 2017, the SEC issued the DAO Report, which explained why DAO-issued tokens were securities and therefore subject to its jurisdiction. While other securities tests exist, the SEC relied on SEC v. W.J. 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 whether there has been an investment of “money” in the specified transaction. In the DAO Report, ETH, the digital currency native to 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 satisfying the test’s criteria.

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. Calling into question the value of cryptocurrency might undermine the SEC’s perceived authority on this matter.

The Internal Revenue Service (IRS) also benefits from acknowledging crypto’s value. As early as 2014, it issued a notice 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: It’s 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 the historically expensive legislation. The Inflation Reduction Act also provided the IRS with $80 billion, which it plans to use to hire numerous agents whose duties will include pursuing crypto-related tax enforcement.

According to the IRS, regardless of crypto’s fundamental value, it can be taxed when there is an increase in the basis of a crypto-related investment. But if crypto has no value or is akin to a worthless asset, will the IRS be able to collect short- and long-term capital gains taxes on crypto-related transactions? If not, Congress’ expensive legislative bills could quickly be in arrears. 

There are other examples of crypto’s 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 in the recent bank run crisis. As the White House Economic Report notes, “bank deposits can also act as money.” Furthermore, the government has “maintained a side hustle” by auctioning off bitcoin and other cryptocurrencies seized by law enforcement during criminal investigations. The proceeds go to the Treasury or the Department of Justice where they can be spent on line-item expenses.

What conclusions can we draw? 

First, given how the crypto industry has expanded the power and reach of the U.S. federal government, a national ban seems far-fetched and counterintuitive. Second, the industry must continue to exist in a constant state of confusion over its perceived legitimacy by those with immense political and regulatory power. Third and least surprising, no matter what we think of it, crypto remains a considerable source of profit and potential tax proceeds. 

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

Agnes Gambill West is a visiting senior research fellow with the Mercatus Center at George Mason University. She is an advisor of the North Carolina Blockchain Initiative and a member of the North Carolina Innovation Council.