Spend too long thinking about the virtual or digital world in opposition to the "real" world, and it's almost guaranteed you'll start overthinking concepts we take for granted on a daily basis.
Take money, for example. According to the OECD's recent report, "virtual currency" remains the most widely used term for payment tokens among regulators, though its use is falling as new terminology evolves. However, all major currencies are to a certain extent virtual these days. Of over 14 trillion Euro, only about 1.3 trillion physically exists in the form of coins and banknotes in circulation. The rest comprises deposits in bank accounts and other financial instruments.
In fact, some "virtual currencies" are represented in paper form. In a "cold paper wallet" arrangement, the digital address and private key of a payment token (two of the three elements used to verify a transaction) are generated on an offline computer and printed. The digital version is then deleted before the computer is re-connected to the internet. But I am getting ahead of myself.
Not all cryptoassets are cryptocurrencies
There is currently no internationally agreed standard definition of "cryptoasset" but, for our purposes, we can define them as assets based on a combination of distributed ledger technology (or "DLT") and cryptography. The OECD report divides these into three categories:
- Payment tokens ("virtual currencies" or "cryptocurrencies"), like traditional currencies, are used as a means of exchange for goods or services.
- Utility tokens are assets representing a right to receive goods or services in the future.
- Security tokens are assets that provide the holder with a tradeable right to cash, or to another financial asset.
Simple enough in the abstract, but the distinction between "asset" and "currency" starts to crumble when you recall that even fiat currency can itself be bought and sold. The OECD report even dedicates a full section to analysing whether cryptocurrencies are better described as "money" or "currency" - if these concepts apply at all.
Given the variety of products on the market - and yet to be developed - categorisation seems a Sisyphean task. Not only that, but cryptocurrencies, like all cryptoassets, are inherently prone to hybridity (the ability to combine characteristics from multiple categories) and mutability (the tendency for characteristics to mutate over an asset's lifetime).
Why does it matter?
To be able to regulate something - or, indeed, to tax it - you need to be able to define it, and (unless you opt for new, bespoke drafting) identify how it fits into the existing regime. This is, as we saw above, no easy task.
Even if most jurisdictions see cryptoassets as a form of property, they are far from agreed on what that means for tax purposes. The majority of countries considered in the OECD report categorise cryptocurrencies as intangible assets, except for value-added tax. Others see them as commodities, financial instruments or foreign fiat currencies. Poland, rather than classifying by analogy in this way, plumped for "digital representation of value".
Unlike other forms of property, however, units in the majority of cryptocurrencies are "mined" or "forged" - essentially created by the holder or another user - leading to further disagreement as to whether this creation is, itself, a taxable event. Similar questions arise where a so-called "hard fork" or "chain split" brings a new token into being.
To add an extra layer of complexity, the lack of formal accounting rules (and, in 13 of the countries surveyed by the OECD, the absence of government guidance) on cryptoassets also means there is a risk that the same token could be treated differently for accounting and tax purposes. This is, of course, neither unique to cryptoassets, nor an insurmountable problem, but is a potential future headache for in-house Treasury and Tax teams nonetheless.
A perpetual problem
The underlying tension, though, is one I've written about before, and that we're likely to see a lot more of in the coming years: in a rapidly changing and increasingly technical landscape, how far must legislators and draftspeople prioritise flexibility at the expense of clarity?
Cryptoassets, and virtual currencies in particular, are in rapid development and tax policymakers are still at an early stage in considering their implications. [...] In this sense, the report provides a first glimpse of the taxation treatment of virtual currencies, in what is a rapidly evolving policy area.