Bitcoin investors should be taxed like any other investor

By Chris Berg, Sinclair Davidson and Jason Potts

Despite its name, cryptocurrency isn’t just money. It could also be debt or equity and so it should be regulated and taxed in the same way as other finance.

The tokens investors get when they buy a cryptocurrency, like Bitcoin, can be used to buy into blockchain startups (businesses that use the same online ledger as cryptocurrencies). When blockchain startups issue shares in their businesses using cryptocurrency, it’s called an initial coin offering. For investors, this is like any other equity investment.

Cryptocurrency can also be used to finance specific assets, like debt. So what we have is a single financial instrument that has the advantages of both debt and equity.

So startups issuing their own tokens for investment purposes should have to comply with the same rules and regulations that startups issuing more traditional instruments must comply with. Cryptocurrency investors should be taxed on the same basis as traditional investors.

Why cryptocurrency is a mix of money, debt and equity

Money is very often defined by its functions: a medium of exchange, a unit of account (used to represent the real value or cost of any economic item), and a store of value (that can be saved, retrieved and exchanged at a later time). The early consensus about Bitcoin among economists is that it’s not money.

At best cryptocurrencies are a medium of exchange. But many economists doubted that Bitcoin, given its volatility, could ever serve as a unit of account, let alone as a store of value.

So if cryptocurrency isn’t money, is has to be something else. It could be an asset of some sort.

Usually if investors acquire or sell an asset, it would be liable to tax, such as the GST. This means people using Bitcoin would be taxed twice when using it.

It would be taxed when the person buys the Bitcoin and taxed again when they used it to buy something. Luckily the federal government realised this was a bad idea and moved to repeal the double taxation of Bitcoin.

Clearly the federal government’s view is that cryptocurrency is not legal tender – so don’t try pay your income tax in Bitcoin anytime soon. And there are important differences between money, specifically legal tender, and cryptocurrency.

Cryptocurrencies tend to strictly rules bound. How they’re created, when they can be earned, how they’re distributed and how many there ever can be, is all determined by rules. In fact, users like strict rules.

By contrast government controlled money is not rules bound. Government employs substantial discretion in exercising control over money. So while the US dollar has the words “In God we trust” printed on it, this system actually requires substantial trust in government.

This trust has been repaid by a substantial reduction of value over the past century. It seems that government-backed money may also be a poor unit of account and store of value.

Debt and equity are financial instruments used to raise money to finance economic activity. It is something of a puzzle to financial economists why firms use debt in some instances to raise finance while using equity in other situations.

An important 1988 paper by the 2009 economics Laureate Oliver Williamson provides a possible answer to that question. Williamson argues that debt, being a strict rules bound financial instrument, is best used to finance general assets, while equity is best used for so-called specific assets. Specific assets are those assets that cannot be cheaply or easily redeployed from their current use to alternate uses without a substantial loss of value.

As it turns out Williamson had speculated about the existence of such an instrument (that he labelled “dequity”) and then rejected that instrument as being unworkable. The reason dequity was unworkable was due to opportunism – investors simply could not trust dequity issuers.

The ledger that cryptocurrencies use – the blockchain – is a actually “trustless” technology because it’s decentralised. It allow users to see each other’s ledgers and transactions, negating the need for a trusted third party to manage risk. Instead it relies on cryptographic verification.

With the absence of the ability for investors to game the system, cryptocurrencies are the dequity Williamson first imagined and it could become an efficient financing mechanism.

How dequity should be regulated

The idea of regulating or taxing cryptocurrency finance may not be to the liking of many crypto-enthusiasts who are likely to argue that traditional rules and regulations are very onerous. They are correct, of course. Yet the solution to over-regulation is not a carve-out for special interests but rather regulatory reform that reduces the burden for all business.

The good news for crypto-enthusiasts is that some governments appear willing to engage in genuine regulatory reform and tax competition to attract investment in this space. For example, the Singaporean government is relaxing existing regulation to accommodate cryptocurrency. Its proposed framework would require applicable companies to obtain a license from the Monetary Authority of Singapore, and divides payment activities into several categories.

But regulators should really regulate cryptocurrencies in much the same way as they do existing financial instruments. It shouldn’t be given special treatment.

Despite all the complexity of cryptocurrency it really is simple: it’s a financial instrument that combines all the advantages of money with debt and equity. It’s none of those well known concepts in isolation, but a viable and workable hybrid of all three.

Institutional Cryptoeconomics: A New Model for a New Century

With Sinclair Davidson and Jason Potts

While cryptoeconomics is already a vibrant research field, the study of the blockchain must not be left solely to computer scientists and game theorists.

The rollout of blockchain technology raises complex questions in economics, public policy, law, sociology and political economy. What we call “institutional cryptoeconomics” starts from a simple premise – the blockchain is not just a new general purpose technology, it is a new institutional technology.

This may sound like a pedantic distinction, but the difference between these two conceptions is profound. General purpose technologies allow us to do what we already do better, faster and cheaper. Economists understand general purpose technologies (like steam power or the semi-conductor) as great engines of economic growth.

There is no doubt that the blockchain is a general purpose technology, but it is much more.

Rather, the blockchain is a new mechanism to coordinate economic activity and to facilitate cooperation between individuals. It opens up new opportunities for exchange, for collaboration and for building communities that were previously closed off due to high information costs and transactions costs.

As a new institutional technology, we expect that blockchains will disrupt and transform both economic activity and social organization. Institutional cryptoeconomics is a new analytic framework to study that evolutionary process.

In the very first instance, we believe that the transaction costs approach of Oliver Williamson – who won the Nobel in economics in 2009 – is the ideal theoretical framework to understand the blockchain. Williamson was primarily interested in understanding the ‘make’ or ‘buy’ decisions that firms have to resolve.

Is it better the buy inputs on the open market or produce them in-house?

That choice defined the limits of the firm, which in turn determined the incentive structures that decision makers faced.

A key determinant of the limits of the firm is “opportunism” or “self-interest seeking with guile” as Williamson described human behavior.

The combination of opportunism and asset specificity (which refers to how easily an investment can be resold or repurposed for another use) meant that complex economic behavior had to take place in large corporations. This in turn implied the need for substantial financial capital investment.

Thus, we saw the dominance of shareholder capitalism in the 19th and 20th centuries.

The blockchain breaks this relationship between size, opportunism and asset specificity.

By substantially eliminating opportunism (that is, being a ‘trustless’ technology), the blockchain allows specific assets to be deployed in small businesses supported not by large amounts of financial capital but by large amounts of human capital. It allows market incentives to deeper penetrate into firm structures resolving problems of team production.

For many industries, the blockchain will radically redefine the boundaries of the firm, allowing individuals to trade their talents and skills in an environment devoid of big business.

The eclipse of the large public firm has been predicted before, of course, but this time we believe those predictions will eventuate for many, if not most, industries.

The decline of shareholder capitalism will have ricochet effects across the economy and society itself. It will put new pressures on employment, inequality, political power and the regulatory state. And it opens up vast new opportunities. The Williamson framework can also help us understand how the blockchain changes – and enhances – the provision of insurance, the provision of public goods, and the provision and protection of identity.

It is often said that we are at the start of a “blockchain revolution.” Institutional cryptoeconomics offers an exciting way to understand what features of the ancien régime we’re about to lose, and what might take its place.

Submission to the Productivity Commission Inquiry into Collection Models for GST on Low Value Imported Goods

With Sinclair Davidson

Introduction: The Productivity Commission (PC) Discussion Paper, Collection Models of a GST on Low Value Imported Goods, suggests that the inquiry that the PC has been directed to pursue is somewhat of a fait accompli. The legislation enacting this policy change (Treasury Laws Amendment (GST Low Value Goods) Bill 2017) has already passed the parliament with broad parliamentary support.

However, the parliament’s decision to delay the implementation of this policy by one year (the original legislation introduced to parliament was scheduled to begin in July 2017) provides an opportunity for the PC to make clear the practical and philosophical problems with the legislated scheme. A clear statement that this scheme is not in the interest of consumers, is unlikely to be effective, threatens Australia’s participation in the global internet commerce economy, and casts Australia as a bad global actor in international taxation, would, in our view, have a concrete public policy impact. The parliament is capable of amending the legislation in response to this investigation, and the government has significant discretionary power to adjust or mollify its implementation.

Available in PDF here

Opening statement to Select Committee on the Future of Public Interest Journalism

A free press underpinned by laws and norms that respect freedom of speech is one of the foundations of liberal democracy. The fact that freedom of speech in the press has an important role in our democracy does not mean that parliament should take it upon itself to support journalism, whether it is publicly interested journalism or not. The question of how to fund journalism is a question for entrepreneurs, not the parliament. The reason I argue this is that government is not an uninterested participant in the public debate. Governments have an interest in favouring journalists and media outlets which are sympathetic to their world views and attacking those they do not. We saw how perversely this dynamic could play out during the media reform debate in 2011 and 2013, and of course we see it in our regular debates about the ABC. Further government involvement in the press would mean that governments have more leverage over the press.

With this in mind, I would like to briefly address two issues that have been raised in debate over public interest journalism so far. Right now, the government directly provisions journalism through the ABC and it has been suggested that this provision be increased, but, as Professor Sinclair Davidson at RMIT and I will argue in a forthcoming book, the ABC is not an independent media organisation.

CHAIR: What’s the name of the book?

Dr Berg: It’s at the moment called ‘Against public broadcasting’, but we haven’t actually finalised the title.

Senator XENOPHON: Senator Dastyari is good at book titles.

Dr Berg: We’ll open that up for recommendations, of course, as we would. The ABC is the only media outlet dependent entirely on the government for its operating expenses, it’s the only media outlet regularly dragged in front of parliamentary committees to answer for minor programming decisions and the ABC is regularly accused of bias by the Left and the Right. This bureaucratic one billion-dollar government owned television and radio network is not the ideal vehicle for the sort of journalism that would suit our digital age.

The second issue that I’d like to raise is the proposal to give public interest journalism outlets deductible gift recipient status. This has much to recommend it, in my view. DGR status would be available to media outlets professing any political slant. DGR status would encourage media firms to self-fund, to be accountable to their supporters and readers, and it would not constitute a direct call on public revenue. One concern with this model, however, is that it would require an authority to decide which media outlets are legitimate public interest journalism outlets and which are illegitimate ones. Poorly designed, this could easily transform into a de facto licensing body through which the government may be able to exert some influence over the press. If the committee recommends this sort of reform, it should think very clearly about how that would be done. There are concrete things the parliament could do to help journalism in the digital age. For instance, the government should review limits on the freedom of speech. You probably don’t want me to talk any further about 18C of the Racial Discrimination Act, but I would draw the committee’s attention to the heavy burden of defamation laws and our lack of fair-use exception for copyrights. I welcome the Senate review announced into the law of contempt.

More generally, media outlets will benefit from regulatory reform that reduces the burden of red tape on the Australian economy. The policies which help firms thrive in the general economy would be the same policies that help media firms and, ultimately, help public interest journalism thrive.

Government must leave encryption alone, or it will endanger blockchain

With Sinclair Davidson and Jason Potts

If we could give Malcolm Turnbull one piece of economic advice right now – one piece of advice about how to protect the economy against a challenging and uncertain future – it would be this: don’t mess with encryption.

Earlier this month the government announced that it was going to “impose an obligation” on device manufacturers and service providers to provide law enforcement authorities access to encrypted information on the presentation of a warrant.

At the moment it’s unclear what exactly this means. Attorney-General George Brandis and Malcolm Turnbull have repeatedly denied they want a legislated “backdoor” into encrypted devices, but the loose way they’ve used that language suggests some sort of backdoor requirement is still a real possibility.

Hopefully we’ll discover more when the legislation is introduced in the August sitting weeks. Turnbull did say at the press conference “I’m not suggesting this is not without some difficulty”. The government may not have made any final decisions yet.

But before any legislation is introduced, the government needs to understand what the stakes are in as they strive against encryption.

Anything the government does to undermine the reliability of encryption could have deleterious consequences for what we believe will be the engine of economic growth in decades to come: the blockchain protocol.

The blockchain is the distributed and decentralised ledger that powers the Bitcoin cryptocurrency. Blockchain constitutes a suite of five technologies: cryptography, a database that can be added to but not altered, peer-to-peer networking, an application of game theory, and an algorithm for ensuring a consensus about what information is held on the ledger.

Taken separately, these are long established technologies and techniques – even mundane ones. But taken together, they constitute an entirely new tool for creating political, economic, and social relationships.

The possibilities far exceed digital currencies. Already banks and other financial institutions are trying to integrate blockchains into their business structures: blockchains drastically reduce the costs of tracking, recording, and verifying transactions. Almost any business or government organisation that is done with a database now can be done more efficiently, more reliably, and cheaper with a blockchain – property registers, intellectual property, security and logistics, healthcare records, you name it.

But these much publicised blockchain applications are just a small taste of the technology’s possibility. “Smart” self-executing contracts and massively distributed organisational structures enabled by the blockchain will allow the creation of new forms of business structures and new ways to work together in every sector and every industry.

In fact, we think that the blockchain is so significant that it should be treated as its own category of human organisation. There are firms, there are markets, there are governments, and now there are blockchains.

But the blockchain revolution is not inevitable.

If there is one key technology in the blockchain, it is cryptography. There are lots of Silicon Valley entrepreneurs playing around with lots of different adaptations of the blockchain protocol, but this one is a constant: the blockchain’s nested levels of encryption are built to ensure that once something is placed on the blockchain it is permanent, immutable, and only accessible to those who own it.

Blockchains only work because their users have absolute confidence that the system is secure.

Any legal restrictions, constraints or hurdles placed on encryption will be a barrier to the introduction of this remarkable new economic technology. In fact, any suggestion of future regulatory challenges to encryption will pull the handbrake on blockchain in Australia. In the wake of the banking, mining and carbon taxes, Australia already has a serious regime uncertainty problem.

Melbourne in particular is starting to see the growth of a small but prospective financial technology industry of which blockchain is a central part. The Australian Financial Review reported earlier this week about the opening of a new fintech hub Stone & Chalk in the establishment heart of Collins St. What’s happening in Melbourne is exactly the sort of innovation-led economic growth that the Coalition government was talking about in the 2016 election.

But the government won’t be able to cash in on those innovation dividends if they threaten encryption: the simple and essential technology at the heart of the blockchain.

Malcolm Turnbull’s Super Ministry

The new Home Affairs Ministry will be an administrative behemoth. It is unlikely that it will bring any great national security dividends. It is very likely that it will have undesirable consequences for Australia’s immigration program.

The Home Affairs Ministry takes the federal police, ASIO, the Australian Transaction Reports and Analysis Centre, and the Australian Criminal Intelligence Commission away from the Attorney-General. It takes the Office of Transport Security away from the Infrastructure Minister. It gives them all to the Immigration Minister Peter Dutton, who already has his own quasi-security agency, the Australian Border Force.

The politics here are obvious. Dutton is a senior conservative in a government that conspicuously lacks senior conservatives. But as a policy matter, there’s little public evidence to suggest that we our federal agencies are struggling to coordinate on security matters – although the 2014 Sydney siege did reveal weaknesses in federal-state security coordination, which the government has rightly moved to repair.

Where agencies sit on the ministerial map can have significant policy consequences. The creation of the Home Affairs Ministry locks in this government’s recasting of immigration as an economic opportunity to immigration as a security threat – a threat to national security, biosecurity, even economic security. Malcolm Turnbull has begun to use Julia Gillard’s old formulation: “Australian jobs are for Australians”.

Immigration and security are only a good fit if you squint very hard. For the most part Dutton’s day job has been the mundane work of supervising and approving or denying marginal visa applicants. The immigration minister is vested more discretionary powers than anyone else in the cabinet. Now that his focus is on security – taking constant briefings from ASIO and the AFP about domestic threats – security is how Australia’s immigration program will now be framed.

Medicare details available on dark web is just tip of data breach iceberg

Modern governments use a lot of data. A lot. Our social services are organised by massive databases. Health, welfare, education and the pension all require reams of information about identity, social needs, eligibility, and entitlement.

Our infrastructure is managed by massive databases holding information about traffic flows, public transport usage, communications networks, and population flows.

Our security is maintained by complex information systems managing defence assets, intelligence data, and capabilities and deployment information.

We should be thinking about these enormous data holdings when we read the news that thieves have been selling Medicare numbers linked to identities on the “dark web” – a mostly untraceable anonymous corner of the internet.

That last detail is what has made this such a scandal for the government, as Human Services Minister Alan Tudge and the Australian Federal Police have scrambled to identity the systems’ weaknesses.

But the fact that the Medicare numbers are being sold is the only thing that makes this an unusual data security breach. Australian government databases are constantly being accessed by people who are not authorised to do so.

Here’s just a taste. Last year the Queensland Crime and Corruption Commission revealed it had laid 81 criminal charges and 11 disciplinary recommendations in the space of 12 months for unauthorised access to confidential information by police. One of those was a police officer who had been trawling through crime databases looking for information about people he had met on a dating service. He was convicted of 50 charges of unauthorised access.

A Queensland police officer was disciplined in May this year for using the police database to share the address of a woman with her husband who was subject to a restraining order.

The Victorian government’s police database was wrongly accessed 214 times between 2008 and 2013, by “hundreds” of officers.

Earlier this year 12 staff were fired from the Australian Taxation Office for accessing tax data on celebrities and people they knew.

We could go on. These of course are the instances we know about because they have been detected and reported on. There are undoubtedly others.

Governments manage a lot of data because we ask them to do it a lot, and to do what they do well.

They run thousands of complex systems. Many of these systems have been jerry-rigged and adapted from earlier systems, a series of politicised, over-budget and under-delivering IT projects stacked on top of each other over decades.

But these repeated episodes of unauthorised access show that these complex systems are in dire need of reform.

It is clear that the “permission” structures on these government databases are deeply broken.

In the debate over mandatory data retention one of the big questions was whether law enforcement and regulatory agencies should have to obtain a warrant before accessing stored data. In the end the government decided no warrant was necessary – because warrants could only slow down investigations.

This is exactly the sort of loose permission structure that leads to abuse. Just two weeks after data retention officially came into effect this April, the Australian Federal Police admitted one of its members had illegally accessed the metadata of a journalist.

This breach was entirely predictable. Data retention opponents repeatedly predicted it.

Last week’s Medicare breach has been made possible because thousands and thousands of people – bureaucrats, health professionals, and so on – can access the Medicare database. Most police officers, bureaucrats, and health professionals are trustworthy. But it only takes a few bad actors to wreck a system built on trust.

Rather than leaving data access up to the discretion of thousands of people, we need stricter codified rules on data access. Government databases need to be restructured to prevent, not simply penalise, government employees from going on fishing expeditions through our data.

The point isn’t to provide a legal or technological fix to the problem of unauthorised access. Rather, we should completely reimagine who owns the information that the government keeps on all of us. We ought to own and control our information, not the state.

New cryptographic technologies increasingly being applied to blockchain and cryptocurrency applications allow for even greater personal control over information. If applied, they would only allow government agents to know exactly what they need to know.

And it would move us from a system of surveillance and big data, to one of personal disclosure and privacy.

In the past, economic reform was targeted at big sectors like banking, telecommunications, and trade.

As Australian governments evolve inevitably into complex information brokers, the next wave of reform will have to focus on data management.

Delegation and Unbundling in a Crypto-Democracy

Abstract: Representative democracy consists of a chain of delegation from voters to the executive and a corresponding chain of accountability, with some questions (particularly constitutional questions) reserved for popular vote. This structure reflects the high transaction costs of coordinating preferences among a large and diverse population, which has in part been determined by technological limitations. A new technology, blockchain, significantly reduces transaction costs. This technology turns out to have significant implications for democratic governance. In a crypto-democracy, voters have contractual relationships that allow them to unbundle, delegate, re-rebundle and reserve their voting power. Rather than planning our democratic structure and thus restricting opportunities for political exchange, the use of blockchain in a crypto-democracy allows us to ‘grow’ a democracy in a Hayekian framework.

Working paper available at SSRN.

The South Australian Major Bank Levy: Arbitrary, unjustified, and harmful for South Australia and the rest of the country

With Sinclair Davidson

Introduction: In the South Australian state budget 2017-18, South Australian Treasurer Tom Koutsantonis announced that the state government intended to introduce a South Australian Major Bank Levy, one of two revenue measures “to help us meet the cost of our significant support for driving economic growth and creating more jobs”. Treasurer Koutsantonis made clear that this levy was explicitly modelled on the Commonwealth government’s Major Bank Levy, which was announced in the May 2017-18 Commonwealth budget and passed the Commonwealth parliament in June.

Banking is a key sector in a modern economy. Banks and the financial markets they serve work to allocate capital across the economy to its most efficient purpose. The health of the banking sector is closely related to the health of the economy in general; likewise, an unstable and inefficient banking sector often causes, or is at least a leading indicator of, turmoil in the general economy. The centrality of banking and financial markets to economic prosperity and recession throughout history is reason to subject public policy proposals that affect banking markets to particular scrutiny.

This paper is an examination of the South Australian Major Bank Levy. The South Australian Major Bank Levy is intended to exactly replicate the Commonwealth Government’s Major Bank Levy but at the state level. Accordingly, it applies an additional 0.015% tax on South Australia’s share of the total value of bank liabilities that are subject to the Commonwealth Major Bank Levy Act 2017. That levy consists of a tax introduced on a range of liabilities held by the five of Australia’s largest banks – the Commonwealth Bank, the ANZ, the National Australia Bank, Westpac and Macquarie Bank. While these banks are not explicitly named in legislation, they are subject to the levy because they each have total liabilities greater than $100 billion – raising the prospect of new banks being added or of existing banks dropping off the list.

Both levies apply to the total liabilities held by each bank with the exception of that bank’s additional Tier 1 capital, its deposits protected by the Financial Claims Scheme (that is, its government guaranteed deposits), an amount equal to the lesser of the derivative asserts and derivative liabilities of each bank, and its exchange settlement account held with the Reserve Bank of Australia.

This paper finds that the South Australian Major Bank Levy:

  • will be economically harmful to a state that has seen a rise in unemployment and a decline in business investment,
  • lacks serious justification in either taxation or banking policy,
  • represents a rollback of the GST compact of 2000 which required South Australia to remove state taxes on banking and financial services,
  • harms the stability of banking in South Australia and Australia more generally,
  • increases ‘regime uncertainty’ for investors, and
  • there are reasons to believe it has already done harm to the South Australian economy.

Not only should the bank levy be rejected by the South Australian parliament, but parliament needs to work to ensure that markets and investors have certainty that such an arbitrary and harmful intervention could not occur in South Australia in the future.

Available in PDF here.

State Government bank levy makes South Australia riskiest place for investment in Australia

Imagine being an international investor looking at Treasurer Tom Koutsantonis’s Budget. You wouldn’t be interested in his infrastructure spend and “future jobs fund”.

You’d immediately hone in on the fact that the South Australian government has doubled down on the Federal Coalition’s bank levy by introducing its own state bank levy.

And you’d immediately understand that this makes SA the riskiest state to invest in, in a country that is looking like an increasingly risky place to invest.

South Australia has the highest unemployment rate in the nation. It needs firms to put their money into the state and create productive private sector jobs. No government spending can substitute for an attractive economic investment climate.

In this, the state’s bank levy is almost comically bad. The federal bank levy is arbitrary, punitive and unjustifiable. Treasurer Scott Morrison groped around for a rationale for taxing the big banks, finally landing on: people “don’t like you”.

Koutsantonis’s tax is even more arbitrary and its rationale even more slight. In his Budget speech, he said that the “banking sector is very profitable” and that given, in his view, the GST should be applied to financial services, SA should expropriate some of the big banks’ money.

But this is nothing more than a rhetorical shell game. The SA bank levy looks nothing like the GST, developed and refined over nearly two decades to be as efficient as possible. The GST is a consumption tax specifically designed to be paid by consumers.

Koutsantonis says he will ban the banks from passing his tax onto consumers. (This is astonishing by itself – the SA government is going to start regulating banks? We ended state-based financial services regulation 20 years ago.)

Finally, the GST was specifically devised in order to get rid of state-based taxes on financial products. These taxes – the bank account debits (BAD) tax and financial institutions duty (FID) – were uniformly agreed to be inefficient, to disproportionately harm the poor, and to harm Australia’s international competitiveness.

Getting rid of the FID and BAD tax was a key part of the GST deal. Is SA going back on that deal? Is it dipping out of the GST compact? How do Koutsantonis and Premier Jay Weatherill think the other states and Commonwealth, should respond?

With the imminent closure of Holden, SA needs to be looking to grow its economy and attract investors. But if there’s one thing investors hate, it is policy uncertainty.

Policy uncertainty is exactly what Koutsantonis has delivered.