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Thursday Collectibles Mailbag

Q: Is crypto a liability?

It is for US banks and will remain that way following Biden’s veto of the Congressional resolution to overturn the SEC’s guidance on crypto accounting. 

The SEC’s guidance (SAB 121) forces banks to account for crypto held on behalf of customers as a liability — which seems unfair because other assets held on behalf of customers are not. 

But I think the SEC has a point here. 

The purpose of SAB 121 was to underscore the risks involved with providing custody for crypto assets and we’ve just had yet another demonstration that providing custody for crypto assets is risky — the crypto exchange DMM Bitcoin lost $300 million of bitcoin held on behalf of customers in a hack last week. 

That’s a reminder that custodying crypto is nothing like custodying traditional assets and therefore possibly something that should be left to the crypto natives.

DMM Bitcoin, founded in 2018, is a subsidiary of DMM, an internet and media company founded in 1999.

I’m only speculating, but it seems logical that an exchange started by a conglomerate might be more hackable than an exchange started by a company that only does crypto.

If so, the same logic might apply to US banks, whose expertise in custodying traditional financial assets wouldn’t do them much good in custodying crypto assets. 

Crypto held on immutable blockchains can be stolen in a way that stocks and bonds held in mutable spreadsheets cannot. This makes them a liability in a way that stocks and bonds are not. 

So, at the risk of getting myself crypto canceled, maybe the SEC has a point here?  

Q: Is crypto an asset?

That depends on who you ask.

If you ask regulators in Japan, for example, they will tell you it’s not — this is why profits made in crypto are considered “miscellaneous income” by Japan’s tax authorities and therefore taxed at ordinary income rates of c. 50% and not Japan’s capital gains rate of 20%. 

On my trip to Tokyo last week, I was reliably told that regulators there won’t classify crypto profits as capital gains until someone can convince them that crypto has utility.

As of yet, no one has.

Q: Is Iggy Azalea that someone?

She is not, no — and if word of her recently launched memecoin, MOTHER, hitting a $200 million market cap reaches Japan, I suspect crypto taxes there may go to 100%.

Governments generally tax capital gains at a lower rate than ordinary income to encourage investment in productive assets.

There’s nothing productive about Azalea’s MOTHER token, which she is meme-ing to relevance mostly with photos of her butt. 

I don’t, therefore, know why the vast profits she’s making should be taxed at the lower rate applied to capital gains (as they would be in the US) and not the higher rate for ordinary income (as they would be in Japan).

Japan’s tax authority extends that logic to all crypto assets and, in most cases, I find that hard to argue with — why should memecoin profits be taxed differently than gambling profits?

Like gambling, memecoins are primarily a form of entertainment, so I don’t know why they should be taxed any differently.

Q: What about bitcoin? 

Bitcoin is similarly unproductive, so you might argue it should be taxed like ordinary income (as it is in Japan) and not as capital gains (as it is in the US).

But it’s not as entertaining, so maybe bitcoin should be treated like gold, which the IRS deems a “collectible.”

In the US, long-term profits made in collectibles are taxed at an in-between rate of 28%: Below the top 37% rate for ordinary income to account for the effect of inflation, but above the 20% capital gains rate to account for being unproductive. 

I’d say that seems about right for most cryptos?

One person’s junk is another’s collectible — and one person’s asset is another’s liability.

Q: What about Ethereum?

In a note out this afternoon, the digital assets team at Van Eck forecasts that by 2030, Ethereum could generate $66 billion of annual free cash flow, all of which would accrue to token holders.

That’s a pretty productive asset!

So, yeah, I’d tax that one at 20%. 

Q: Is Ethereum Blackberry?

I’m asking myself that same question after listening to Ethereum’s Justin Drake debate Solana’s Anatoly Yakovenko on Bankless this week.

Drake argues that the layer-1 blockchain space is a winner-take-most market and he’s ready to call it: “Ethereum has won.”

He bases that assessment on his contention that Ethereum’s current lead over Solana on metrics like TVL and active developers is insurmountable, mostly due to network effects.

But this sounds familiar to me.

There’s a long history of companies with a seemingly insurmountable lead in a new market being overtaken by competitors: Blackberry lost to Apple, MySpace lost to Facebook, Yahoo lost to Google, Kodak lost to the Japanese, Compaq lost to everyone.

I’m old enough to remember that none of those outcomes seemed at all likely early on.

Are crypto’s network effects so strong that Ethereum is in no danger of being similarly overtaken?

The debate on Bankless gets technical (on the relative merits of synchronous and asynchronous systems, for example) and even futuristic (on the prospect of transmitting data via neutrinos that can pass through Earth).

But I’m not sure you need to have a view on all that to think that we’re far too close to the starting line to declare a winner.

Unless you think the best that crypto will come up with is celebrity memecoins, declaring victory for Ethereum now seems no less hubristic than declaring victory for Blackberry in 2007.

Until we have some use cases that even Japan’s regulators would acknowledge, the race will remain wide-open

— Byron Gilliam

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The Fed Wants To Ease, Will The Everything Rally Continue?

This episode Warren Pies Founder of 3Fourteen Research joins the show to discuss the current state of markets with oil trending lower, markets continuing to rally & a pivotal FOMC next week.

Watch or listen to On the Margin on YouTube, Spotify, or Apple.

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