It’s been a rough year. Not only is the cryptocurrency market down 50 percent year-to-date but every tax authority in the world is taking a close look at cryptocurrency investors who have possibly not been appropriately reporting their crypto capital gains.
In 2015, only 802 people reportedly declared their cryptocurrency investment earnings to the I.R.S. If we take this as a proxy for the rest of the world, it is clear that crypto investors have not been totally honest on their capital gains tax forms or were simply not aware that cryptocurrency earnings are required to be taxed as digital currencies as they are – to some extent – “only” computer code.
How US tax crackdown has weighed on crypto prices
Head of research at Fundstrat Global Advisors, Thomas Lee, stated in an interview with CNBC that he believes that U.S. households likely owe $25 billion in capital gains tax for their cryptocurrency holdings in 2017, which has been one of the key reasons why the market has underperformed in 2018 as individuals have been cashing their cryptocurrency holdings into fiat to cover their capital gains tax payments for the past year.
Furthermore, he expects that digital asset exchanges have been forced to sell cryptocurrency holdings to pay for their own tax bills.
“Additionally, we believe there is selling pressure by crypto exchanges who are subject to income tax in U.S. jurisdictions. Many exchanges have net income in 2017 [of more than] $1 billion and keep working capital in [bitcoin]/[ether], not USD — hence, to meet these tax liabilities, are selling BTC/ETH,” Lee told CNBC.
Lee’s opinion is shared by Tim Enneking, founder and managing director of Crypto Asset Management.
“Odds are very high that if [cryptocurrency investors] made a bunch of realized money in crypto in 2017, they are still heavily weighted in crypto,” Enneking told MarketWatch. Hence, investors who sold at the highs in late 2017 and re-entered the market at lower levels in the first quarter of 2018 will have needed to cash out into U.S. dollars to cover their capital gains tax payments due in mid-April.
In a blog post titled ‘Cryptoassets: Flow & Reflexivity’, former cryptocurrency buy-side analyst and author Chris Burniske looks at the “Crypto Tax Crisis of 2018” together with Distributed Global’s Jonathan Cheesman. He suggests that we are currently witnessing “the most concentrated period of net fiat outflows that the crypto asset ecosystem has experienced in its short life.”
Not only are Americans filing their taxes in mid-April but Japan – one of the largest Bitcoin trading hubs – has just had its tax day on March 15. Hence, Burniske also believes that crypto taxes played a major role in this year’s bear market.
Having said that, Burniske believes that “concentrated tax selling is likely nearing completion”.
Moreover, due to what Burniske calls the “fiat amplifier”, which is a measurement of how much one dollar put in or taken out of crypto relates to crypto price movements, once crypto taxes have been paid, we could see the crypto asset market rallying again.
This is what Fundstrat’s Tom Lee believes. He told CNBC: “Ultimately, we expect bitcoin to find footing after April , tax day.”
How tax season affects U.S. stock returns
The reasoning behind the predictions that the market will start to rally again once tax season is over is not entirely unfounded given that a similar effect can be witnessed in the U.S. stock market. it is It is a widely believed phenomenon for the stock market to be down in the first two weeks of April and to rebound after April 15, especially in specific sectors.
Market data analytics firm Kensho has found that since 2000, the S&P500 stock index has been down an average of 0.2 percent in the period of April 1 to April 14 and has only been up 41 percent of the time. Conversely, after tax day, the S&P rises 75 percent of the time and is up an average of 1.7 percent.
The sectors that show the most notable moves during tax season are technology, energy, industrials, and financials, according to data compiled by Kensho.
Where will the crypto market go next?
With Mt.Gox’s bankruptcy trustee still in possession of over 165,000 of bitcoin (BTC) and the equivalent amount of bitcoin cash (BCH) that will still need to be sold and uncertainty surrounding possible global cryptocurrency regulation that will be discussed at the next G20 meeting in July, even the most die-hard “HODLlers” seem cautious about the current market environment.
Furthermore, when looking at Google search trends, the demand for keywords such as “how to buy cryptocurrencies” or “buy bitcoin” has dropped substantially since the beginning of the year, which suggests that interest in crypto assets may be waning among the general public.
Having said that, the number of hedge funds that are being launched to invest specifically in cryptographic assets is still on the rise and more and more private banks, brokerages, and wealth managers are offering investment products that have bitcoin and other digital currencies as the underlying assets. This should help to create new institutional and high-net-worth investor money inflows in the cryptographic assets.
Moreover, with the launch of bitcoin futures on the CBOE and CME in December 2017, the possibility of a bitcoin ETF is back on the table as well as the potential for further regulated bitcoin-based financial products, which could push the market to never before seen highs in the second half of 2018.