Cryptoization Through Currency Substitution: Tax Policy Options for Low-Income Countries

The rise of cryptocurrencies in low-income countries highlights the need for suitable income tax policy for those assets.¹ This article focuses on how a tailor-made policy for low-income countries should look, arguing that a crucial component of that policy is determining the tax consequences of using cryptocurrencies to buy goods and services.

In the first half of 2022, crypto experienced a crisis. At the end of 2021, the total market capitalization of global cryptocurrency peaked at around $3 trillion; by July it was hovering around $1 trillion — $2 billion wiped out in just six months, taking with it some of the earnings of those who bet big on crypto.

Although crypto prices were reasonably stable in June and July — at a level comparable to the one reached at the end of 2021 — it is unclear whether they will be maintained in the long run or sink even further. Commentators have argued that that when the dust settles, crypto mania, like the dot-com bubble of the late 1990s, will turn out to have been the precursor of a more stable and lasting Web3 revolution. The crypto companies that survive the current crash will be tomorrow’s dominant players.² Skeptics are quick to point out that when the dot-com bubble burst, the underlying product — the internet — showed a lot of functionality in the form of web browsing or email communication. Some say that is not the case for cryptocurrency and Web3. In the words of a group of tech experts urging the U.S. Congress to resist the cryptocurrency lobby: Blockchain technology is a solution in search of a problem.

Whichever view one wants to adopt, the price volatility shows that policymakers should tread carefully when regulating what the IMF has described as the “cryptoization” of the economy — that is, the increased substitution of traditional assets and currency for cryptocurrencies.³ In low-income countries, the stakes are higher than in high-income countries, and the benefits drawn from the adoption of cryptocurrencies — increased financial inclusion, cheaper inbound remittances, hedge against hyperinflation — might quickly be outweighed by the downsides.

In a July policy brief, the United Nations Conference on Trade and Development (UNCTAD) warned low-income countries about the cost of doing too little too late.⁴ Cryptoization will be detrimental to domestic resource mobilization for sustainable development if the leakage of financial resources through cryptocurrencies is not staunched. UNCTAD said that will be the case if cryptoization: (i) is allowed to bring along a national increase in illicit financial flows (although the data show that this risk should not be overemphasized); (ii) is allowed to undermine capital controls; and (iii) allows income and capital gains to go untaxed because of the absence of tax regulations or of the unenforceability of existing regulations. UNCTAD thus recommends that countries “clearly define the legal status of cryptocurrencies” and “agree and implement a global tax cryptocurrency regulation that considers the needs and challenges of developing countries.”

Easier said than done, of course. As shown below, characterizing cryptocurrencies for tax purposes — that is, as property or currency — is largely determined by whether a country wants to encourage or discourage some types of cryptocurrency use. Opinions and approaches to cryptoization range from outward bans to full endorsement of crypto as legal tender, which makes it seemingly impossible for countries to agree on global cryptocurrency regulations. Therefore, countries will have to do their own homework when devising a suitable national crypto tax policy.

A comprehensive crypto tax policy typically gravitates around identifying the relevant taxable events involving cryptocurrency income and gains. On the one hand, there are the sui generis events endemic to the cryptocurrency realm in which a taxpayer obtains crypto without consideration, such as through mining or staking, or via airdrops or hard forks. Then there are the more mundane taxable events in which cryptocurrency is obtained for consideration (or vice versa): the exchange of cryptocurrency for fiat currency, another type of cryptocurrency (swapping), or a good or a service.

This article discusses the income tax consequences of exchanging cryptocurrency for goods and services. How a country taxes the exchange of crypto for goods and services is a telltale sign of whether its tax system embraces the cryptoization of the economy, but low-income countries might be better off with different crypto tax policy approaches than those usually favored in high-income countries.

I. Cryptoization: A Tale of Two Taxpayers

The bifurcated substitution of assets and currency for crypto makes regulating cryptocurrencies a challenge. Designing rules that are tailored to the use of cryptocurrencies for payments and settlements risks failing to adequately address the fact that cryptocurrencies are also held and traded as assets. Designing rules for the asset-substitution aspect of cryptoization risks stifling crypto’s potential as a currency substitute. But a lopsided policy might be a deliberate choice: Policymakers might want to stimulate the asset-substitution aspect of cryptoization while remaining wary of the potential macro-financial stability issues that go hand in hand with currency substitution.

The cryptoization of the economy does not occur at equal pace across countries, and in some countries the asset-substitution aspect is far more prevalent than the currency substitution (and vice versa). Blockchain analysis of both cryptocurrency ownership and trading volumes shows that low-income countries tend to have different cryptoization profiles from high-income countries — for example, Chainalysis’s 2021 global crypto adoption index lists only one high-income country among the 20 countries with the highest cryptocurrency adoption.⁵ The index is based on metrics that include the total value of retail transactions (defined as any transaction for less than $10,000 worth of cryptocurrency) and of peer-to-peer (P2P) crypto exchange volume,⁶ both weighted by a country’s purchasing power parity per capita. Low-income countries rank high in those metrics. Low-income country crypto users rely on P2P trades not only to “on-ramp” into cryptocurrency — that is, exchange fiat currency for cryptocurrency — but also to send and receive remittances to and from abroad. Cryptocurrencies are used, for example, to pay for imports of salable goods from exporters abroad who otherwise demand payment in foreign currency, which is often a costly and slow process and subject to capital controls.

Hyperinflation of the local fiat currency is another driver of the grassroots adoption of cryptocurrency in some low-income countries. A study based on the Chainalysis report and examining global cryptocurrency ownership by individuals shows that only five of the 20 countries ranked with the highest population percentage of ownership are high-income countries.⁷

In high-income countries, the opposite trend is seen. Crypto ownership is less widespread among the population, and P2P and retail transaction volumes tend to be on the low side. Yet the total cryptocurrency transaction volume generated in those countries largely overshadows the volumes generated in low-income countries. The bulk of the transaction volume is generated by institutional investors (transactions with values of more than $1 million) and professionals (transactions with values between $10,000 and $1 million).⁸ Part of the growth in crypto trade volumes is further explained by the growth of decentralized finance, which is strongest in high-income countries and insignificant in most low-income countries.⁹

As a result, one can conclude that the typical use of cryptocurrencies in high-income countries is not the same as in low-income countries. In high-income countries, cryptoization is mostly driven by asset substitution, whereas in low-income countries currency substitution is equally or more prevalent. That means a typical cryptocurrency taxpayer in a high-income country uses crypto as an investment asset; using it as a means of payment is ancillary. In a low-income country, on the other hand, a cryptocurrency taxpayer will typically interact with the currency because of its characteristics.

The tale of two crypto taxpayers is that of two different tax policies: one for high-income countries and geared toward cryptoization through asset substitution, and the other for low-income countries and geared toward cryptoization that also involves currency substitution.

II. Cryptoization Through Currency Substitution

A. Currency Substitution vs. Asset Substitution

Before delving into the tax aspects of a policy geared toward taxpayers who use cryptocurrency as a means of payment, it is worth further exploring the phenomenon of cryptoization through currency substitution.

As the story goes in crypto folklore, on May 22, 2010, Laszlo Hanyecz agreed to pay BTC 10,000 for two pizzas from a local pizza restaurant in Florida. The transaction marks the first time cryptocurrency was used in a commercial transaction to purchase tangible goods or services, and the day is celebrated as Bitcoin Pizza Day — the start of the global cryptoization movement.¹⁰

The movement did not deliver on its objective to disrupt fiat currency as the global means of payment. Contrary to initial expectations, global consumer brands were not keen to accept cryptocurrency as payment. A pivotal moment was Amazon’s decision in 2014 against accepting bitcoin, despite earlier indications to the contrary.¹¹ Cryptocurrency would not go mainstream as a means of payment, at least not in high-income countries. Even so, because of asset substitution, the crypto market boomed. The culmination of asset substitution is evidenced in the increasing correlation between cryptoasset prices and prices on the traditional equity markets. Cryptoassets are no longer on the fringe of the financial system.¹² Cryptocurrencies act like financial assets, and the crypto market fluctuates (or crashes) in tune with the financial markets.¹³

Those developments do not mean that cryptocurrencies lost any of their potential for currency substitution in high-income countries. On the contrary. A recent survey by Visa of nine countries, including the United States and Germany, revealed that 70 percent of small businesses believed that accepting new forms of payment was fundamental to growth in 2022, and 24 percent of the surveyed businesses indicated that they planned to accept cryptocurrencies soon.¹⁴ At the same time, global consumer brands seemed to jump on the crypto bandwagon, with consumers finally able to pay in crypto for consumer goods ranging from airline tickets to a cup of morning joe.¹⁵ Amazon continues to hold off.¹⁶

Is that growing acceptance of payment in crypto a genuine sign of cryptoization through currency substitution? Arguably, it is not. For cryptocurrency to substitute traditional currency in the market, it should perform a currency’s three functions as a store of value, unit of account, and medium of exchange. Even if businesses advertise prices in crypto or allow it as a medium of exchange, in practice, they seem less keen on embracing it as a store of value. Most businesses accepting crypto payments are reported to use a hands-off approach: While they accept crypto as a form of payment, they avoid holding crypto receipts on their balance sheets.¹⁷ As such, most businesses rely on the services of third-party crypto service providers that will act as their agents and accept or make payments in crypto through conversion into and out of fiat currency. The third party charges a fee and assumes the bulk of the risk, including the compliance risk¹⁸ and the all-important cryptocurrency volatility risk. Prices are charged in function of the product price in fiat currency, calculated at the crypto spot rate.

The few businesses that use a hands-on approach rely on a third party to serve as the custodian of their cryptocurrency holdings, or they perform self-custody. The second approach is complex and not without risk, but it allows companies to undertake peer-to-peer cryptocurrency exchanges with customers without the intervention of a single intermediary, as with a cash payment. The hands-on approach implies that the company will keep the crypto receipts on its books and will involve treasury functions to properly manage its cryptoassets.

The recent collapse of cryptocurrency prices shows that mixing operational risk and cryptocurrency volatility risk is probably not the best idea. For businesses using a hands-off approach, the crypto price collapse has had little impact.

In low-income countries, the situation is markedly different. Crypto users tend to onboard out of necessity or distrust of the traditional financial industry and government, or simply because of a lack of access to banking services. Some governments, such as Nigeria’s, have tried to ban the use of cryptocurrency to purchase goods and services and of centralized crypto exchanges to accept fiat currency. That, however, has pushed cryptocurrency activity toward P2P platforms and informal P2P trading.¹⁹

Similarly, in countries where the local population relies on remittances from abroad, the use of cryptocurrency in daily economic life without conversion into local fiat is a guaranteed way to avoid the devaluation of remittances caused by local hyperinflation. More crucially, and unlike in high-income countries, in low-income countries, cryptoization through currency substitution largely takes place in the informal “shadow” economy that is usually outside the grasp of monetary, regulatory, and tax controls. An optimal policy would mitigate the risks involved with cryptoization without pushing citizens to revert to cash as the preferred means of payment.

B. Government-Induced Cryptoization

1. Bitcoin as Legal Tender

In most countries, cryptoization is a market-driven response to external factors, such as inflation and war. It can also be induced by the government or, in extreme cases, forced on the local population when cryptocurrency is given the status of legal tender.

In September 2021 El Salvador became the first country to make bitcoin legal tender. Its bitcoin law provides that the government will accept bitcoin as payment for taxes and outstanding debts, and it requires local businesses to accept bitcoin.

That litmus test of compulsory cryptoization has been a disaster. A February survey showed that less than 5 percent of Salvadorans are paying taxes in crypto. And although compulsory by law, only 20 percent of Salvadoran businesses are accepting bitcoin payments for goods and services. Of those, nearly 90 percent convert bitcoin into U.S. dollars, either keeping the dollars online or withdrawing them as cash.²⁰ Businesses that kept bitcoin on the books most likely did so out of ignorance rather than out of desire to speculate.

For those business, and for El Salvador in general, the bitcoin price collapse was dramatic — even though the Salvadoran government is keeping faith in bitcoin and, more astonishingly, continues buying during the bitcoin dip.²¹ Meanwhile, economic growth numbers have collapsed, and government debt has risen uncontrollably: The country is expected to default on the $800 million eurobond repayment due in January 2023.²² The IMF — which strongly advised against the country’s embrace of bitcoin — has already dropped hints that it will not bail El Salvador out if bitcoin remains legal tender there.²³

It remains to be seen whether the failed bitcoin experiment in El Salvador has deterred other countries in the region that were reportedly on track to make bitcoin legal tender before the recent price crash. In those South American countries, bitcoin’s appeal as legal tender is not merely as a tool to foster technological investment and economic growth through cryptoization but also as a way to escape dollar hegemony.²⁴

Similar analyses have been performed for the Central African Republic. In May the African country became the world’s second country to adopt bitcoin as legal tender. The mineral-rich nation is one of the poorest in the world, suffering almost a decade of civil war that has devastated much of the country. Estimates from 2020 show that only 14 percent of the population has access to electricity and only 10 percent has internet access. As such, the decision to adopt bitcoin has puzzled both external observers and local residents. It has also prompted caution from the IMF, with observers noting that by adopting bitcoin, the Central African Republic is sending a message of rebuke regarding the Central African CFA franc, a regional currency used by six states (including the Central African Republic), governed by the Bank of Central African States, and pegged to the euro — an arrangement that has been criticized for its neocolonial undertones.²⁵

2. Paying Wages and Taxes in Crypto

Making bitcoin legal tender is the most radical, but not the only, strategy governments have used to aid cryptoization through asset substitution. Two examples of soft approaches are the payment of wages and taxes in cryptocurrency.

Considering the volatility of cryptocurrencies and their potential for money laundering and tax evasion, many countries restrict the payment of wages in cryptocurrency, with lending institutions such as the IMF positioning themselves against the practice.²⁶ However, in countries with galloping inflation rates, there is a clear incentive for employers to sidestep the local currency and make full or partial wage payments in cryptocurrency. Unsurprisingly, high-inflation countries like Argentina, Nigeria, and Brazil top the list of countries where that practice is gaining traction.²⁷ One way to mitigate some of the risks associated with the payment of wages in crypto would be to adhere to best practices, such as (i) requiring employers to pay the regulated minimum wage in fiat currency, with cryptocurrency being usable only for remuneration beyond the base pay; or (ii) granting employees the statutory right to be paid wages in fiat currency and having that prevail over contractual arrangements to the contrary.

From an income tax perspective, paying and receiving wages in crypto creates some complexities. Assuming a country characterizes cryptocurrencies as assets for tax purposes and levies income and capital gains taxes on the alienation of assets, paying wages triggers a series of taxable events. On the employer’s side, the payment of the wages creates a taxable event for which tax will be due on the difference in value between the acquisition of the cryptocurrency and its disposal in the form of wages. On the employee’s side, wage taxes will be levied on the spot price of the cryptocurrencies received in wages. Unless personal currency substitution tax exemptions apply, a third series of taxable events occurs on disposal of the income denominated in crypto, with any gains realized between the payment and the spending of the wages subject to tax. A corollary is the treatment of losses incurred on crypto transactions and whether they will be allowed to be offset by any other taxable income derived by the employee.

A specific scenario is that of employers paying wages in cryptocurrency that has not been obtained from third parties or block validation activities — that is, mining and staking — but in the form of ICO tokens from the employer’s own fundraising project. In that case, other policy considerations come into play, and it might be more appropriate to apply rules for deferred wages in the form of traditional stock-based employee compensation.

An important issue for income tax purposes is the valuation of the wages denominated in crypto when payment is made. If a country applies a “pay as you earn” wage tax system, a portion of the cryptocurrency paid as wages must be exchanged into fiat so the employer can fulfill his obligations as a wage tax withholding agent. There are generally two approaches to determining the value of the wages paid in cryptocurrency: by reference to the fair market value or based on mutual agreement. Relying on the FMV makes most sense, but there are no official listed crypto prices, and regional price listings tend to vary substantially. Relying on a mutually agreed value is prone to manipulation in the form of undervaluation. One approach might be to combine both methods and allow valuation by mutual agreement with a maximum tolerance of variation from the FMV.²⁸ That is not a new development: The same would hold true for any fringe benefit paid by an employer that is not denominated in kind.

A viable strategy to mitigate the problem is for the government to allow tax payments to be made in cryptocurrency. That solution brings with it a whole new set of problems and risks, so few countries have pursued it. However, regional and municipal authorities seem less hesitant. In the United States, Colorado and Ohio²⁹ have contemplated (and, in Ohio, suspended) legislation that allows residents to pay state and local taxes in cryptocurrency. Rio de Janeiro recently announced that it will accept payments of its immovable property tax in cryptocurrency as of tax year 2023 in an attempt to stimulate the circulation of cryptocurrencies in the city as a means of payment.

Some observers have noted that the holding and management of cryptocurrency by government treasuries can help reduce the volatility that cryptoassets are known for.³⁰ Rio de Janeiro was, however, quick to point out that it would use a hands-off approach to its crypto receipts: A third-party intermediary will collect and convert the crypto into fiat currency, and no cryptocurrency holdings will appear on the city’s books.³¹ That cautious approach conflicts with earlier statements by Rio de Janeiro Mayor Eduardo Paes to maintain 1 percent of the city’s budget in cryptocurrencies.³² Interestingly, the payment of local taxes in crypto might in itself trigger a taxable event for Brazilian federal income tax purposes because doing so is nothing more than a disposal of crypto on which taxable gains might be realized.

III. Taxing Cryptoization: Currency Substitution

A. Qualifying Crypto for Tax Purposes

How to qualify cryptocurrencies for income tax purposes is both the most fundamental and most challenging issue in the design of cryptocurrency tax policy. Most transactions involving cryptocurrencies are not sui generis in form. Whether the crypto is considered an asset or currency will determine which tax rules apply. Further qualification under either category will determine the application of specific rules:

• asset: movable property, financial asset, or commodity; or

• currency: currency in general or foreign currency.

A few approaches can be followed to choose the appropriate qualification of cryptocurrencies for income tax purposes. One can, for instance, rely on the qualification by regulatory bodies in other domains — private law, financial law, commercial law — and adopt that. That approach is problematic because other domains of law will emphasize some characteristics and uses of crypto to assert why they are competent to regulate that currency and downplay others. For example, a country’s financial market regulator might assert that cryptocurrencies are financial assets akin to an investment contract or a security. A commodities and derivatives regulator might claim that crypto falls within its competence because much of the trade involves the sale of a good (commodity) for future delivery. On the currency side of the spectrum, anti-fraud and anti-money-laundering agencies might argue that crypto is a currency so that the anti-money-laundering requirements for international payments also apply to international transfers of it. Banking regulators might argue the same for the purpose of requiring cryptocurrency exchanges and wallet-hosting service providers to obtain banking licenses. A country’s central bank that plans to introduce a central bank digital currency (CBDC) or wants to avoid watering down its control over a country’s monetary policy might have a clear interest to qualify private digital currencies as assets rather than currencies. An extra layer of complication is added if regulators start differentiating the qualification depending on the characteristics of individual cryptocurrencies.³³

As shown above, regional differences in cryptoization — that is, in high-income countries the asset substitution aspect prevails, and in low-income countries currency substitution does — mean regional solutions by similarly situated countries are not necessarily sacrosanct. Guidelines issued by the EU and OECD might not necessarily be optimal policy for low-income countries.

The OECD’s proposed cryptoasset reporting framework is a case in point. Unlike the common reporting standard, which requires qualifying intermediaries to report on annual account balances, the OECD framework is expected to apply on a transactional basis. Qualifying crypto intermediaries will be required to report on each user transaction that involves: (1) exchanges between crypto and fiat; (2) exchanges between crypto; (3) reportable retail payments; and (4) transfers of crypto. That is a perfect match for countries that treat cryptocurrencies as assets for tax purposes and submit any gain from transactions to tax, including gains on the exchange of cryptocurrency for goods and services. It is less so for countries experiencing cryptoization through currency substitution and that don’t share the same fundamental view that cryptocurrencies should be qualified as assets for tax purposes. Those countries — mostly low-income ones — might be better served with a CRS type of system.

That is not a plea for low-income countries to qualify cryptocurrencies as (foreign) currency, rather than as assets or property. Rather, it is believed that for income tax purposes, low-income countries should devise rules that take into account the hybrid nature of cryptocurrencies. Some commentators have suggested that the United States use a similar bifurcated tax treatment to better accommodate cryptoization through currency substitution.³⁴ In short-term crypto transactions, crypto should be treated as money, and in long-term transactions, the current treatment as property should prevail.

B. Designing a Currency-Substitution Exemption

Few low-income countries have clearly articulated cryptocurrency tax rules, while high-income countries have a huge variety of design options for exempting from income tax gains realized on the spending of crypto to buy goods and services.

In the United States, a personal-use exemption for gains on crypto transactions under $200, similar to the exemption for foreign currency gains in IRC section 988, has been suggested.³⁵ The exemption would apply only to short-term crypto transactions, defined as transactions that involve the exchange for goods and services of cryptocurrency held for less than a year; the personal exemption in section 988 is not limited to short-term foreign exchange transaction.

At the time of publication, there were two U.S. congressional proposals for a de minimis exemption on the taxation of crypto. The first is the Lummis-Gillibrand Responsible Financial Innovation Act (S. 4356), proposed June 7 by Sens. Cynthia Lummis, R-Wyo., and Kirsten E. Gillibrand, D-N.Y., to extend the forex personal-use exemption of $200 per transaction to cryptocurrency transactions, regardless of the holding term of the crypto. The second is the proposed Virtual Currency Tax Fairness Act of 2022 (S. 4608), proposed July 26 by Sen. Patrick J. Toomey, R-Pa., which would exempt gains from crypto transactions if the total value of the sale or exchange, or if the gain on the transaction, is lower than $50.

It is unsurprising that the debate on the taxation of cryptoization through currency substitution is unfolding in the United States more so than in other high-income countries. The United States outranks all other high-income countries when it comes to crypto adoption.

Other countries have taken different approaches that generally were not developed specifically for taxing gains from spending crypto. The rules apply because those states have qualified cryptocurrency as property, so spending it is considered a taxable disposal of property. Before the rise of crypto, few taxpayers would be buying coffee or plane tickets in exchange for movable property; cryptoization through currency substitution puts those kinds of rules under new scrutiny. Failure to adapt the rules to the reality of cryptoization is a policy approach in itself.

Germany is a good example. There, exchanges of crypto for goods and services are subject to the standard rules of capital gains taxation, so taxpayers benefit from the standard tax-free allowance of €600 per year of capital gains on short-term disposals. If the gains from the disposal of movable property (crypto and other types of property income) exceed that, their entire amount is subject to tax at progressive income tax rates. Gains on the disposal of cryptocurrency (and other movable property) held longer than one year are exempt from tax.³⁶

The German rules clearly favor cryptoization through asset substitution over currency substitution. The rules even encourage the typical “hold on for dear life” strategy used by many crypto investors, while a German taxpayer who earns part of his wages in cryptocurrency and uses it to buy, say, a motorcycle will pay tax on the gains if he makes payments in monthly installments. The gain will be tax free only if the crypto used to buy the motorcycle is held for at least one year. Both for the calculation of the gain and the holding period, the German tax authorities endorse the last-in, first-out and average cost methods to determine the historic cost base value if individual consideration of the spent coins is impossible.³⁷

The United Kingdom has a similar rule, but one that is more favorable to currency substitution. Gains from the buying of goods and services are subject to capital gains tax at a rate of 10 percent (or 20 percent if the taxpayer’s annual income is above £50,270). Taxpayers benefit from a tax-free allowance of £12,300. Unlike in Germany, only capital gains above the allowance threshold are subject to capital gains tax.³⁸ Using the previous example, if the U.K. taxpayer does not incur any other chargeable gains, his purchase of the motorcycle will be exempt up to £12,300, regardless of the payment method.

Australia takes a third approach: Like gains on the disposal of most other property, gains from spending crypto on goods and services are generally subject to capital gains tax. Taxpayers can benefit from an exemption only if the cryptocurrency can be qualified as a personal-use asset, which is the case if: (1) there was no intent or reasonable expectation to realize a capital gain; (2) the time between the asset’s purchase and disposal is considered short (while that term is undefined, tax authorities are more likely to consider a cryptoasset a personal asset the longer it is held); and (3) the asset was disposed in a barter-style transaction for a good or service. The benefit applies only if the personal asset — that is, the cryptocurrency — was acquired for less than AUD 10,000.

Most Australian crypto owners applying for the personal-use exemption face rejection by the Australian Taxation Office because they fail to show that the cryptocurrency was not obtained with the intent to realize a capital gain. Also, the exemption is not granted if the provider of goods or services applies the hands-off approach and has the crypto exchanged into fiat currency by a third-party crypto payment provider.³⁹ Arguably, the application of the exemption has yet to be tested in the context of full cryptoization in which the taxpayer obtained the cryptocurrency for providing services and then uses the same cryptocurrency to buy goods and services. In theory, the application of the personal-use exemption should allow our hypothetical taxpayer to buy his motorcycle tax free if the listed conditions are fulfilled.

Interestingly, the high-income countries with the highest ranking in the Chainalysis crypto adoption index are also the ones with the most generous exemptions (either proposed or in force): The United States (highest-ranked high-income country at No. 8) and the United Kingdom (ranked 21st) have fairly generous rules, whereas Australia (ranked No. 38) and Germany (ranked 48th) apply standard capital gains tax rules.⁴⁰

Finally, in the United States, it would be wrong to consider new tax rules that accommodate cryptoization through currency substitution a surrender to the interests of the crypto industry.⁴¹ A recent study by the U.S. Federal Reserve confirmed that in the United States, crypto use for investment purposes is far more common than for the payments of goods and services; however, people using cryptocurrencies to purchase goods and services frequently lack traditional bank and credit card accounts, and most of them had income of less than $10,000. Those who held cryptocurrency purely for investment purposes were disproportionately high-income, always had a traditional banking relationship, and typically had other retirement savings. Just like in low-income countries, in the United States, the development of an exemption for currency substitution is also a matter of preserving cryptocurrencies’ potential for increased financial inclusion of low-income taxpayers.

C. Withholding Tax on Crypto Payments

1. Policy Considerations

One policy avenue that seems to go hand in hand with cryptoization through currency substitution in low-income countries is the introduction of a tax at source on cryptocurrency payments. The tax is typically withheld by the intermediary (such as a crypto exchange or wallet-hosting company) and levied on a gross basis. It is not a tax on income unless the payer is entitled to claim a tax credit against the income tax due, which requires a taxpayer to declare her taxable income from cryptocurrency transactions. Compliance is often problematic in low-income countries, so from the government’s perspective, it is easier to require the tax to be withheld on a gross amount and to potentially provide a credit if the taxpayer claims the credit than to run a complex reporting and compliance program. If no source-tax crediting facilities are provided at the payer level, the tax is akin to a transaction tax. In other countries, the source tax is characterized as a digital services tax.

Especially in countries where crypto is used in the informal sector as a replacement for cash, a tax withheld at source could be an effective way to raise revenue from the local crypto boom. Besides securing tax revenue, other policy reasons seem to be driving countries to adopt a crypto transaction tax. Some governments see it as a way to deter cryptoization through currency substitution. For other countries, subjecting crypto payments to a transfer tax is merely an extension of the existing policy to levy such a tax on share transactions, mobile and digital payments, or foreign currency transactions.

Extending the scope of the transfer tax to crypto is part of the government’s capital or foreign exchange control policy. In a July policy brief, UNCTAD recommended a crypto transfer tax for that purpose and said it generally welcomes any policy that imposes higher taxes on cryptocurrencies than other financial assets to discourage transacting in and holding cryptocurrencies.⁴²

a. Asia

In Indonesia, the largest economy of Southeast Asia, the government is about to introduce a tax of 0.1 percent on the gross value of transactions involving cryptocurrencies. The tax will be a final tax and is similar to the 0.1 percent tax levied on the transfer of shares listed on the Indonesian stock exchange.

The new crypto transaction tax was proposed jointly with the introduction of VAT on the supply of cryptoassets, also expected to be levied at 0.1 percent — a much lower rate than the standard Indonesian VAT rate of 11 percent. Unlike in India, Indonesia’s plans to tax cryptocurrency are driven by the need to raise revenue for the economic recovery from the COVID-19 pandemic, rather than an attempt to deter Indonesians from engaging in crypto ownership and transactions.^43.

Neighboring Thailand is adopting a radically different approach. In January Minister of Finance Arkhom Termpittayapaisith announced the introduction of a 15 percent withholding tax on capital gains realized on crypto transactions.⁴⁴ The proposal resulted in extensive lobbying by the local industry, hammering on the fact that a tax on digital asset trading could significantly reduce market liquidity and deter small investors.⁴⁵ That risk was sufficient for the Thai government to completely change its strategy. In a recent statement, the Thai government indicated that it had scrapped the planned 15 percent capital gains tax and would exempt transfer tax and VAT on cryptocurrency transactions taking place on government-approved exchanges until the end of 2023.⁴⁶

However, Thailand’s embrace of cryptoization is only halfhearted. In March the country’s financial regulator announced it would start banning cryptocurrency as a means of exchange for goods and services April 1; cryptocurrency trading and investing are not affected by the ban.⁴⁷ Thus, it is believed that the tax exemptions have more to do with Thai Central Bank’s plan to roll out a CBDC — CBDC transactions are also benefiting from the temporal tax exemption — rather than turning Thailand into a crypto haven.⁴⁸

India’s new cryptocurrency tax rules came into force in March. Under the controversial new regime, a flat tax of 30 percent applies on income from cryptocurrency transactions without any offset for prior cryptocurrency losses.⁴⁹ The new regime also introduces a tax deducted at source (TDS) of 1 percent from July 1.⁵⁰ The tax is due by any person who pays consideration to an Indian resident person in the transfer of cryptocurrencies.

The 1 percent rate is identical to the rate for payments for the sale of goods or provision of services by e-commerce operators through digital platforms. De minimis thresholds apply. Individuals will be required to deduct the tax when buying the cryptocurrency if the payment exceeds INR 50,000 (approximately $630); for companies, the threshold is lowered to INR 10,000. The liability to withhold the tax falls on the person responsible for paying the consideration for the transfer of the cryptocurrencies, not on the person buying the cryptocurrencies. Those might be different people — for instance, if the cryptocurrency is transferred through a broker or exchange.⁵¹

Like any other TDS, the tax withheld on crypto transactions is creditable against income tax due. It is unclear whether the crypto TDS is creditable against tax on any taxable income or only crypto income. If creditable only against crypto income, the TDS — which is levied on transaction value and not on income — might turn out to be a final tax. That harsh outcome might deter taxpayer speculation, similar to the effect of the high fixed tax rate of 30 percent on cryptocurrency transactions.

The Indian government has justified the new crypto tax regime as a disincentive for individuals with low income to invest in cryptocurrencies, and that corrective taxation seems to have worked so far. Cryptocurrency trading volumes in India are reported to have collapsed after the introduction of the new tax, and beginners reportedly appeared to be less willing to invest in crypto in the short term.⁵² The collapse of cryptocurrencies’ prices in the two months after the regime was introduced makes one conclude that the Indian government’s use of tax as a crypto speculation deterrent was not completely misguided. In the bull market climate, the introduction of the TDS with limited crediting options and the general lack of loss compensation operates de facto as a final tax and will most certainly have a deterring effect on the Indian crypto market.

b. Africa

In Africa, the rise of cryptocurrency transaction taxes is intertwined with the trend of countries introducing taxes on mobile payment services (MPS). In many low-income countries, traditional banks shy away from catering to the segment of the population living in poverty. For the unbanked, the only alternative payment mechanism is cash, which is costly to store and dangerous to transport.

MPS address that market failure and are a cheap and secure way to transfer deposited money via mobile phone without the need to open a bank account. They have grown extremely popular in the informal sector⁵³ — which did not go unnoticed by African governments as an opportunity to tax all layers of society. Several African countries recently introduced a tax on mobile money transactions. The liability to withhold the tax is put on the MPS provider, but the burden of the tax, which makes MPS more costly, lies with the user.

The IMF and other observers have warned that taxing MPS transactions might cause unintended harm, such as undermining increases in financial inclusion by pushing consumers toward untraceable transactions in cash⁵⁴ or cryptocurrencies. Cryptocurrency ownership via a hosted wallet on a mobile phone has in practice the same functionality as MPS technology, so it is unsurprising that countries are considering extending the scope of MPS transaction taxes to cover crypto payment transactions.

In 2019 the Zimbabwean government introduced the intermediated money transfer tax of 2 percent on mobile payment transfers. It accounted for a whopping 50 percent of Zimbabwe’s tax revenues from businesses in 2020.⁵⁵ In January the government announced that a private-public cooperation was set up to develop a revenue collection service for taxing qualifying companies that provide cryptocurrency services to Zimbabwean persons and organizations,⁵⁶ arguably with an eye on replicating the revenue success of the 2019 tax.

Kenya, which ranks fifth in the Chainalysis global crypto adoption index,⁵⁷ subjects fees paid for mobile money transfers and other financial transactions to a 12 percent levy. The Kenyan tax authorities recently confirmed that cryptocurrency transactions will be subject to the country’s DST of 1.5 percent, which came into effect January 1, 2021.

That cryptocurrency transactions trigger a country’s DST is not controversial. For example, the U.K. tax authorities released guidance in June 2021 confirming that cryptocurrency exchanges are subject to the country’s DST.⁵⁸ Given that the United Kingdom generally does not consider financial instruments, commodities, or currency, crypto exchanges cannot benefit from the DST exemption for online financial marketplaces. As a consequence, a 2 percent tax is due on the revenues generated from U.K. users of crypto exchanges and other crypto-related online marketplaces.

Even so, the application of the Kenyan DST to cryptocurrencies is controversial because it subjects cryptocurrency exchanges operating in the Kenyan market to a 1.5 percent tax on the gross transaction value, not on the fee paid by users of the platform to effectuate the transaction, as in the United Kingdom. That effectively turns the DST on the crypto service provider into a gross crypto tax on the user, with the service provider functioning as the withholding agent. The Kenyan tax authorities confirmed that the withholding obligation would apply to resident and nonresident cryptocurrency platforms active in Kenya. For residents, the remitted DST would be offset against income tax; for nonresidents, the DST is a final tax.⁵⁹

One would assume that countries contemplating the introduction of a tax on mobile payments cannot ignore the current or future cryptoization of the local economy. By the law of substitution, the lack of crypto tax rules also risks eroding tax revenue collection from traditional industries that could be disrupted by crypto.

Contrary to that assumption, Ghana recently introduced an electronic transfer levy (Act No. 1075) of 1.5 percent on the transaction value of mobile money transfers. The e-levy applies as of May 2022 and is meant to enhance revenue mobilization by broadening the tax base. Ghana does not recognize cryptocurrencies as currency or money, which implies that the e-levy does not apply to cryptocurrency payments. That led one commentator to conclude that “blockchain can save mobile money transaction costs,” predicting a mass migration of mobile payment users to crypto payments.⁶⁰ Not that the citizens of Ghana did not have an appetite for cryptocurrencies before the introduction of the e-levy: The country ranks 17th on Chainalysis’s Top 20 index.⁶¹

c. South America

Argentina initially adopted a law by which cryptocurrency transactions were treated as if they were (exempt) cash transfers under the country’s “check tax.” The check tax applies to all debiting and crediting operations made via a bank account and is levied at a rate of 0.6 percent of the transfer value. Besides VAT and income tax, the check tax is reported to be the third most important source of government revenue in Argentina. Its introduction dates from the Argentine debt crisis of 2001, and in a November 2021 decree (Decreto 796/2021), the government announced that the check tax would also apply to “transactions in which the movements of funds are linked to the purchase, sale, exchange, intermediation and/or any other operation of cryptocurrencies, digital currencies, or similar instruments.”⁶² The tax applies independently from general rules that subject cryptocurrency transactions to capital gains tax.

In Venezuela, where hyperinflation and a national currency crisis have given rise to a cryptocurrency craze, the government has introduced a tax of between 2 and 20 percent on transactions in any form of currency other than those issued by the Bolivarian Republic of Venezuela — that is, the Venezuelan bolivar and the el petro, the country’s oil-backed national cryptocurrency. The tax is meant to deter interest in foreign currencies (including crypto) and revive the national currencies, which have lost 70 percent in value in recent times.

IV. Conclusion

Cryptocurrencies have two fundamental uses: They can be used as a means of payment, just like traditional fiat currency, and as a store of value, with the properties of an investment asset. The so-called cryptoization of the economy involves both the substitution by crypto of assets and the use of crypto as if it were currency.

Cryptoization through asset substitution is more prevalent in high-income countries, whereas for various reasons low-income countries are experiencing the brunt of cryptoization through currency substitution. Hyperinflation, low financial inclusion, distrust of the central government and traditional banking sector, and cryptocurrency use for remittances from abroad mean many low-income countries witness crypto being used as a means of payment.

Low-income countries should be aware of that divergent development when designing their crypto tax policies. High-income countries tend to construct their crypto tax policies on the fundamental principle that cryptocurrencies should be treated as assets rather than currency, with little consideration for the stifling effect that has on the use of crypto as a payment for goods and services. Often, that is a deliberate choice.

In low-income countries, cryptoization through currency substitution brings benefits such as financial inclusion and tax revenue from the informal sector that can be stifled if policies like those of high-income countries are adopted.

Low-income countries should not go as far as qualifying crypto as currency for tax purposes. Rather, attention should be given to the development of suitable exemptions for the use of cryptocurrency to buy goods and services. Several baseline approaches are suggested for that kind of exemption, ranging from a transaction-based exemption up to a set value of the transaction or the gain realized on the transaction. Alternatively, tax-free allowances can be granted up to a specific aggregate amount of gains or only if the aggregate threshold amount is not exceeded.

Finally, the rise of cryptoization through currency substitution in low-income countries also explains the rise of taxes on cryptocurrency payments there. A tax at source on crypto payments has the benefit of securing tax revenue from sectors and taxpayers that escape the ordinary income tax system, potentially covering the informal sector as well. Those taxes generally operate on a difficult equilibrium between raising tax revenue and regulating the market. They should not be so high as to deter taxpayers from using crypto as a means of payment. In some countries, the deterrent effect is the main purpose of the taxes, and those policies should perhaps be revisited to embrace crypto as a new business that can bring new opportunities.

Both the U.N. Committee of Experts and the OECD Committee on Fiscal Affairs are working on guidelines for countries’ cryptocurrency income tax policy. It remains to be seen whether the U.N. committee will champion novel solutions that are tailored toward the needs of low-income countries or stick with settled country practice that is mostly derived from the experiences of high-income countries.

UNCTAD has recommended the use of tax policy to deter the cryptoization of the economy in low-income countries. The recent and pending accessions of countries like Colombia, Costa Rica, and Brazil show that the OECD’s membership has become increasingly diverse. Thus, it remains to be seen whether the organization will be able to develop suitable policy standards that cater to the diversity of its members.