The question of whether Bitcoin and other cryptocurrencies should be subject to capital gains taxation has been bandied about for years, but has found renewed interest since former President Trump won a second term. The typical argument for capital gains treatment being inappropriate for cryptocurrencies is an assumption, in contravention of current tax policy, that they are currencies—and that currencies are not subject to capital gains tax.

This is partly true, but not for the reasons proponents think, as profits from currency exchanges are by default taxed as ordinary income under Internal Revenue Code (IRC) Section 988. This would mean any profit made from currency exchanges, including cryptocurrencies if they gain currency treatment, would be subject to taxation at ordinary income tax rates. Of course, as the top capital gain rate is 20% while the top income tax bracket is 37%, holders of cryptocurrencies in the upper income brackets would be none too pleased with this outcome.

That said, if a foreign currency is held as an investment and an election is made by a taxpayer under IRC Section 988(a)(1)(B) prior to any transaction occurring, it is possible for currency exchanges to receive capital treatment.

Advocates for excluding cryptocurrencies from the capital gains regime in favor of treating them as more traditional currencies, however, seem to be misunderstanding the effect and assuming that would mean gains on cryptocurrencies would not be taxed. In fact, by default, they’d be taxed at the potentially higher ordinary income rates.

Eliminating Tax on Bitcoin

It is clear what advocates for cryptocurrency tax reform are really hoping for is tax exemption.

However, there is no policy rationale for eliminating taxes on Bitcoin or any other cryptocurrency. At best, cryptocurrencies function as currencies—but ones with an incredibly inefficient and resource-intensive minting process and for which the very use creates externalities.

Unlike traditional fiat currencies, whose creation and transaction costs are relatively minimal, cryptocurrencies like Bitcoin require significant computing power, electricity, and the resulting environmental impact to maintain. Even cryptocurrencies that rely on more efficient systems than Bitcoin’s proof-of-work are still more resource-intensive than minting a nickel. This inefficiency undermines the argument that cryptocurrencies should enjoy the incentivizing power of complete exemption from taxation.

Moreover, cryptocurrencies lack the stability and governmental backing of traditional currencies, which makes them speculative assets rather than conventional mediums of exchange—regardless of what you call them.

Given that cryptocurrencies can and do function in the economy in a manner similar to other investment assets—like stocks or real estate—exempting them from taxation would create an inequitable tax environment. Other investment vehicles that generate a profit are subject to tax, and granting an exception for cryptocurrencies would simply endorse them as a special class of untaxed speculative wealth—a precedent with no underlying policy goal beyond boosting the wealth of those that hold it.

Economic and Social Realities of Tax-Exempt Crypto

There’s no precedent for the special treatment proposed for cryptocurrency gains, as no other asset class is exempted from tax solely for speculation. Municipal bonds are the closest comparison, but they differ in purpose and impact.

Municipal bonds are traditionally tax-advantaged to encourage investment in local and state infrastructure and keep the cost of municipal borrowing as low as possible. Tax exemptions on the interest from these bonds incentivize investors to support public projects which benefit society as a whole. Cryptocurrency holdings provide no such benefits.

A tax exemption for cryptocurrencies would almost certainly disproportionately benefit high-income individuals, further exacerbating wealth inequality. Much of cryptocurrency wealth is highly concentrated among a small group—with large holdings by early adopted and institutional investors. Placing cryptocurrencies on par with municipal bonds in terms of tax treatment would be a huge tax break grant to well-capitalized groups, rather than toward investments in social projects—depending economic divides.

There is also the tax revenue loss to contend with—as capital gains from cryptocurrencies are a growing revenue source for governments, particularly as the market for these assets expands. This revenue loss would likely need to be offset by shifting the tax burden onto wage earners and businesses or by reducing public services and infrastructure investments. I

Cryptocurrency Tax Policy Realities

The reality is that most of the proponents of eliminating capital gains tax treatment on cryptocurrencies—beginning with former President Trump and extending to others in his political sphere—likely do not fully understand the implications of their proposals. Statements from these advocates reveal a fundamental misunderstanding of the current tax system as they seem to believe that by treating assets like Bitcoin as currency, their gains would be rendered tax-free. In reality, however, shifting cryptocurrencies to “currency” treatment would, by default, subject profits to higher tax rates.

This misconception stems from an incomplete, or wholly lacking, grasp of tax law fundamentals. By framing cryptocurrencies as currency without understanding the tax implications, they risk promoting a policy that would, in practice, often result in taxing these assets more heavily—rather than less. This is emblematic of their broader policy understanding and corresponding vision.

In conclusion, while cryptocurrency itself is undoubtedly volatile, tax policy should be anything but. Any fundamental alteration to cryptocurrency tax treatment should be based on a thorough analysis and a compelling rationale, rather than mere hunch or political impulses.