Week of 1.12.20 - Issue #11
Welcome to the 11th edition of the ₿it Economy! Each week, I break down the top stories in Bitcoin in a simple in clear format. Enjoy!
Topics: Bitcoin Taxes, Pull Request & Lightning Network Update
The Brief:
A bipartisan legislation was introduced into Congress earlier this week which would amend the IRS tax code and exempt realized gains under $200. Bitcoin Core developer Pieter Wuille has opened the pull request for BIP numbers to be assigned for BIP Schnorr+BIP Taproot+BIP Transcript. BitMEX Research reveal statistics about Lightning Network's private channels and that usage is higher than previously expected.
S1: Virtual Currency Tax Fairness Act of 2020
What is it? - On Thursday, The Virtual Currency Tax Fairness Act of 2020 was introduced by Congresswoman Suzan Delbene of Washington and Congressman David Schweikert of Arizona with bipartisan support. The bill is revised version of a 2017 proposal and would create a de minimis tax exemption for small cryptocurrency transactions. A de minimus tax rule states a price threshold to determine whether a discount should be taxed as capital or ordinary income. Under current IRS tax policy, digital assets are taxed as property, digital currency transactions trigger taxable events that require users to track any appreciation or depreciation of the currency's value for purposes of capital gain taxation. The bill states,
“Gross income of an individual shall not include gain, by reason of changes in exchange rates, from the disposition of virtual currency in a personal transaction (as such term is defined in section 988(e)). The preceding sentence shall not apply if the gain which would otherwise be recognized on the transaction exceeds $200.”
Why it Matters? - Existing tax law struggles to cope with Bitcoin and other cryptocurrencies, as they behave across a spectrum: investments, commodities, other currencies. The reintroduction of this bill shows the Internal Revenue Service (IRS) that many in Congress believe that the current tax treatment of cryptocurrencies needs to be revised. Every time someone spends bitcoin, a taxable event occurs. Thus, the user is responsible for tracking the value any time they purchase a cup of coffee or a gift card.
The IRS has ruled that bitcoin and "other virtual currencies" are "treated as property," not treated as currency. To some this may seem appear to be a minor distinction, but it is not. It determines how bitcoins are taxed, what information you will need to make sure your taxes are calculated correctly, and what tax planning techniques you can use to minimize your taxes on bitcoin transactions. There are three moments in time that are critical to taxation of any type of property: when you acquire it, how long you hold it, and when you dispose of it. When disposed, four things occur of:
Income is realized from any gain.
Gain is measured by the delta in the dollar value between the purchase price and the selling price.
Tax rates that apply depend on whether the property was held for a long or short term period.
Disposition of property is reported on your tax return using schedule D and Form 849 or Form 4797.
As one can see, the taxation process is cumbersome for everyday transactions and has been a major sticking point for several years in the United States. If successful, tax legislation like this and the safe harbor act introduced earlier this year are paving the way to appropriate tax laws for bitcoin and other cryptocurrency holders.
Final Take - Organization's like Coincenter are working with legislators to bring clarity into an muddled grey area of tax policy.
S2: BIP Shnorr + BIP Taproot + BIP Tapscript
What is it? - Pieter Wuille, a Bitcoin Core Developer and co-founder of Blockstream, has opened the pull request for taproot. For those who need a refresher about the protocol please refer to last week’s edition here.
A pull request informs others about changes one has pushed to a brand in a repository in GitHub. Once the pull request is opened, a discussion and review of the potential changes can occur prior to a merge into the base branch. The reason for the pull request was to assign Bitcoin Improvement Proposal (BIP) numbers. A BIP is a standard for proposing changes to the Bitcoin protocol and can include consensus-critical changes that benefit from coordination across different Bitcoin software implementations. As with any proposal, a BIP starts off with a basic draft that is submitted by one or more authors. The idea of the protocol change is bounced back and forth for a couple of months or years. Once refined enough, it becomes a Draft. In order to become a Draft, it must pass the first editor, from which it can be deferred or withdrawn by the author or accepted or rejected by the community.
After being assigned a BIP number, the discussion continues as stakeholders to the network voice their concerns or objections. In order for a BIP to become accepted and labelled as final, each of the following conditions must be met:
Follows the correct format as specified by BIP-1.
Includes code implementations of the proposed changes to the protocol.
Has 95% support from the last 2,016 miners (~14 days worth)
Depending on which layer the BIP specifies, a BIP acceptance may signal a "soft fork" upgrade wherein the community members must upgrade their versions of the protocol to allow for newly built functionality. These changes are compatible with previous versions of the software, allowing older versions to continue to function as normal.
Why It Matters? - It has been a while since Bitcoin has received a major upgrade. The proposed bitcoin soft-fork designed to improve the platform security and boost privacy is already moving through the developer feedback phase. When implemented, the Taproot/Schnoor upgrade could accelerate the process of block validation by as much as 250% and cut transaction fees by as much as 30% to 75%. Furthermore, the foundation from the implementation of BIP Schnorr+BIP Taproot+BIP Transcript could bring novel smart contracts to Bitcoin's base layer. One can only speculate on the initial set of contracts, but they will likely support better custody solutions.
The upgrade has direct impact on the scalability, decentralization features, and fungibility of Bitcoin, which impacts long-term value. The consensus model of BIPs ensures that no one bad-actor or minority group thereof can control the fate of bitcoin. The community can never be forced to adopt undesirable or malicious changes to the network. In the case bad actors or a group take bitcoin in a poor direction, the community has the freedom to support the better version of the project. The economic activity that occurs on the better version of the project will result in bad actors maintaining an empty blockchain. The rigorous process contributes to a systematic, stable and reliable protocol that does not change often or in flamboyant ways.
Final Take - A very small percentage of Bitcoin users pay attention to system updates on the network, yet they often are the most bullish indicators for the success of Bitcoin.
S3: Lightning Network Research
What is it? - The Bitcoin Mercantile Exchange, BitMEX, is a cryptocurrency exchange that offers investors access to the global financial markets using only Bitcoin. Last weekend, their research arm released their sixth piece on the Lightning Network (LN), covering new data regarding its growth and size. According to txstats.com, the Lightning Network usage surpassed previous expectations for the second-layer protocol, consisting of over 36,000 public channels.
While this suggests that the network has grown over the past two years, it does not provide a complete picture. Due to the analysis of only public channels, the team had to extrapolate its conclusions after evaluating both the Bitcoin blockchain data and all Lightning Network non-cooperative channel closures. Non-cooperative channel closure happens when a LN node initiates the closure of a payment channel without directly communicating with the node that the channel is linked to. Closures like these are more easily tracked and recognized, since they must be confirmed in blocks on the blockchain. The report also notes that some non-cooperative channel closures saw one party attempt to steal the funds, which is a breach closure. This can be followed by a penalty transaction if the attempted theft is detected as the other party would secure claim to all funds in the channel.
Why it Matters? - The Lightning Network is developing into one of the most important tools in Bitcoin's long-term growth. To date, the network has seen unprecedented levels of interest from both developers and investors alike searching for alternatives to costly on-chain transactions. The data shows that non-cooperative channel closures made up much of the activity on the network. A large number of non-cooperative Lightning Network channel closures than expected suggests that there are a significant number of private channels that cannot be normally seen. So you might be asked what ends up happening to funds that were part of a non-cooperative closing? Well, there are three possibilities:
Funds are distributed correctly to the two parties involved, according to the latest channel state.
A malicious party successful steals funds by broadcasting an old channel state
The theft is caught and all funds go to the honest party.
The lower bound estimate suggests a total of 59, 508 total transactions that traded 1,074 Bitcoin.
While the upper bound suggests a total of 90,667 total transactions that traded 1,405 Bitcoin.
The majority of blockchain networks can handle about 6 to 50 transactions per second on average, pushing beyond it often result in higher fees. Therefore, successful implementation and rising usage of second-layer solutions are crucial for any large-scale blockchain network. If the fundamentals of lightning continue to improve in the months to come, it is expected to have a positive effect on the adoption of bitcoin.
"The fact that non-cooperative closures are more common than many thought, means the privacy and scalability benefits of lightning are lower than many expected too. However, Bitcoin protocol upgrades and lightning protocol upgrades could make this type of analysis more difficult in the future. At the same time, as users learn more about how to use the lightning network and lightning wallets improve, the prevalence of non-cooperative closures could fall."
Final Thought - The Lightning Network is still an experimental project and increasing usage of second-layer solutions is one of many important fundamental factors for bitcoin's long-term trend.
Market Watch
- High: $8,832.97
- Low: $8,016.25
- ATTOW: $8,631.60
Bitcoin broke out from last week’s bull flag resulting in a new high just below $9,200. However, the digital asset was unable to hold the level and reversed back towards $8,580 - $8,680 range. The price breakout near $8,400 provides a level of initial support but ultimately, the major support is closer to $8,100. Daily volume has been descending since October only to have been breached late last week. This uptick in volume contributed to the ~10% increase seen in the middle of the week. Unfortunately, bullish investors were unable to make a solid move above $9,100, signaling exhaustion. A potential retracement is to the major support level is to occur if the price closes below the breakout point near $8,400. On the other hand, if Bitcoin were to surpass the major resistant at $9,300, then expect the rally to continue towards $10,000.
Announcements
- Blockstream's Liquid announces support for BTCPay Server - Link
- FTX launches Bitcoin options - Link
- CME launches Bitcoin options - Link
- BTCPAY version 1.03.147 - Link
- Samourai Wallet announces OXT Research - Link
- Zeus releases v0.2.0-rc1 - Link
Interesting Reads
- Bitcoin Optech Newsletter #80 - Link
- What are the key properties of bitcoin? - Link
- What happened in the 2010s - Link
Great Listens
- Tales from the Crypt #128: Jamal James - Link
- The Tim Ferriss show: Adam Grant - Link
Final Quote
"I believe that over the 2020s, the technology industry will end up aligning behind Bitcoin and crypto as part of a broader international realignment. Cryptocurrency simultaneously reflects many fundamental American values (like freedom of speech, freedom of contract, freedom of association, protection against unreasonable search & seizure, the right to privacy, and so on) while also demonstrating broad international appeal to millions of people around world.
This realignment would not be traditional right vs left, but rather land vs cloud, state vs network, centralized vs decentralized, new money vs old money, internationalist/capitalist vs nationalist/socialist, MMT vs BTC, and (perhaps most symbolically) Hamilton vs Satoshi. The new American center may be decentralized."
- Balaji S. Srinivasan - Former CTO of Coinbase and GP Andreeseen Horowitz
Have a great week!