## Annex I. The Mechanics of Cryptocurrencies

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### Introduction and market evolution
- Market rise from zero in 2008 to a peak market value of around USD 3 trillion in November 2021; subsequently fallen to less than USD 1 trillion.
- Bitcoin introduced in 2009; several thousand other cryptocurrencies have since emerged.
- Aggregate user estimates:
  - Perhaps 20 percent of the adult population in the US and 10 percent of that in the UK hold or have held some crypto assets.
  - Number of global users has been put at more than 400 million.
- Contextual scale: the USD 3 trillion peak was around 3 percent of the global value of equities.
- Historical concentration example: in 2014 Bitcoin comprised 95 percent of market capitalization of all cryptocurrencies.

### Market structure and notable cryptocurrencies
- As of November 2022 market shares by market capitalization:
  - Bitcoin: 40 percent
  - Ethereum: 19.5 percent
  - Tether: 7.4 percent
- XRP described as a cryptocurrency associated with a payment settlement system for financial institutions.
- Categories set aside in focus: security tokens (including NFTs) and central bank digital currencies (CBDCs).
- Primary focus: privately issued cryptocurrencies, especially non-stablecoins.

### Nature, features, and usage
- Definition used: a “digital representation of value that relies on a cryptographically secured distributed ledger...to validate and secure transactions”.
- Stablecoins:
  - Aim to maintain stable value relative to specified asset(s); prominent examples Tether and USDC.
  - Primary purpose as means of payment but holders face valuation risk (collapse of Terra in May 2022 cited).
  - Noted: "Only 6 percent of the liabilities of Tether, for example, are backed by cash (IMF, 2023)."
- Unbacked tokens/non-stablecoins: Bitcoin, Ethereum, privacy coins; proof-of-work vs proof-of-stake; smart contracts; Bitcoin legal tender in El Salvador and the Central African Republic.
- Price volatility and transaction costs:
  - Bitcoin fees averaged USD 2.72 per transaction over the past three years; median Bitcoin transaction value USD 93.61 implying fee of almost 3 percent; fee has at times reached USD 60.

### Trading modes and use in commerce
- Three trading modes:
  - Peer-to-peer (P2P) direct trades.
  - Decentralized exchanges (customers retain custody of private keys).
  - Centralized exchanges (exchanges hold customers’ private keys; may trade "off the chain").
- Usage for purchases:
  - Around 15,000 firms globally accept Bitcoin (400 in California); household names include Overstock.com, Sothebys, Whole Foods, Microsoft.
  - Chainalysis reports spending around USD 15 million per day in early 2021 versus daily U.S. retail sales of around USD 550 billion.
  - Survey evidence: about 2 percent of Americans used crypto for purchases or money transfers in 2021; HMRC (2022a) reports about 4 percent of crypto owners in the UK received crypto for goods/services.
  - El Salvador: businesses required to accept Bitcoin since September 2021; only around 20 percent do so, and only around 5 percent of all sales are in this form.
- Geographic penetration and user counts:
  - Chainalysis penetration index top four: Vietnam, the Philippines, Ukraine, India; only high-income countries in top twenty are the US (5th) and the UK (17th).
  - Estimated 420 million users; more than one-third in India.
  - Population shares: UAE 28 percent, Vietnam 26 percent, US 13 percent.
  - US accounts for 16.5 percent of global crypto value and is top crypto mining country at 37.8 percent (followed by China 21 percent and Kazakhstan 13.2 percent).

### Distributional patterns and investor outcomes
- Wealth concentration:
  - Forbes (2022) lists 19 "crypto billionaires".
  - FTX founder Sam Bankman-Fried estimated net worth USD 8.7 billion (contextual mention).
  - Hoopes et al. (2022) identify 1,245 "crypto millionaires" (cumulative reported gains of USD 1 million or more between 2013 and 2020).
  - Top 116 addresses own nearly 16 percent of all Bitcoins.
  - Makarov and Schoar (2021) estimate largest 0.01 percent of individual holders (a total of 10,000) controlled around 5 million Bitcoins, or one quarter of the total outstanding.
- Distribution across incomes:
  - Survey at crypto peak (November 2021): about two-thirds of Americans with net worth > USD 1 million hold some cryptocurrency; two-thirds of these hold more than half their wealth in crypto.
  - Estimate of around 100,000 Americans holding more than USD 1 million in crypto (CBS, 2021).
  - Holding prevalence among lower incomes: in the US, 30 percent of holders have annual income below USD 50,000; Hoopes et al. find over half of crypto-sellers have taxable income less than USD 40,000.
  - UK: HMRC (2022a) finds 85 percent of crypto holders have income below £50,000.
- Investor outcomes and losses:
  - Auer et al. (2022) suggest that 75 percent of users have lost money on their Bitcoin investments.

### Tax policy challenges and design principles
- Overarching principle: neutrality — tax cryptocurrencies the same way as comparable traditional instruments, subject to externalities and administrative constraints.
- Key complications:
  - Dual nature as investment asset and medium of exchange complicates application of neutrality.
  - Fundamental challenge: tax systems were not designed for assets traded and transactions completed in anything other than national currencies.
  - Element of anonymity in crypto assets raises enforcement issues akin to cash.
  - Coherence issues for taxation of capital income (viewing crypto as property) versus taxation of final sales under VAT/sales taxes (viewing crypto as currency).
  - Policymakers must encompass developments in crypto use into well-functioning tax systems regardless of crypto’s future.

### Income taxation options and examples
- Two main classification options:
  - Property (capital gains treatment): requires calculation of gain/loss on every transaction; ring-fencing, exempt amounts, holding-period treatments matter.
  - (Foreign) currency treatment: different implications (example: many countries exempt individuals’ capital gains on foreign currencies).
- Country examples and variants:
  - US classifies cryptocurrencies as property: capital gains reportable on all transactions; lower rates may apply if held more than one year.
  - Portugal previously exempted gains on cryptoholdings (now applies only to holdings over one year); El Salvador has an outright exemption.
  - India: bespoke regime taxing at 30 percent gains and/or income from trading in "virtual digital assets" (VDAs), with a one percent surcharge on the transfer of any VDA. (Applicable above an annual threshold of around USD 600 is noted.)

### VAT/sales tax implications
- Principle: VAT/sales taxes apply to supplies made for "consideration", broad enough to encompass crypto assets.
- Jurisdictional responses:
  - Some countries (Australia, Japan, South Africa) provide explicit VAT exemption to prevent VAT on acquisition of crypto for fiat.
  - EU Court of Justice 2015 held VAT should not apply to such transactions.
- VAT treatment of miners' fees and newly minted coins:
  - In principle, fees and newly minted coins should be liable to VAT with right to credit for input VAT.
  - Many VAT systems exempt fees for financial services, causing potential over-taxation of business use (miners' unrecovered input VAT) and under-taxation of individual use.
- Practical complications: price volatility, fraud risk, and cross-border rule integration complicate VAT application and verification of transaction timing.

### Externalities and corrective taxation options
- Identified externalities that may motivate regulation or corrective taxes:
  - Consumer protection, financial stability, anti-crime (money laundering, terrorist financing).
  - Gambling-like behavior and self-control problems.
  - "Cryptoization" risking substitution of national currencies and undermining monetary policy and capital flow management.
- Environmental externalities:
  - Proof-of-work mechanisms require considerable energy.
  - Hebous and Vernon (forthcoming) estimate that in 2021 Bitcoin and Ethereum used more electricity than Bangladesh or Belgium, generating 0.28 percent of global greenhouse gas emissions.
  - Policy responses:
    - Preferable: address via a general carbon tax to internalize mining-related emissions.
    - Targeted measures in absence of carbon tax:
      - March Biden administration proposal: 30 percent tax on miners’ electricity use (no differentiation by carbon-intensity).
      - Kazakhstan introduced a similar tax at the start of 2023, with a reduced rate for those using renewable sources.
      - Other measures: limit/deny income tax deductions for mining energy costs; deny input VAT credit for energy costs where those costs are not VAT exempt.
- Financial stability/behavioral measures:
  - Transaction taxes akin to financial transactions taxes proposed to reduce volatility or discourage risky trading.
  - India’s 1 percent transfer surcharge offered as an example of corrective taxation.

### Evasion, crime, and empirical findings
- Anonymity concerns:
  - Cryptocurrencies’ anonymity properties raise longstanding concerns about facilitating criminal activity.
- Empirical analyses and estimates:
  - Foley et al. (2019) using data to April 2017 estimate for 2017:
    - Around 25 percent of all Bitcoin users were engaged in criminal activity.
    - These users accounted for around 23 percent of all transactions by number.
    - These users accounted for about 17 percent of all transactions by value.
    - These users held around half of all Bitcoins.
    - In dollar terms, corresponds to transactions of USD 76 billion and Bitcoin holdings of USD 7 billion.
  - For 2017, about 6 percent of all Bitcoin users are placed in the category identified from seizures and darknet trading, accounting for around one-third of all transactions.
  - Chainalysis (2022a) estimates for 2017:
    - ‘Illicit addresses’ accounted for around 1.4 percent of all transactions.
    - Received payments of around USD 4 billion.
  - Makarov and Schoar (2021) estimate illegality and gambling at under 3 percent of the total.
- Consensus:
  - Crypto-enabled crime is growing rapidly in absolute volume and value but declining in relative terms.
  - Criminality continues to rely more heavily on traditional financing means, including cash.
- Privacy coins:
  - Monero conceals public keys and transaction details and is increasingly seen as the cryptocurrency of choice for serious crime.
  - In 2020 the IRS issued a request for proposals to enhance capacity to trace transactions on Monero and other privacy coins.

### Evasion, compliance signals, and enforcement examples
- Taxation context:
  - Proceeds of illegal activities are generally taxable, so illegality estimates include some tax evasion.
  - For serious crimes, tax evasion is likely a by-product rather than the primary motivation.
- Key tax questions:
  1. Incentives to use crypto to evade taxes on otherwise legal transactions.
  2. Extent to which cryptocurrencies are used for tax evasion.
  3. Extent to which taxes on generation/trading of crypto assets (e.g., mining earnings, gains on sale) are properly paid.
- Evidence and compliance signals:
  - India: authorities seized nearly USD one billion in evaded GST from local exchanges in May 2022.
  - UK: HMRC seized crypto assets and NFTs apparently intended to set up a VAT fraud.
  - US: Hoopes et al. (2022) imply around one percent of all returns in 2020 reported some sales of crypto.
  - UK HMRC (2022a) survey highlights:
    - 45 percent of crypto owners thought they might be subject to capital gains tax.
    - 34 percent believed they had a good understanding of the rules.
    - Nearly 30 percent had sought guidance on tax treatment of crypto.
    - For Group A (higher incomes, more frequent trading): 64 percent estimated to have a taxable gain on crypto alone; in the other three groups the figure is no more than one percent.
  - Cong et al. (2022) find loss-harvesting behavior increases after IRS public statements highlighting tax obligations, indicating both compliance responses and manipulation.

### Revenue potential — illustrative scenarios and figures
- Thiemann (2021) EU estimate (using Chainalysis data, 2020):
  - Estimated tax due (upper bound on evasion) EUR 850–900 million in 2020 (about 0.3 percent of total property tax revenue in the EU).
- Back-of-envelope global scenarios:
  - Assume total crypto market capitalization USD 1 trillion, rate of return 5 percent, tax rate 20 percent → implied total tax due USD 10 billion.
  - Using peak market valuation USD 2.6 trillion → implied annual tax USD 26 billion.
- High volatility illustrative figures:
  - Market capitalization of crypto assets in 2021: from USD 752 billion to USD 2,368 billion; in 2022 dropped to USD 836 billion.
  - Assuming a tax rate of 20 percent on accrued capital gains:
    - Tax revenue in 2021 would have been USD 323 billion (around 12 percent of global CIT revenue).
    - If one third of gains were realized, revenue would still be around USD 100 billion.
    - In 2022, large capital losses could erode revenue by a similar magnitude.
- Concentration implications:
  - In 2021, implied tax on realized gains of 116 largest addresses around USD 17 billion.
  - In a ‘normal times’ scenario, around USD 1.4 billion.
- Financial transactions tax examples:
  - At 0.1 percent on all crypto transactions (USD 15.8 trillion in 2021) → revenue around USD 15.8 billion.
  - At 0.01118 percent (rate applied in Brazil to certain transactions) → revenue USD 1.8 billion.
- VAT/sales tax framing:
  - If all crypto transactions were a VAT chain with final sales accounting for 5 percent of total transactions by value and total transactions USD 15.8 trillion in 2021:
    - At VAT/sales tax rate of 15 percent, implied revenue loss USD 118.5 billion.
    - If only 2 percent of transactions were legal final sales, implied revenue USD 47.4 billion.
- US reporting-rule revenue estimate (Joint Committee on Taxation, 2021):
  - Revenue USD 1.5 billion in the first year of operation, rising to USD 4.6 billion in 2031 (around one percent of total (federal, state, and local) revenue from individual capital gains tax in 2020).
- Lesson: worldwide revenue at stake plausibly in the tens of billions, perhaps high tens if crypto performs strongly; much recoverable revenue relates to large and wealthy holders.

### Implementation challenges: anonymity and enforcement tools
- Fundamental obstacle: element of pseudo-anonymity linking transactions with individuals.
- Tax system implications:
  - Some tax types (single-rate transactions tax) require no identities but complex tax systems require linking transactions to individuals.
  - Theoretical possibility: unique digital identifiers for individuals linked to blockchain could enable sophisticated tax implementation while preserving privacy, but practical and political doubts exist.
- Current approaches and limitations:
  - Centralized intermediaries (exchanges) can obtain ownership information and are focal points for reporting.
  - AML and KYC measures:
    - KYC, suspicious transaction reports (STRs), attaching customer information to transactions (‘travel rules’).
    - US clarified AML applicability to crypto in 2013; FATF issued guidance in 2015.
    - EU prior regulations excluded cryptocurrencies; updated regulation proposal awaits Council approval.
    - KYC enabled IRS ‘John Doe’ notices seeking information on US taxpayers transacting USD 20,000 or more between 2016 and 2021.
    - In the UK KYC enabled HMRC to write targeted letters to crypto owners.
  - Practical limits:
    - As of June 2022 FATF reports more than 20 jurisdictions under ‘increased monitoring’.
    - OECD (2015) survey: only 20 percent of tax administrations had direct access to STRs.
    - KYC may identify cash-out events but not compute capital gain/loss without further data.
- Information reporting initiatives:
  - US Infrastructure Improvement and Jobs Act (IIJA) of November 2021:
    1. Broadly defined digital service providers (potentially including miners) to report customer transaction details annually to the IRS.
    2. All businesses report crypto asset transactions over USD 10,000 (takes effect tax year 2023).
  - Brazil (2019) regulations require reporting of virtual currency operations exceeding USD 5,548 (30,000 Reais) monthly by individuals/legal entities; exchanges domiciled in Brazil must provide annual user information.
- Risks of migration and cross-border issues:
  - Domestic reporting may drive transactions to foreign or non-reporting platforms.
  - Cong et al. (2022) find IRS-targeted action at specific exchanges decreased activity on US exchanges.
  - 22 percent of UK survey respondents preferred foreign exchanges (HMRC, 2022a).
  - OECD (2022) framework for crypto information exchange includes reporting of purchases of goods and services exceeding USD 50,000; implementation requires domestic rules and remains distant.
  - Entities can avoid reporting by locating servers in tolerant jurisdictions.
- Decentralized exchanges and miners as alternative upstream points:
  - Decentralized exchanges could not meet US reporting obligations; IIJA reporting applies to providers “regularly providing any service effectuating transfers of digital assets on behalf of another person” (Section 8060); decentralized exchanges not explicitly included.
  - OECD (2022) would include decentralized exchanges only to the extent they exercise control or sufficient influence.
  - Estimating peer-to-peer share is highly uncertain: FATF assessments ranged from close to zero to nearly 100 percent; HMRC (2022a) reports 8 percent overall use of decentralized exchanges, rising to nearly 50 percent for Group A.
  - Miners see every transaction in non-stablecoins and are relatively few; Makarov and Schoar (2021) estimate around 55-60 entities controlled more than half of Bitcoin mining capacity at end-2020.
  - Possible miner-focused policies: require miner reporting, impose transaction taxes/withholding on miners, encourage compliance via incentives (e.g., delayed remittance allowances); raise security and feasibility concerns (concentration risks, inability of users to select miners ex ante).
- Forensic and technological enforcement tools:
  - Public blockchain data supports forensic analysis and firms linking identities to virtual asset service providers.
  - Artificial intelligence can identify potentially tax-relevant behaviors.
  - Traditional investigative methods, taxpayer education, nudges, and high-profile enforcement actions complement technical tools.
  - Enforcement rhetoric examples: FBI claims ability to uncover sophisticated schemes; HMRC used NFT seizure to warn about hiding money from HMRC.

### VAT/sales tax specific risks and priorities
- VAT and sales tax risks may be greater than income tax risks as crypto use as means of payment increases.
- First-line defenses:
  - Legal requirements for businesses to report large crypto transactions (US and OECD proposals) to generate red flags and audit clues.
- Fraud risk:
  - Crypto may facilitate VAT frauds such as carousel schemes enabling refunds for unpaid tax.
  - Little systematic thought yet on protecting VAT/sales taxes from crypto-enabled fraud, risks especially latent in emerging and developing economies with strong crypto demand and weaker tax administration.
- HMRC (2022a) usage figures:
  - 9 percent of crypto owners reported being paid for work in crypto assets.
  - 4 percent indicated having received crypto for provision of goods and services; for Group A this rises to 26 percent.

### Policy recommendations and implementation priorities
- Tax design and neutrality:
  - Aim to tax cryptocurrencies the same way as comparable traditional instruments, mindful of externalities and administrative constraints.
- Income tax:
  - Clarify classification (property vs currency) and apply consistent rules (e.g., capital gains accounting, holding-period rules, ring-fencing).
- VAT/sales tax:
  - Treat cryptocurrency the same way as national currencies for VAT/sales tax purposes.
  - Address miner fees and newly minted coins within VAT frameworks to avoid mismatches in input credit recovery and over/under-taxation.
- Corrective and environmental taxation:
  - Prefer addressing mining carbon externalities via a general carbon tax.
  - In absence of carbon tax, consider targeted measures (e.g., electricity-use taxes, limits on energy deductions, denial of input VAT credits).
- Enforcement and information:
  - Apply AML rules and third-party reporting requirements where feasible (US measures cited).
  - Strengthen cross-border information exchange frameworks (OECD (2022)), while acknowledging implementation will be gradual.
  - Anticipate migration of transactions to decentralized or peer-to-peer forms as centralized reporting improves.
  - Explore role for miners in reporting/withholding consistent with upstream collection principles, weighing security and feasibility concerns.
  - Use forensic analysis, blockchain analytics, AI, traditional investigations, taxpayer education, and high-profile enforcement to improve compliance.
- Revenue focus:
  - Recognize that recoverable revenue is likely concentrated among large and wealthy holders; prioritize approaches that capture large holders.
- Practical caution:
  - Policymakers must act on limited information and adapt tax systems amid rapid innovation and technical complexities.

### Empirical observations and concluding points
- Hard to assess quasi-anonymity’s facilitation of tax evasion beyond criminality (which accounts for a declining share of crypto activity).
- US evidence: about one percent of returns reported crypto sales in 2020, with signs of significant avoidance activity.
- Rough calculations:
  - In 2021 a global tax at 20 percent on accrued capital gains might have raised around USD 300 billion (about 12 percent of global CIT revenue); 2022 reversals could have similarly large negative effects.
- Concentration and distribution implications:
  - Crypto wealth is highly concentrated, more so than equity ownership, implying significant revenue potential concentrated among relatively few holders; however, many holders in the UK and US are far from rich.
- Key takeaways:
  - Worldwide revenue at stake plausibly in the tens of billions, possibly high tens if crypto markets perform strongly.
  - Major recoverable revenue likely associated with large and wealthy holders.
  - VAT and sales taxes may pose the most significant risks to existing tax systems from increased crypto use as a means of payment.

*Source: Annex I. The Mechanics of Cryptocurrencies, Taxing Cryptocurrencies — IMF WORKING PAPERS, wpiea2023144-print-pdf*

### Annex I. The Mechanics of Cryptocurrencies .............................................................................

### Annex I. The Mechanics of Cryptocurrencies

### Introduction and market evolution
- Rise from zero in 2008 to a market value that peaked at around USD 3 trillion in November 2021.
- Bitcoin introduced in 2009; from Bitcoin have sprung several thousand other cryptocurrencies.
- Aggregate user estimates: perhaps 20 percent of the adult population in the US and 10 percent of that in the UK hold or have held some crypto assets; number of global users has been put at more than 400 million.
- Contextual scale: the USD 3 trillion peak was around 3 percent of the global value of equities.
- Subsequent market contraction: the USD 3 trillion has now fallen to less than USD 1 trillion.
- Example concentration and history: in 2014, Bitcoin comprised 95 percent of market capitalization of all cryptocurrencies.

### Market structure and notable cryptocurrencies (selected figures)
- As of November 2022 market shares by market capitalization:
  - Bitcoin: 40 percent
  - Ethereum: 19.5 percent
  - Tether: 7.4 percent
- XRP described as a cryptocurrency associated with a payment settlement system for financial institutions.

### Perspectives on benefits and risks
- Advocates’ claims highlighted:
  - Liberation from oversight by government and reliance on financial institutions via cryptographically-protected distributed ledgers.
  - Potential for greatly reduced transactions costs.
  - Emergence of decentralized finance extending benefits across the financial system.
  - Arguments noting fiat currency also has no intrinsic value and pointing to innovations such as “green cryptocurrencies” and crypto’s use in support provided to Ukraine.
- Critics’ concerns highlighted:
  - Crypto markets characterized as a “Wild West” facilitating criminal activities and exposing investors to massive price swings, bankruptcies, scams, and frauds (FTX collapse cited as an example).
  - Environmental damage from asset creation and claims of no intrinsic value for many crypto assets.

### Tax policy and enforcement challenges
- Fundamental challenge: tax systems were not designed for assets traded and transactions completed in anything other than national currencies.
- Key complications:
  - Element of anonymity in crypto assets raises enforcement issues akin to those associated with cash.
  - Coherence issues for taxation of capital income (viewing crypto assets as a form of property).
  - Issues for taxation of final sales under VAT and similar taxes (viewing crypto as a form of currency).
  - Whether taxation could play a corrective role complementing regulatory interventions.
- Practical tax-authority task: encompass developments in the use of crypto assets into a well-functioning tax system regardless of whether crypto withers or blossoms.

### Concerns about tax evasion and distributional implications
- Prominent presumption: crypto assets provide a new and important way for the rich, criminal, and others to evade or avoid taxation.
- Wealth creation examples:
  - 19 “crypto billionaires” made it to the Forbes List of April 2022.
- Investor outcomes:
  - Auer et al. (2022) suggest that 75 percent of users have lost money on their Bitcoin investments, raising tax issues around the treatment of losses.

### Opportunities from distributed ledger technologies
- Distributed ledger technology (blockchain) described as remarkably transparent in the transaction histories it contains, potentially valuable for tax administration.
- Smart contracts (self-executing programs) within blockchains could, in principle, help secure chains of VAT compliance and enforce withholding.
- The paper’s focus remains on tax challenges associated with crypto assets themselves rather than on ledger-enabled administrative innovations.

### Evidence base and analytical limitations
- Relatively little analytical work or empirical evidence on tax aspects of crypto; tax aspects have received relatively little attention within the broader crypto literature.
- Available resources:
  - Compendia on tax treatment in various countries and an overview in OECD (2020) are noted.
  - Vast amounts of transaction data exist in principle, but empirical analysis is difficult because the technology’s design aims to leave no tracks.
  - Experience is accumulating: surveys are proliferating (quality varies) and blockchain analytics are beginning to provide harder evidence.
- Policy implication: policymakers are required to act on severely limited information in a technically difficult area.

### Structure of the paper (as signposted)
- Review of key elements of crypto technologies, trading and use, and user demographics.
- Section 3: crypto-related issues of tax design.
- Section 4: scope for tax evasion that cryptocurrencies offer.

*Source: Annex I. The Mechanics of Cryptocurrencies, wpiea2023144-print-pdf*

### Section 5 turns to the critical issue of tax enforcement. Section 6 concludes.

### wpiea2023144-print-pdf - Section 5 turns to the critical issue of tax enforcement. Section 6 concludes.

### II. Context
- Paper focuses on privately issued crypto assets that serve both investment and settlement functions, referred to as "cryptocurrencies."
- Key tension for tax policy: dual nature of cryptocurrencies as investment assets and as a medium of exchange; innovation and multifunctionality complicate tax characterizations.
- Cryptocurrencies are generally "quasi-anonymous" (private key/address control, wallets) yet transaction records are publicly available on distributed ledgers, enabling cryptoanalytics and clustering of addresses by likely holder type.
- Extra-territoriality: transactions reveal no jurisdictional location, creating incentives to locate activities where tax/regulatory burdens are light.

### A. The Nature of Crypto Assets
- Definition used: a “digital representation of value that relies on a cryptographically secured distributed ledger...to validate and secure transactions”. (OECD (2022) definition cited)
- Categories set aside: security tokens (including NFTs) and central bank digital currencies (CBDCs).
- Primary focus: privately issued cryptocurrencies, especially non-stablecoins.
- Examples and features:
  - Stablecoins: aim to maintain stable value relative to specified asset(s); prominent examples Tether and USDC; primary purpose is as means of payment but holders face valuation risk (example: collapse of Terra in May 2022). Noted: "Only 6 percent of the liabilities of Tether, for example, are backed by cash (IMF, 2023)."
  - Unbacked tokens/non-stablecoins: Bitcoin, Ethereum, privacy coins, proof-of-work vs proof-of-stake, smart contracts; Bitcoin legal tender in El Salvador and the Central African Republic.
- Price volatility:
  - Cryptocurrencies have extensive price volatility; stablecoins also exhibit non-zero variability.
  - Transaction fee example: Bitcoin fees averaged USD 2.72 per transaction over the past three years; median Bitcoin transaction value USD 93.61 implies fee of almost 3 percent; fee has at times reached USD 60.

### B. Trading in and Using Cryptocurrencies
- Three trading modes:
  - Peer-to-peer (P2P) direct trades.
  - Decentralized exchanges (customers retain custody of private keys).
  - Centralized exchanges (exchanges hold customers’ private keys; may trade "off the chain" to avoid transaction costs).
- Usage for purchases is limited but present:
  - Around 15,000 firms globally accept Bitcoin (400 in California); household names include Overstock.com, Sothebys, Whole Foods, Microsoft.
  - Chainalysis reports spending around USD 15 million per day in early 2021 versus daily U.S. retail sales of around USD 550 billion.
  - Survey evidence: about 2 percent of Americans used crypto for purchases or money transfers in 2021; HMRC (2022a) reports about 4 percent of crypto owners in the UK received crypto for goods/services.
  - El Salvador: businesses required to accept Bitcoin since September 2021; only around 20 percent do so, and only around 5 percent of all sales are in this form.
- Geographic penetration and user counts:
  - Chainalysis penetration index top four: Vietnam, the Philippines, Ukraine, India; only high-income countries in top twenty are the US (5th) and the UK (17th).
  - Estimated 420 million users; more than one-third in India; population shares: UAE 28 percent, Vietnam 26 percent, US 13 percent.
  - In absolute terms, the US accounts for 16.5 percent of global crypto value and is top crypto mining country at 37.8 percent (followed by China 21 percent and Kazakhstan 13.2 percent).

### C. Cryptocurrencies, the Rich, and the Not-so Rich
- Wealth and concentration:
  - Forbes (2022) lists 19 "crypto billionaires"; FTX founder Sam Bankman-Fried estimated net worth USD 8.7 billion (noted earlier in context).
  - Hoopes et al. (2022) identify 1,245 "crypto millionaires" (cumulative reported gains of USD 1 million or more between 2013 and 2020).
  - Top 116 addresses own nearly 16 percent of all Bitcoins.
  - Makarov and Schoar (2021) estimate largest 0.01 percent of individual holders (a total of 10,000) controlled around 5 million Bitcoins, or one quarter of the total outstanding.
- Distribution across incomes:
  - Survey at crypto peak (November 2021): about two-thirds of Americans with net worth > USD 1 million hold some cryptocurrency; two-thirds of these hold more than half their wealth in crypto.
  - Estimate of around 100,000 Americans holding more than USD 1 million in crypto (CBS, 2021).
  - Holding prevalence among lower incomes: in the US, 30 percent of holders have annual income below USD 50,000; Hoopes et al. find over half of crypto-sellers have taxable income less than USD 40,000.
  - UK: HMRC (2022a) finds 85 percent of crypto holders have income below £50,000.

### III. Cryptocurrencies and Tax Design
- Overarching principle: neutrality — tax cryptocurrencies the same way as comparable traditional instruments, subject to externalities and administrative constraints.
- Dual nature complicates application of neutrality: investment asset vs medium of exchange.

### A. Income Taxation
- Two main classification options for income tax:
  - Property (like shares or bonds) → capital gains tax treatment; requires calculation of gain/loss on every transaction; ring-fencing, exempt amounts, holding-period treatments matter.
  - (Foreign) currency → different tax implications (example: many countries exempt individuals’ capital gains on foreign currencies).
- Practical implications and burdens:
  - US classifies cryptocurrencies as property: capital gains reportable on all transactions; lower rates may apply if held more than one year; currency classification would tax as ordinary income with a USD 200 threshold in some analogies.
  - Burden for small users: calculating gain/loss on every transaction can impede routine use of crypto for purchases.
- Alternative analogies:
  - Gambling analogy has been proposed (Panetta (2023)), which would affect income taxation and VAT/sales tax; aptness unclear.
- International variation and examples:
  - Many countries treat crypto as property for capital gains tax, but practices vary widely (exemptions, holding-period rules).
  - Portugal had exempted gains on cryptoholdings (now applies only to holdings over one year); El Salvador has an outright exemption.
  - India: bespoke tax regime taxing at 30 percent gains and/or income from trading in "virtual digital assets" (VDAs), with a one percent surcharge on the transfer of any VDA. (Applicable above an annual threshold of around USD 600 is noted in the text.)

### B. VAT and Sales Taxation
- Principle: VAT/sales taxes apply to supplies made for "consideration", a term broad enough to encompass crypto assets.
- To prevent VAT being levied on acquisition of crypto for fiat, some countries (Australia, Japan, South Africa) provide explicit VAT exemption; EU Court of Justice 2015 held VAT should not apply to such transactions.
- VAT treatment of miners' fees and newly minted cryptocurrencies:
  - In principle, fees and newly minted coins should be liable to VAT with right to credit for input VAT.
  - Many VAT systems exempt fees for financial services, which causes:
    - Over-taxation of business use of cryptocurrency (miners' unrecovered input VAT).
    - Under-taxation of individual use.
- Practical complications: price volatility, fraud risk, and cross-border rule integration complicate VAT application and verification of transaction timing.

### C. Externalities
- Externalities motivating regulatory or corrective tax measures:
  - Consumer protection, financial stability, anti-crime (money laundering, terrorist financing) often addressed by regulation.
  - Possible direct externalities from crypto use:
    - Gambling-like behavior and self-control problems (argument for corrective taxation).
    - "Cryptoization": extensive substitution of national currencies could undermine monetary policy and capital flow management.
    - Transaction taxes akin to financial transactions taxes have been proposed to reduce excessive volatility or discourage risky trading.
- Policy trade-offs:
  - Corrective taxes (or the India 1 percent transfer surcharge) might be used as second-best measures pending regulation, but implementation is problematic and may clash with goals of fostering innovation.

*Source: IMF WORKING PAPERS Taxing Cryptocurrencies.*

### Section 5: while national application to the subset of transactions through centralized domestic exchanges

### Section 5: while national application to the subset of transactions through centralized domestic exchanges (and/or miners) may be feasible, this might simply drive transactions into peer-to-peer form or offshore

### Environmental externalities and corrective taxation
- Proof-of-work consensus mechanisms (such as that behind Bitcoin) require considerable energy, as they rest on finding the solution to a complex mathematical problem by making an enormous number of guesses.
- Hebous and Vernon (forthcoming) estimate that in 2021 Bitcoin and Ethereum used more electricity than did Bangladesh or Belgium, generating 0.28 percent of global greenhouse gas emissions.
- Awareness of environmental impact is reflected in explicit marketing of some cryptocurrencies as ’green,’ but voluntariness alone is unlikely to provide a complete solution.
- By the usual arguments, externalities from mining-related carbon emissions are best addressed within a general carbon tax, which would automatically internalize the costs of the energy-heavy proof-of-work verification mechanisms.
- In the absence of a carbon tax, there is a case for more targeted tax measures:
  - In March, the Biden administration proposed a 30 percent tax on miners’ electricity use, though with no differentiation to reflect the carbon-intensity with which it is generated.
  - Kazakhstan introduced a similar tax at the start of 2023, with a reduced rate for those using renewable sources.
- Less efficient but meaningful measures in the absence of specific energy taxes include:
  - Limiting or denying income tax deductions for energy costs incurred in mining activities.
  - Denying input VAT credit for energy costs where those costs are not VAT exempt.

### Tax design and market considerations
- Tax design has a role in avoiding biases towards excessive debt finance (Keen, 2011).
- National application to centralized domestic exchanges (and/or miners) may be feasible, but risks driving transactions into peer-to-peer form or offshore.
- Less dramatic measures within existing structures (for example, denying or limiting loss offsetting under the capital gains tax) might be warranted.

### Evasion and revenue potential — overview
- Cryptocurrencies’ anonymity properties have long raised concerns about facilitation of criminal activities.
- Large seizures and price responses illustrate criminal use (largest seizure in February 2022 being of Bitcoin valued at USD 3.6 billion).
- There is a strong negative cross-country correlation between usage of Bitcoin and various indicators of institutional quality/control of corruption.

### Crime and crypto — empirical findings
- The blockchain’s public record (entire history of transactions and public keys) provides meaningful clues to the extent of hard-core criminal activities.
- Using data on the universe of (over 600 million) transactions from 2009 until April 2017, Foley et al. (2019) identify addresses associated with seizures and darknet trading and estimate a wider population likely engaged in illegal activities by clustering and characteristic-based methods (such as the use of ‘tumbling’ and other measures of obfuscation).
- Foley et al. (2019) final estimates for 2017:
  - Around 25 percent of all Bitcoin users were engaged in criminal activity.
  - These users accounted for around 23 percent of all transactions by number.
  - These users accounted for about 17 percent of all transactions by value.
  - These users held around half of all Bitcoins.
  - In dollar terms, this corresponds to transactions of USD 76 billion and Bitcoin holdings of USD 7 billion.
- For 2017, about 6 percent of all Bitcoin users are placed in the category identified from seizures and darknet trading, accounting for around one-third of all transactions.

*Source: IMF Working Paper — Section 5: while national application to the subset of transactions through centralized domestic exchanges (and/or miners) may be feasible*

### 2017. These are large enough figures to conclude that “a significant component of [Bitcoin’s] value as a

### wpiea2023144-print-pdf - 2017. These are large enough figures to conclude that “a significant component of [Bitcoin’s] value as a

### Illegal activity and scale
- Foley et al. (2019) conclude “a significant component of [Bitcoin’s] value as a payment system derives from its use in facilitating illegal trade.”
- Chainalysis (2022a) estimates for 2017:
  - ‘Illicit addresses’ accounted for around 1.4 percent of all transactions.
  - Received payments of around USD 4 billion.
- Makarov and Schoar (2021) estimate illegality and gambling at under 3 percent of the total.
- Differences in estimates largely attributed to differences in the denominator; Foley et al. include exchange-related transactions that Makarov and Schoar exclude, with such transactions accounting for about 80 percent of total volume.
- Consensus points:
  - Crypto-enabled crime is growing rapidly in absolute volume and value but declining in relative terms.
  - Criminality continues to rely more heavily on traditional financing means, including cash.
- Privacy-focused cryptocurrencies:
  - Monero conceals public keys and transaction details and is increasingly seen as the cryptocurrency of choice for serious crime.
  - In 2020 the IRS issued a request for proposals to enhance capacity to trace transactions on Monero and other privacy coins.

### Evasion and crypto
- Taxation context:
  - Proceeds of illegal activities are generally taxable, so illegality estimates include some tax evasion.
  - For serious crimes, tax evasion is likely a by-product rather than primary motivation.
- Three paramount tax questions:
  1. Incentives to use crypto to evade taxes on otherwise legal transactions.
  2. Extent to which cryptocurrencies are used for tax evasion.
  3. Extent to which taxes on generation/trading of crypto assets (e.g., mining earnings, gains on sale) are properly paid.
- Transaction costs and anonymity:
  - Crypto may offer transaction cost savings relative to cash in some cases: estimated fee for a USD 200 remittance is 5.7 percent (cash) compared to 1.4 percent for a Bitcoin transaction (Beck et al., 2022).
  - Use of crypto for anonymity may require costly skills; this obstacle may decrease over time.
- Volatility and risk:
  - High price volatility of cryptocurrencies may discourage use for evasion; risk-averse evaders may cash out quickly.
- Evidence and compliance signals:
  - India: authorities seized nearly USD one billion in evaded GST from local exchanges in May 2022.
  - UK: HMRC seized crypto assets and NFTs apparently intended to set up a VAT fraud.
  - US: Hoopes et al. (2022) imply around one percent of all returns in 2020 reported some sales of crypto.
  - UK HMRC (2022a) survey results:
    - 45 percent of crypto owners thought they might be subject to capital gains tax.
    - 34 percent believed they had a good understanding of the rules.
    - Nearly 30 percent had sought guidance on tax treatment of crypto.
    - For Group A (higher incomes, more frequent trading): 64 percent estimated to have a taxable gain on crypto alone; in the other three groups the figure is no more than one percent.
  - Cong et al. (2022) find loss-harvesting behavior occurs and increases after IRS public statements highlighting tax obligations, indicating both compliance and consequential non-compliance or ignorance.

### Revenue potential
- Thiemann (2021) estimate for EU residents (using Chainalysis data, 2020):
  - Estimated tax due (upper bound on evasion) put at EUR 850–900 million in 2020.
  - This is about 0.3 percent of total property tax revenue in the EU (per Thiemann) and compared to capital gains tax revenue in the UK of about EUR 12 billion.
- Back-of-envelope global scenarios:
  - Assume total crypto market capitalization USD 1 trillion, rate of return 5 percent, tax rate 20 percent:
    - Implied total tax due USD 10 billion.
  - Using peak market valuation USD 2.6 trillion:
    - Implied annual tax USD 26 billion.
- High volatility illustrative figures:
  - Market capitalization of crypto assets in 2021: from USD 752 billion to USD 2,368 billion; in 2022 dropped to USD 836 billion.
  - Assuming a tax rate of 20 percent on accrued capital gains:
    - Tax revenue in 2021 would have been USD 323 billion (around 12 percent of global CIT revenue).
    - If one third of gains were realized, revenue would still be around USD 100 billion.
  - In 2022, large capital losses could erode revenue by a similar magnitude.
- Concentration of holdings:
  - In 2021, implied tax on realized gains of 116 largest addresses around USD 17 billion.
  - In a ‘normal times’ scenario, around USD 1.4 billion.
- Financial transactions tax example:
  - At 0.1 percent on all crypto transactions (USD 15.8 trillion in 2021), revenue around USD 15.8 billion.
  - At 0.01118 percent (rate applied in Brazil to certain transactions) revenue would be USD 1.8 billion.
- VAT/sales tax framing:
  - If all crypto transactions were a VAT chain with final sales accounting for 5 percent of total transactions by value and total transactions USD 15.8 trillion in 2021:
    - At VAT/sales tax rate of 15 percent, implied revenue loss USD 118.5 billion.
    - If only 2 percent of transactions were legal final sales, implied revenue USD 47.4 billion.
- US Joint Committee on Taxation (2021) estimate for new crypto reporting requirements:
  - Revenue USD 1.5 billion in the first year of operation, rising to USD 4.6 billion in 2031.
  - This is around one percent of total (federal, state, and local) revenue from individual capital gains tax in 2020.
- Lessons:
  - Worldwide revenue at stake plausibly in the tens of billions, perhaps high tens if crypto performs strongly.
  - Much recoverable revenue relates to large and wealthy holders.
  - VAT and sales taxes may present greater risks than income tax as crypto use as currency increases.

### Implementation: the core challenges of anonymity
- Fundamental obstacle: element of pseudo-anonymity linking transactions with individuals.
- Tax implications:
  - Some tax types require no identities (single-rate transactions tax) but cannot be implemented anonymously on blockchain without authority insertion into chain.
  - Complex tax systems (nonlinear income taxes, VATs with credits) require linking distinct transactions to individuals.
  - Ultimate theoretical possibility: if all transactions on blockchain and each individual had unique digital identifier, sophisticated tax systems could be implemented with privacy preserved; practical and political doubts remain.
- For foreseeable future the challenge is accommodating pseudo-anonymity within existing systems.

### Dealing with anonymity: current approaches and limitations
- Centralized intermediaries (exchanges) play a core role and can obtain ownership information.
- Anti-money laundering (AML) and KYC measures:
  - Key AML requirements: KYC to verify identity, suspicious transaction reports (STRs), attaching customer information to transactions (‘travel rules’).
  - US clarified AML applicability to crypto in 2013; FATF issued guidance in 2015.
  - EU prior regulations excluded cryptocurrencies; updated regulation proposal awaits Council approval.
  - KYC enabled IRS ‘John Doe’ notices seeking information on US taxpayers transacting USD 20,000 or more between 2016 and 2021.
  - In the UK KYC enabled HMRC to write targeted letters to crypto owners.
- Practical limitations of AML for tax:
  - Not all jurisdictions comply with FATF guidelines; as of June 2022 FATF reports more than 20 jurisdictions under ‘increased monitoring’.
  - OECD (2015) survey of 28 members: only 20 percent of tax administrations had direct access to STRs.
  - KYC may tell authorities someone cashed out crypto but not identify capital gain/loss without further information.
- Information reporting initiatives:
  - US Infrastructure Improvement and Jobs Act (IIJA) of November 2021:
    1. Broadly defined digital service providers (potentially including miners) to report customer transaction details annually to the IRS.
    2. All businesses report crypto asset transactions over USD 10,000 (takes effect tax year 2023).
  - Brazil regulations (introduced 2019) require reporting of virtual currency operations exceeding USD 5,548 (30,000 Reais) monthly by individuals/legal entities; exchanges domiciled in Brazil must provide annual user information.
- Risks of migration and cross-border issues:
  - Domestic reporting may drive transactions to foreign or domestic non-reporting platforms.
  - Cong et al. (2022) find IRS-targeted action at specific exchanges decreased activity on US exchanges.
  - 22 percent of UK survey respondents preferred foreign exchanges (HMRC, 2022a).
  - Cross-border exchange of information frameworks not designed for crypto; OECD (2022) sets out a framework for crypto information exchange and includes reporting of purchases of goods and services exceeding USD 50,000.
  - Implementation of OECD framework requires domestic rules in place, so adoption remains distant.
  - Entities can avoid reporting by locating servers in tolerant jurisdictions.
- Decentralized exchanges and peer-to-peer transactions:
  - Decentralized exchanges could not meet US reporting obligations; reporting in the IIJA applies to providers “regularly providing any service effectuating transfers of digital assets on behalf of another person” (Section 8060); decentralized exchanges not explicitly included in final language.
  - OECD (2022) would include decentralized exchanges only to the extent they exercise control or sufficient influence.
  - Estimating peer-to-peer share is highly uncertain: FATF assessments ranged from close to zero to nearly 100 percent; HMRC (2022a) reports 8 percent overall use of decentralized exchanges, rising to nearly 50 percent for Group A.
- Alternative upstream points:
  - Miners see every transaction in non-stablecoins and are relatively few; Makarov and Schoar (2021) estimate around 55-60 entities controlled more than half of Bitcoin mining capacity at end-2020.
  - Possible policies involving miners:
    - Require information reporting by miners.
    - Impose corrective transaction tax or withholding on miners.
    - Encourage compliance via incentives such as delayed remittance allowances.
  - These approaches raise security concerns (concentration risks like a “51% attack”) and feasibility issues (users normally cannot select miners ex ante).
- Forensic analysis and enforcement tools:
  - Vast public information in unpermissioned blockchains supports forensic analysis and firms linking names, account numbers, IP addresses to virtual asset service providers.
  - Artificial intelligence can identify potentially tax-relevant behaviors.
  - Traditional investigative methods and taxpayer education, nudges, and high-profile enforcement actions can support compliance.
  - Examples of enforcement rhetoric:
    - FBI: “able to uncover the source even the most sophisticated schemes…”
    - HMRC said a seizure of NFTs “serves as a warning” about hiding money from HMRC.

### Value added and sales taxes (VAT/sales tax) concerns
- VAT and sales tax risks may be greater than income tax risks as use of crypto as means of payment increases.
- Current use of crypto to acquire goods and services is modest but could change.
- First line of defense: legal requirements for businesses to report large crypto transactions (as in US and OECD proposals) to generate red flags and audit clues.
- Crypto may facilitate VAT frauds such as carousels enabling refunds for unpaid tax.
- Little systematic thought yet to protecting sales taxation and VAT against crypto-enabled fraud; risks may be latent but could become significant, especially in emerging and developing economies with strong crypto demand and weaker tax administration.
- HMRC (2022a) usage figures:
  - 9 percent of crypto owners reported being paid for work in crypto assets.
  - 4 percent indicated having received crypto for provision of goods and services; for Group A this rises to 26 percent.

### Conclusion and policy implications
- Future of cryptocurrencies uncertain: bubble risk versus foundation for decentralized finance.
- Tax systems currently lack coherence, clarity, and effectiveness to accommodate crypto assets and must adapt amid rapid innovation and limited information.
- Conceptual challenge: dual nature of crypto as investment asset and means of payment complicates capital gains treatment without obstructing currency use.
- VAT/sales tax critical step: treat cryptocurrency the same way as national currencies.
- Potential corrective taxation:
  - Consider charge to address climate impact of proof-of-work consensus mechanisms—ideally as part of a wider carbon tax or as a sector-specific charge.
- Implementation priorities:
  - Apply AML rules and third-party reporting requirements where feasible (US recent measures cited).
  - Anticipate migration of transactions to decentralized or peer-to-peer forms as centralized reporting improves.
  - Explore role for miners in reporting/withholding consistent with upstream collection principles, while weighing security and feasibility concerns.
  - Strengthen cross-border information exchange frameworks (OECD (2022)) though widespread implementation remains distant.
- Empirical observations:
  - Hard to assess quasi-anonymity’s facilitation of tax evasion beyond criminality (which accounts for a declining share of crypto activity).
  - US evidence: about one percent of returns report crypto sales, with signs of significant avoidance activity.
  - Rough calculations suggest in 2021 a global tax at 20 percent on accrued capital gains might have raised around USD 300 billion (about 12 percent of global CIT revenue); 2022 reversals could have similarly large negative effects.
  - Crypto wealth is highly concentrated, more so than equity ownership, implying significant revenue potential concentrated among relatively few holders; however, many holders in the UK and US are far from rich.
- Key takeaways:
  - Worldwide revenue at stake plausibly in the tens of billions, possibly high tens if crypto markets perform strongly.
  - Major recoverable revenue likely associated with large and wealthy holders.
  - VAT and sales taxes may pose the most significant risks to existing tax systems from crypto use.

*IMF WORKING PAPERS Taxing Cryptocurrencies — INTERNATIONAL MONETARY FUND*

### Annex I.  The Mechanics of Cryptocurrencies

### Annex I.  The Mechanics of Cryptocurrencies

### Distributed Ledger Technology and Blockchain
- A Distributed Ledger Technology (DLT) is one that makes some database available, for inspection and/or amendment, to authorized users, with a protocol of consensus in place to ensure that—without any need for a central authority—all entries are accurate and protected against tampering.
- The best known and most widely used DLT is blockchain, whose distinctive feature is that transactions are added to the database sequentially, with approval of each new block entailing confirmation of previous blocks, and the use of encryption to make it extremely difficult to change earlier entries.
- For many applications (for instance, tracking the movement of goods) the system is "permissioned", meaning that access and/or rights are in some way limited, and authority to introduce and confirm changes restricted to particular users.
- Cryptocurrencies are generally "permissionless", meaning that access to the database is fully public; this requires particular measures to ensure trust in the database and avoid "double-spending" of holdings.

### Cryptographic Protection and Keys
- Protection against tampering in cryptocurrencies rests on cryptographic methods that enable private information to be encrypted in such a way that its accuracy can be verified without revealing that information itself.103
- Users have a private key (or "address") that is encrypted into a public key that is known to all users, but from which it cannot be inferred.
- Details of a proposed transaction, along with the public key, are broadcast to all participants; the accuracy of that information and availability of the necessary coins is easily checked.
- Footnote detail: "This rests on the use of non-invertible ‘hash’ functions which map a number or text of arbitrary length into a unique number from which it cannot be inferred."103

### Validation Mechanisms: Proof of Work and Proof of Stake
- Validation (addition to the chain) is made costly to deter tampering and double spending; this costliness requires some reward for validators.
- Proof of work:
  - Validators ("miners") compete to solve—more accurately, guess a solution to—a complex numerical problem, requiring extensive computing power, in return for which they receive an allocation of the cryptocurrency and/or a fee.
- Proof of stake:
  - The task of verification is allocated probabilistically in proportion to an amount of crypto that is staked; the reward for such validation is again some amount of the cryptocurrency, with a loss of stake in the event of failure or misrepresentation.
- Once confirmed by these mechanisms, the new block is added to the chain.

### Stablecoins and Wallets
- Stablecoins, being backed or with their supply controlled algorithmically, do not require verification in this way (i.e., costly mining/validation mechanisms).
- Private keys, from which public addresses are derived by encryption, are held in electronic/digital wallets, which may be held offline ("cold") or by service providers.
- Service-provider wallet roles:
  - Custodians: take control of the key, executing trades at the customer’s request.
  - Security providers: simply provide security without taking control of the key.

### Notable textual footnote
- Many subtleties are skimmed over here; for more detail, see for instance Hallaburda et al. (2022) and Box 8-2 of Council of Economic Advisers (2023).102

*Annex I. The Mechanics of Cryptocurrencies — Taxing Cryptocurrencies, Working Paper No. WP/2023/144*

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_Source: https://www.imf.org/-/media/files/publications/wp/2023/english/wpiea2023144-print-pdf.pdf_