Why Crypto Needs an Automated Tax Management System
And How It Might Work
Blockchain infrastructure should make it easier to handle taxes. Not harder. In the current state, transactions are difficult to manage, and the accounting is cumbersome.
Every year, I dread having to calculate my profits/losses from transactions. Calculating fees from wallets, exchange transactions, profits, and losses can easily take up a whole day. And I have to organize it super simple so that my accountant knows what happened.
I’m not the only one who has this problem.
Everyone I know complains about the same issue. And I’m one of the fortunate ones. People doing yield farming have it even worse because everything is happening on defi-exchanges.
I’ve written about a scenario involving Bob (fictional) for the last two days and how he got hammered by the upcoming NFT crash caused by long-term capital gains taxes for collectibles. One possible solution to this problem is to create an automated method for tax allocation from crypto transactions.
Here’s how it could work in the realm of NFTs:
Sally airdrops an NFT into Bob’s wallet. At some point, Tom makes an offer to Bob for the NFT. Bob agrees, and they execute a trade. A smart contract monitors Bob’s wallet. For now, I will assume ERC-20.
The smart contract contains two oracles.
The first oracle queries a digital identity protocol that contains metadata with Bob’s private information such as country of residence, state, tax ID, etc.
The second oracle uses Bob’s private information to query a government database containing Bob’s prior year income.
When the network mines the block executing the sale between Bob and Tom, the smart contract calculates Bob’s short/long term capital gains tax based on a combination of the length of time Bob held the asset in his wallet and his prior year income. A government-controlled cold wallet address receives a portion of the proceeds from the sale. The smart contract creates a transaction hash linking the trade between Bob and Tom to the funds distributed to the government-controlled wallet.
The transaction hash contains meta-data proving that Bob made the tax payment.
When Bob files his taxes, he may be entitled to a return in the event of an overpayment. Upon submitting his tax return via smart contract, a hot wallet controlled by the government releases excess into Bob’s address from which he initiated the transaction. If Bob no longer has access to the address, he can include a new address on the return filing.
This system has a few benefits.
This system prevents Bob from spending or losing funds which he needs to pay his taxes. Additionally, it reduces the headache he would have had otherwise in preparing his tax documentation. And it incentivizes the government to fund infrastructure development.
Some would argue that such a system “isn’t crypto.”
To that, I say if you think governments won’t eventually become a major ecosystem player… Wake up, dude!
Thanks for reading!
All the best,
Roy Naquin
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