Like any major innovation, blockchains have introduced a lot of new jargon, much of which has an overlap with existing words that creates confusion and misunderstanding. One of the common assumptions within the cryptocurrency community is that taxes only come into play when you sell a token for a fiat currency of some country, based on the common ruling that these tokens are a commodity, or tradable property, and so are subject to capital gains taxes. Since names are not associated with the wallets that hold these virtual coins, many individuals feel that taxation can be ignored.

However, there are two conditions that make ignoring the whole subject a bad idea: professional traders and miners’ revenue. “Professional traders” means someone whose primary activity is in the area of financial trading, whether it be in stocks, pork bellies, or bitcoin. These people are treated like businesses, and have to keep track of their cost basis and file detailed returns at the end of the year. Miner’s revenue is simply taxed at the market value at the time of their production (as well as being subject to capital gains when sold).[1,2]

What does that have to do with the Markets?

Several months ago, I noticed what I though looked like a trend in the relationship between bitcoin’s market share of the total cryptocurrency market, and the rest of the ‘alt-coins’. Everyone agrees that bitcoins’ dominance shrinks over time as many new blockchain tokens are added to the market, but the chart also reveals 3 drastic periodic fluctuations where the alt-coin share spikes, and then returns back to the normal slope after some time.

Bitcoin Percentage of Total Market Capitalization — Source: http://coinmarketcap.com / http://highcharts.com

While there is enough variation in the onset, peak, and duration to obscure the trend, it was enough to motivate a follow-up look in 2017. If it was a valid trend, then we should see a repeat near March, extending the dip in Bitcoin’s (BTC) market share down to at least the 70% range.

So, when the 4th dip did happen this month, the elephant in the room blared its trumpet: what is causing this?

Bitcoin Percentage of Total Market Capitalization — Source: http://coinmarketcap.com / http://highcharts.com

Let’s review some facts that are relevant to answering that question.

As shown above, the first important fact is that BTC dominates the industry in volume, price, and so-called “market cap”.[3] So the answer should also be dominated by that token.

Next, we find that 90% of the trading, and 70% of the mining are done in China.[4,5,6] So the answer must also have its roots in China.

Finally, we need a cause that would apply to everyone, at the same time of year. It’s no surprise then that we look to the annual tax filing, which in China, must be done before March 31st.[2] Since this is very close the the April 15th deadline in the US (and similar dates in many countries), large players there will also contribute to this trend.

While mining operations do have to sell some of their mined tokens to cover monthly expenses, it’s the end of the year where the totals add up. Combine this with the professional traders also filing at this time, and you get a serious market movement like we see in the charts above.

The total BTC mining & transaction revenue for 2016 was ~$562,000,000 [7] (70% of that — around $393,400,000 — went to Chinese miners). So 15–30% income taxes on that would move $84,000,000–$168,000,000 into the legal tender of the taxing authority of the miners.

If you bought 1 BTC on Jan. 1, 2016, and sold on Dec. 31, 2016, where the price rose from $435 to $960, you’d have a profit of $525 subject to a 15% capital gains tax of $79.00. If that were applied to the whole token market, which went from $7.1 billion to $17.5 billion in 2016 [3], would mean a profit of $10.4 billion generating $1.5 billion in capital gains taxes.

If even a fraction of these numbers get pulled from the markets during tax season, they are more than enough to cause the trend every year of the severe dip in “bitcoin dominance” (the ratio of BTC to all Altcoins). I believe that the industry players understand this, and not only make trades into alts to maintain their BTC value, but also have figured out that it’s easy for them to profit on this activity, pumping alt prices up high and then selling, and getting back into BTC at a lower price, as the crowds are not aware of this, and wild speculation & FUD (fear, uncertainty, and doubt) run rampant in the community. In many countries, trading for another (stock) re-sets your cost basis anyway, so if you’ve moved into a handful of options, you can then select which ones you’d keep or sell based on how the market responded, and keep some in these alts as a hedge.

Loose ends:

What happened in 2015 that was so different (earlier onset, longer duration)? There’s quite a back story here regarding the loss of value in the CNY, and capital flight concerns. [8] Why is the rise in the alt-coin share so much higher this year than in past years? A few reasons. First, recent changes in regulation in China, including KYC style requirements that resulted in several Chinese exchanges putting a freeze on BTC (and Litecoin) withdrawals until March 15th.[9] Second, the other alt-coins were not subject to this limitation, so people could easily trade BTC for, say ETH or DASH, and then sell. This would seemingly only apply to foreign currencies (mainly the Dollar), as it was still possible to get CNY for BTC on their exchanges. This may amount to a grand experimental test to see how much capital flight is aided by bitcoin trading.[10] The all-time highs also contribute to this being a larger effect, and then also the fact that the ratio of market caps between BTC and Alts is not absolute — as the alt prices were pumped, and now BTC price is in decline, the ratio difference has continued to grow dramatically, though also on target for the projections. It’s not all based on value moving from one to the others. A probable loophole is that you can re-set your cost basis by trading one token for another, and then move back to the favored store of value (BTC) after you’ve filed. Remember, we have to explain the previous years’ trends too, and there was no such freeze on BTC withdrawals from the exchanges then. What will happen next? If previous years are repeated, this is a bubble for most alt-coins, and a correction will take place over the next couple weeks. Of course, the fundamentals will come back into play, and better projects will fare better and recover more quickly than others.

Combined Altcoin Market Capitalization — Source: http://coinmarketcap.com / http://highcharts.com — Red dots indicate the 4 dips in BTC market share in the charts above.

Post script

While the focus of this article is to highlight the annual trend, there are a couple points worth making about the current situation.

There are surely effects on the BTC market today regarding the pressure and ongoing debate over the state of that blockchain. Combined with the unfreezing date, which could be extended again, the trough could be extended considerably.

There is surely an amplification of the annual trend coming from day traders who study these charts carefully, and would take advantage of it.

This work is for educational purposes, and will hopefully inspire further study. It is not tax or investment advice. The views given here should be considered as educated speculation yet to be peer reviewed, and are not necessarily the views of organizations the author is affiliated with.

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References

[1] http://www.coindesk.com/irs-bitcoin-tax-guidelines-mean/

[2] https://home.kpmg.com/xx/en/home/insights/2011/12/china-income-tax.html

[3] http://coinmarketcap.com/

[4] https://www.bloomberg.com/news/articles/2016-07-06/after-4-400-surge-bitcoin-s-fate-hinges-on-huge-chinese-miners

[5] https://www.cryptocoinsnews.com/chinas-mining-dominance-good-or-bad-for-bitcoin/

[6] https://www.cryptocoinsnews.com/china-now-controls-bitcoin-thats-just-beginning/

[7] https://www.quandl.com/data/BCHAIN/MIREV-Bitcoin-Miners-Revenue

[8] http://www.zerohedge.com/news/2015-11-03/bitcoin-surges-1-year-highs-100-china-capital-controls-august-lows

[9] http://www.coindesk.com/china-btcc-exchange-halt-withdrawals/

[10] http://calvinayre.com/2017/02/17/business/btc-china-extends-bitcoin-withdrawal-freeze-march/

tl/dr: The filing & payment of annual tax returns by the biggest participants, which requires trades to local legal tender (fiat) to transact, causes large, predictable fluctuations in the market every year.