How the Infrastructure Bill Will Affect Cryptocurrency Miners

How the Infrastructure Bill Will Affect Cryptocurrency Miners

On November 12, 2021, the House of Representatives passed the $1.2 trillion Infrastructure Investment and Jobs Act (the “Act”), forwarding it to President Biden’s desk to be signed into law.^[1] To help fund such a massive project, Section 80603, added to the Act last July by the Senate with the stated purpose of closing the crypto tax gap, potentially imposes significant requirements on cryptocurrency miners that run counter to many of the core features of blockchain.^[2]

To best assess the impacts of Section 80603 on the crypto community, an understanding of the key features of a blockchain and how it functions is helpful. In essence, a blockchain is a database that maintains a decentralized, pseudonymous record of transactions between parties.^[3] Such transactions are stored in “blocks” that are recorded chronologically and linked to other blocks in the order in which they have been mined forming a “chain.”^[4] Blockchains are considered to be decentralized as no one person or entity controls the database and no one server hosts the database.^[5] Furthermore, blockchains are pseudonymous because parties in the recorded transactions are identifiable only through their public key — a long string of alphanumeric characters that serve as the address for the account which holds a person’s currency.^[6] On most blockchains, the public keys of the parties along with the amount of cryptocurrency transacted between the two are visible on the record.^[7]

On the surface, cryptocurrency transactions on blockchains operate in a similar way to centralized digital money transfers on services such as PayPal, Venmo, Cash App, etc.^[8] One party accesses their account and sends X quantity of currency to or requests X quantity of currency from another’s public key, in which that person then accesses their account and accepts or sends the X quantity of currency, respectively. ^[9] Once accepted or sent, the transaction is sent to all the computers connected to the blockchain network to be mined. ^[10] Miners check the transaction to ensure the sending party has the funds to execute it and then place it in a block which they then mine to the chain.^[11] To incentivize miners’ verification and mining efforts, which depending on the consensus mechanism that particular blockchain utilizes could require them to expend large amounts of computing power, they are compensated a base fee proportional to the size of the transaction and in some blockchains, such as Bitcoin, are offered a reward for mining the block.^[12]

Now how does the infrastructure bill impact the features of a blockchain and the transactional framework mentioned above? The current Internal Revenue Code requires “every person doing business as a broker” to make returns reporting to the IRS information such as the name and address of their clients.^[13] The term broker includes “a dealer, a barter exchange, and any other person who (for a consideration) regularly acts as a middleman with respect to property or services.”^[14] Currently, such reporting is limited to brokerage work related to sales of corporate stock, interests in trusts and partnerships, debt obligations, certain commodities and certain associated derivatives.^[15] Furthermore, for “covered securities” which include corporate stock shares, debt obligations, commodities, and certain financial instruments, the law imposes an additional reporting requirement involving disclosure of the client’s “adjusted basis in such security and whether any gain or loss with respect to such security is long-term or short term”^[16]

Section 80603 of the Act, which is estimated to generate $28 billion in crypto taxes, broadens the definition of broker in the Internal Revenue Code to also include “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.”^[17] Furthermore, the Act states “[e]xcept as otherwise provided by the Secretary, the term ‘digital asset’ means any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary.”^[18] Finally, the Act would expand the definition of “covered security” to also include “digital assets.”^[19]

Section 80603 almost certainly imposes reporting requirements to centralized cryptocurrency exchanges, such as Coinbase, Kraken, Gemini, etc., which already have consumer information such as names, billing addresses, and social securities. However, if this definition of “broker” is read broadly the term could also encompass miners since they are “effectuating transfers of digital assets on behalf of another person” by validating transactions, storing them in blocks, and mining them to the blockchain. This broad reading would mandate miners to disclose the identities behind the public keys of all the transactions they validate and mine. Additionally, considering “digital assets” would fall under the umbrella of “covered securities” miners would also be forced to disclose the adjusted basis and the character of the gain or loss of the sale of the digital asset.

Not only would this force miners to undergo costly and time-consuming practices it would contradict some of the core features and appeal of blockchain itself and pose significant challenges. If miners are required to report the identifies of the parties behind the transactions they validate and mine it would contradict blockchain’s pseudonymous nature. Further, how would miners know whose transactions they are mining? This could possibly force consumers to register with certain miners and those miners would only validate transactions on behalf of their registered users.^[20] But, then again, there are complications if two consumers registered with different miners wanted to transact with each other. This could lead to many users registering with individual miners and further concentrating, the already highly-concentrated mining landscape for certain blockchains. Such concentration in mining power would go against the grain of another core feature of blockchain – centralization. If only a few entities control all mining operations, then a small set of people would have ultimate control over what transactions can be confirmed. This could potentially compromise blockchain’s peer to peer system in which anyone could access and participate in the blockchain network.

Although such legislation could be a serious blow to the crypto industry in the United States it is possible that such catastrophic effects may not materialize as it is ultimately up to the Secretary of Treasury and the Treasury Department to interpret Section 80603.^[21] Favorably for the crypto industry, reports out of the Treasury Department hint that the Department will not target non-brokers, such as miners, and only focus the reporting requirements on crypto exchanges.^[22]