Tax havens: A macro outlook at Bitcoin and how it could facilitate offshore banking services

Bitcoin. The word means many different things to many different people. As the world’s first and foremost decentralized digital currency, Bitcoin attempts to throw a wrench into the traditional monetary system. Here we will discuss the possibility that parallels exist between traditional tax havens used by the wealthy and cryptocurrencies like Bitcoin.

Estimates on the high side claim that the amount of money held offshore is anywhere from $20-30 trillion, and that up to 10% of the world’s GDP is parked offshore. It can be said that the most wealthy individuals have already had access to this form of secrecy and privacy for years. Approximately 80% of offshore wealth belongs to the top 0.1% richest households and about 50% to the top 0.01%. In order to get access to these tax havens typically you needed a minimum amount of assets to invest ranging from $1-10 million.

Now, however, cryptocurrencies like Bitcoin may offer an opportunity to ordinary citizens who normally could not afford this luxury. A study found no sufficient evidence that exchange programs or pressure on financial institutions reduce tax evasion, and that investors may even turn to cryptocurrencies like Bitcoin, and this is precisely what we will put to the test.

Tax havens: What are they?

For our purposes, one must define what tax havens are. According to the OECD, tax havens have the following four attributes:

1. No or low effective tax rates. 
2. No need to generate substantial economic activity in the location to gain tax benefits. 
3. Lack of mandated transparency with regards to customer details and other lenient laws that govern financial dealings. 
4. A lack of exchange of information.

Typically, tax havens cater to wealthy individuals or corporations and offer a variety of different financial services. They boast “little or no taxes” as well as privacy about the ownership of assets or wealth through the use of anonymous “shell” corporations. The shell company essentially only exists on paper and its sole purpose is to enjoy the tax benefits of that particular jurisdiction. Multinational companies will use this exploit to record their profits somewhere tax-friendly and then shift their costs to the higher-taxed location where the company actually physically resides. 

When we think of tax havens the first thing that usually comes to mind is illicit activity, but there are other reasons investors consider leaving funds offshore. Some of the most active users are well-known financial institutions. An IMF paper in July 2010 estimated that by 2007, the seven largest players in market at the time: Lehman Brothers, Bear Stearns, Morgan Stanley, Goldman Sachs, Merrill/BoA, Citigroup, and JPMorgan, had shifted $4.5 trillion of their balances in this way. A study by Jim Omartian, a professor at the University of Michigan, provides us with a couple legal purposes, “For Investors residing in countries with weak property rights, using an offshore entity may prevent government expropriation. Investors buying property or acquiring a firm may want to conceal their identity from the counterpart for an edge in negotiations.”

Why money might leave tax havens for Bitcoin

Omartian found that secrecy was also extremely important to investors when considering tax havens. “When investors lose confidence in their bank as a supportive partner in crime, they are less likely to use offshore entities — as evidenced by fewer incorporations and increased closures.” Once UBS declared in 2009 an agreement to release account information on American citizens who held accounts there, the closure rate of Swiss bank accounts increased by 33.8%. This shows how even though this only affected Americans, it shook faith in Swiss bank accounts globally.

Some recent tax evasion studies found that when one tax evasion method becomes difficult, it is simply replaced. As tax haven loopholes keep being discovered and closed, encryption and decentralized networks like bitcoin may become the most efficient alternative. 

Regulatory Crackdown

At the same time, every year some jurisdictions introduce stricter KYC/AML laws, and we've seen the advent of compliance guidelines like FACTA, EUSD, and AEOI. Under Automatic Exchange of Information (AEOI), for example, both Switzerland and EU countries automatically exchange their respective residents' account information. 

The EU continues to apply pressure to jurisdictions with especially favorable tax laws. In 2017, the EU published a list of non-cooperative tax jurisdictions. 47 jurisdictions were initially put on a watchlist to apply pressure for reforms and currently there are 11 jurisdictions “blacklisted”. Countries who have not complied and are blacklisted cannot receive EU funding and are subject to sanctions. 

Notorious offshore UK tax havens including Jersey, Guernsey and the Isle of Man are also reforming their systems where it will be required for companies to publish the real owners on a public database by 2023.

Hong Kong

Shaken faith in tax havens in Switzerland and the EU represents an opportunity for Asia-Pacific jurisdictions, such as Hong Kong, to vie for a share of the money leaving Swiss banks and other European jurisdictions. During the 2008 financial crisis, Switzerland accounted for approximately 50% of the money flowing through tax havens, which has now decreased to about 25%. During the same time period, from 2010 to 2016, Hong Kong experienced growth of 125% and became the fourth-largest internal wealth management centre. 

In 2017, Hong Kong was added to the EU’s watchlist and due to pressure the government has agreed to reforms. Part of the agreement is applying the same standards as their European counterparts around account information exchange through (AEOI), and new transfer pricing rules. 

Accountability and transparency on the rise presents an existential problem for tax havens, as privacy is often seen as their single most important element. Switching to an alternative like Bitcoin may be a way to regain privacy. The U.S. Senate found that 90% of the wealth held by U.S. citizens at UBS and Credit Suisse was undeclared. We see similar statistics in Switzerland where a study found 90% wealth owned by Europeans in Swiss banks was also undeclared. 

The looming crisis in Italy and Tax Evasion

Italy’s current debt crisis and issues balancing the budget offers us an interesting case study. Recently, the Italian government has entertained issuing more public debt through “mini-BOTs”, which would be short-term, interest-free government securities to be used as an internal currency. The government has even proposed taxing cash and other valuables held in safety deposit boxes.

Tax evasion has been a longstanding issue for the Italians where it is estimated that its shadow economy may account for nearly one-third of its gross domestic product. Taxes have been dodged though false expense claims, value added tax (VAT) avoidance, and international tax havens. In March of 2017, it was estimated that tax evasion in Italy is worth 110 billion euros a year, that breaks down as the following:

While cryptocurrencies like Bitcoin cannot fill all of these needs, some parallels certainly exist, and it could play an increasing role in the region as changes to Italy's political and economic landscape continue to unfold.

Autocracies already recognize Bitcoin’s ability as a tax haven

Traditionally, escaping capital controls has been a major use-case of offshore banking. In Argentina, the government has been cracking down on Bitcoin mining, as police monitor power consumption in an attempt to uncover miners. Venezuela requires Bitcoin miners to join an online registry to keep the government apprised on what they are doing. Russia drafted a law that allowed the trading of cryptocurrencies, but it will have to take place though specialized “exchange offices.” Through these exchanges, private keys will not be provided, meaning users can't have actual ownership of the their coins. These examples indicate that Venezuela and Russia consider Bitcoin a potential threat.

Another example is China, where in September of 2017 there was a government crackdown on major cryptocurrency exchanges. Authorities were concerned Bitcoin was be being used to bypass Chinese capital controls. Immediately after, some central exchanges began to close down. However, volume hit all-time highs, rising from about $80 million to approximately $371 million in a matter of weeks, on a platform that didn’t require KYC. We can conclude that this was likely not an outlier as during similar situations in China volume has skyrocketed. This doesn’t tell us specifically that Bitcoin is being used to escape capital controls, but it shows us that Bitcoin activity did pick up and increase by about 363% immediately following crackdowns by the PBoC.

The monitoring of Bitcoin by Argentina, Russia, and China makes sense, as they are some of the most active users of offshore banking. It is estimated that Russia stores over 45% of its wealth offshore. As you can see in the chart provided below, Venezuela currently stores over 60% of its current GDP in these havens. With China, an ICJ leak revealed how over 22,000 Chinese citizens were storing wealth overseas. It is estimated that China has transferred $1-4 trillion worth of untraced assets since 2000. A recent study found that the Chinese do not really use tax havens to conceal wealth, but rather to “circumvent a number of regulations that restrict cross-border investments in and out of China.” This is also represented by how investing outside of China rose from 19% in 2011 to 56% in 2016.

Source: IMF

Can cryptocurrencies like Bitcoin capture some of offshore banking services market?

Given the shear volume of funds we're talking about, it seems doubtful that Bitcoin can capture all of the money currently kept in tax havens. Offshore banking provides services beyond simply concealing ownership of assets. For example, corporations can use transfer pricing to book their profits in the lower-taxed jurisdiction, essentially paying little or no taxes.

On the other hand, there seems to be sufficient evidence that tax havens are also used by individuals who live in autocracies or places where property rights are shaky. Cryptocurrencies like Bitcoin can also offer an alternative to residents of countries like Italy, if it does decide to move forward with taxing cash and other valuable possessions. This is certainly a case where Bitcoin can find a use and it seems likely that it will tap into this market, if it is not already doing so. It seems inevitable, and a matter of when, not if, a non-insignificant percentage of the wealth held in tax havens begins to flow into Bitcoin and the cryptocurrency economy.