Bitcoin. The word means many different things to many different people. As the world’s first and foremost decentralized digital currency, Bitcoin throws a wrench into the traditional monetary system. This article discusses the possibility that parallels exist between traditional tax havens used by the wealthy and Bitcoin. This hopes to give the reader a better idea if it will be seen in the future as more of an alternative to the financial system altogether, or play a part in offshore banking services.
If Bitcoin is a viable utility for these services this will have an astronomical effect on its potential price and market cap. Estimates on the high side claim that the amount of money held offshore could be anywhere from $20 to $30 trillion dollars, and that up to 10% of the world’s GDP is held there. The purpose of this article is not to debate the legality or morality of these services. Rather, it is to be objective about a huge market that exists and likely isn’t going away soon. It isn’t going away, and in fact the likelihood that Bitcoin will penetrate into these markets increases as time goes on.
It can also be said that the .01% most wealthy have already had access to this form of secrecy and privacy for quite some time. About 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 amounts of assets to invest ranging from $1 to $10 million. Now, however, Bitcoin may open the playing field for ordinary citizens who normally could not afford this luxury. We won’t focus too much on this due to lack of data, but the fact that ordinary citizens are not effectively barred from entry into Bitcoin like in offshore banking makes it likely the potential market may be much larger than current estimates. In Omartian (2017) it concluded there is not sufficient evidence that exchange programs or pressure on financial institutions reduces tax evasion. “For instance, investors may move to anonymous currencies like Bitcoin.”
This is precisely what this article will put to the test. First and foremost, for the purpose of this article, one must define what offshore 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.
They typically 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. For example, multinational companies will use this exploit to record their profits there and then shift their costs to the higher taxed distract, the place where there company actually physically resides. Nicholas Shaxon in the book Treasure Island describes them nicely, “Tax havens provide escape routes from rules and laws elsewhere…The zero tax rates offered in the Cayman Islands, for example, are not designed for Caymanians but are set up to attract business of North and South Americans, Europeans, Asians, Middle Easterners, and Africans alike.”
When we think of tax havens the first thing that usually comes to mind is illicit activity. This certainly happens to an extent, but there are also other factors for why investors consider leaving funds offshore. Some of the most active users are well known financial institutions. Nicholas Shaxon in the book Treasure Island brings this to attention, “A little-noticed IMF paper in July 2010 estimated that by 2007 the seven largest players in the market — Lehman Brothers, Bear Stearns, Morgan Stanley, Goldman Sachs, Merrill/BoA, Citigroup, and JPMorgan — had shifted $4.5 trillion of their balance in this way.” Omartian (2017) 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.”
There seems to be a reasonable amount of factors that may contribute to money leaving tax havens and going into Bitcoin. Omartian (2017) 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 the faith in Swiss bank accounts globally.
Some recent tax evasion studies found that when one tax evasion method becomes difficult, it is simply supplanted by another alternative. As data collection improves and more leaks like the Panama Papers continue, there will be no alternative but to turn to encryption and decentralized networks like bitcoin for true privacy. At the time of the leak, Mossack Fonseca was the world’s fourth biggest provider of offshore financial services. Governments continue to crack down on these havens through stricter laws and regulations pertaining to the sharing of information on who is in ownership of these offshore entities between each other.
At the same time, every year there are stricter KYC/AML laws in some jurisdiction and there’s been the introduction of FACTA, EUSD, and AEOI. For example under Automatic Exchange of Information (AEOI): both Switzerland and EU countries will automatically exchange information on the financial accounts of each other’s residents. This will begin in 2018 and can have big repercussions for tax havens as a whole, as it is estimated that Switzerland is the sole holder of 30 to 50% of wealth held offshore. Accountability and transparency is on the rise relating to tax havens where privacy is seen as often the most important element. Two U.S. Senate (2008, 2014) 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 Zucman (2014) and Roussille (2015) found 90% wealth owned by Europeans in Swiss banks was undeclared. As these leaks and legal crackdowns intensify, switching to alternatives like Bitcoin may be the best alternative to regain privacy in the practical sense as well as technological. There seems to be some validity to the theory that Bitcoin could be used to escape capital controls in places ruled by autocracies. This has traditionally been a major use-case of offshore banking.
Autocracies already recognize Bitcoin’s ability as a tax haven. In Argentina, the government has been cracking down on Bitcoin mining, as police monitor power consumption in an attempt to uncover who may be mining the currency. Venezuela requires Bitcoin miners to join an online registry to keep the government appraised on what they are doing. This gives the indication that Venezuela does consider Bitcoin a current threat or at the least a potential one. Russia has just drafted a law that would allow the trading of cryptocurrencies on exchanges but there is one giant catch. The trading will take place though specialized “exchange offices.” Through these exchanges private keys will not be provided. This means that they won’t have actual ownership of their coins the exchange does. Unfortunately for Russia, these laws and regulations aren’t really enforceable as there a magnitude of ways to bypass this. This only adds legitimacy to the narrative that Russia sees Bitcoin as a threat since they will not allow their citizens to have direct ownership of their private keys.
Another example brings us to China, where in September of 2017 there was a crackdown by the government 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 began to pick up significantly in China on platforms that didn’t require KYC. Volume on China’s LocalBitcoins hit an all-time trading volume record. We can conclude that this was likely not an outlier as during similar situations in China volume has skyrocketed. As you can see here that when the PBoC cracked down on exchanges there is a giant spike in volume. 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 immediately following crackdowns.
It is rather ironic that these three nations Argentina, Russia, and China see Bitcoin as a threat. They would know best since they are some of the most active users of offshore banking and or autocracies. It is estimated that Russia’s households store 60% of their wealth offshore. As you can see in the chart provided below, Venezuela currently stores over 60% of their current GDP in these havens. With China, an ICJ leak revealed how over 22,000 Chinese citizens were storing wealth oversees. China responded by trying to block access to the site. It is estimated that China has transferred 1$ to 4$ trillion dollars worth of untraced assets since 2000. Alstadsaetar and Johannesen and Zucman (2017) 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.” The irony here is the autocrats know best that Bitcoin can be useful here; however, they only want that ability to themselves.
It seems doubtful that Bitcoin can capture all the money currently in tax havens. Offshore banking provides services beyond just concealed ownership of assets. For example, corporations can use transfer pricing to book their profits in the lower tax jurisdiction, essentially paying little or no taxes. On the contrary, there seems to be sufficient evidence that tax havens are also used by individuals who live in autocracies or a district were property rights are shaky where there is a risk of their property being confiscated. 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. In the near future, it may become very possible to use Bitcoin on decentralized exchanges to buy a wide variety of tokenized securities and assets. Using this method, the buyer will be in complete control of the assets they are trading in an anonymous manner.
With decentralized exchanges, there will be no way to store information on the participants as the exchange itself does not hold or control that data. As public backlash, leaks, and political turmoil increase, it seems very likely that even the autocrats themselves may have to turn to alternatives like Bitcoin to conceal and keep their wealth, at the very least as a hedge. It seems inevitable and a matter of when not if that a percentage of the wealth held in tax havens begins to flow into Bitcoin and the cryptocurrency economy.
Thanks to armor123123 for the editorial help!
 Hines, James, Jr.(2004). “Do Tax Havens Flourish?” NBER Working Paper #10936.
 Errico, Luca and Alberto Musalem, “Offshore Banking: An Analysis of Micro-and Macro-Prudential Issues,” IMF Working Paper WP/99/5, IMF, January 1999.
 Alstadsæter, Annette and Niels Johannesen and Gabriel Zucman (2017), “Who Owns the Wealth in Tax Havens? Macro Evidence and Implications for Global Inequality” NBER Working Paper #23085.
 Omartian, Jim, Do Banks Aid and Abet Asset Concealment: Evidence from the Panama Papers (October 23, 2017). Available at SSRN: https://ssrn.com/abstract=2836635 or http://dx.doi.org/10.2139/ssrn.2836635
 “Treasure Islands: Uncovering the Damage of Offshore Banking and Tax Havens.” Treasure Islands: Uncovering the Damage of Offshore Banking and Tax Havens, by Nicholas Shaxson, Palgrave Macmillan, 2012, pp. 6–7, 68.