Member-only story
Why Sophisticated Crypto Investors Don’t Care if the Market Tanks
They’ll make money — and pay $0 in taxes — either way
Crypto has had a wild ride lately. Over the last six months, Bitcoin plummeted by nearly half, erasing billions of dollars of market value. Many sophisticated crypto investors, though, likely don’t care at all. Why? These crypto whales use a special kind of financial alchemy to achieve massive profits even if the crypto markets tank. And they do it all without paying taxes. It’s totally legal (for now anyway), and is driven by a loophole that’s hiding in plain sight.
To understand how their process works, we need to look at Defi, tax policy, and the weird dynamics that drive crypto markets.
Selling Coca Cola
Imagine that an investor buys a traditional stock, like Coca-Cola. The company then has a bad quarter, and its share price goes down. Our investor sells her shares at a loss. On her taxes, our investor can then take a deduction for her capital loss. (Just a reminder — this article isn’t intended to provide tax or investment advice, and you should consult a professional advisor for advice on your own tax and investment situation.)
Basically, she can use her investing loss on Coca-Cola stock to offset any investment gains she’s made elsewhere in her portfolio or even some of the income she earned from her job. Allowing deductions for capital losses is a way that the IRS eases the blow of financial losses for investors.
What our investor can’t do, though, is buy Coca-Cola, sell it at a loss, claim the loss on her taxes, and then immediately buy Coca-Cola stock again. That’s called a “wash sale,” and it’s against the rules. For most traditional securities, investors need to wait 30 days after selling shares before they can buy them again, or they risk losing their tax deduction.
The wash sale rule makes sense. Without it, investors would be constantly selling their stocks and buying them again, eking out tax deductions when the market dropped without really exiting their investment. Sure, they’d part with their Coca-Cola stock for a few minutes each time the market went down. But they’d immediately buy those same shares back, so it would be like they never parted…
