Crypto Is About To Get Even Less Private

New proposed IRS reporting rule chips away at pseudonymity of cryptocurrency and paves the way for a wallet registry

The IRS issued a long awaited draft form 1099-DA last week. Normally we wouldn’t comment on tax issues, but this one has significant privacy implications for U.S. cryptocurrency holders.

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Backstory

Entities defined as “brokers” by the IRS are now required to generate a new form for each cryptocurrency sale transaction. This request starts January 1, 2025. “Broker” means any person who in exchange for a fee, regularly provides a service transferring a digital asset on behalf of someone else (paraphrased). The scope is broad and can include digital asset trading platforms, digital asset payment processors, and certain digital asset wallets.

Some of the data collected on the form is benign and not controversial. Primarily standard transaction details. If you’ve been paying your taxes on crypto sales, you’ll have little concern.

For a deeper dive on the details and tax implications of this form, see this post by

Big Dog 1111

What’s new is the form collects the following additional data with direct privacy implications:

1. Wallet addresses for both sides of the transaction

2. Transaction Hashes

3. Tax IDs of wallet owners

4. Whether the transaction involves an “unhosted wallet provider”

Collecting wallet addresses and Tax IDs of wallet owners is a significant change from current practice. It represents a substantial reduction in the pseudonymity of standard cryptocurrencies like Bitcoin and Ethereum.

To date, the IRS has not required the reporting of wallet address information when individuals or organizations report crypto tax data. Wallet addresses are a form of personal information since they are tied to a unique individual or entity. Requiring the disclosure of that information poses an obvious privacy risk.

Collecting wallet information and Tax IDs of wallet owners establishes a defacto crypto wallet registry. While standard cryptocurrencies are not anonymous or private, this development would severely undermine the pseudonymity of standard cryptocurrencies. It’s already possible for tech savy and determined individuals to identify the wallets of specific individuals. (source). As many of our readers probably know, the IRS has a history of leaking taxpayer information for political purposes. Or there’s a data breach like what happened to the U.S. Office of Personnel Management (OPM). (source) We should assume these scenarios will repeat once the IRS has access to a crypto wallet database.

Unhosted wallet providers are crypto wallets where the individual holds the private key. Unlike Coinbase, for example where Coinbase has the private key for your assets and effectively controls the funds (“not your keys, not your coins,” as the saying goes). Coinbase themselves, via quarterly filing, even admitted if the firm encounters financial hardship, it is possible that clients may not get all of their digital assets back (source). The typical unhosted wallet example is Metamask, which is a software wallet where an individual possess the private key.

Unhosted wallet providers are comparable to your at home piggy bank while hosted wallets like Coinbase are comparable to a bank account. The IRS could be indicating that they expect unhosted wallet providers like Metamask to comply with this reporting requirement. Which is like your piggy bank filing a report with the IRS every time you make a purchase with money withdrawn from the piggy bank. The idea is absurd and a massive privacy invasion. This will have to be flushed out in the upcoming public comment period on the new form.

What are the Privacy Implications?