Crypto 101: What Tax Authorities Need to Know about Cryptocurrency
As cryptocurrency continues to evolve and gain adoption, tax authorities are under increasing pressure to understand the technologies behind it—and how to enforce compliance. This blog is part of IVIX’s series on "Crypto 101," and today’s post provides an overview of the main concepts authorities need to understand. This blog is tailored for public-sector professionals seeking to make sense of blockchain, digital assets, and the growing ecosystem of crypto-related activity.
Starting with the Basics: What Is a Blockchain?
At its core, a blockchain is a decentralized, cryptographically secured ledger maintained by a network of computers, or nodes. These nodes work together, following a consensus protocol, to verify and add new transactions to the ledger. Every transaction becomes part of a block, and once validated, that block is added to the chain—creating an immutable public record.
What are the Main Types of Digital Assets?
Digital assets are diverse and expanding rapidly. Here are the key terms for tax authorities to understand:
- Cryptocurrencies: Decentralized, peer-to-peer currencies like bitcoin or Ether. (The Bitcoin blockchain is “B”, while the currency itself is “bitcoin” with a “b.” Ether is the native currency of the Ethereum blockchain.)
- Native Currency: The primary token of a blockchain (e.g., ETH on Ethereum).
- Tokens: Digital units issued on top of a blockchain platform. Tokens are created via code and can have conditions imposed on their use and ownership.
- Stablecoins: Tokens pegged to real-world currency or other assets for price stability. Many stablecoins are reserve backed stablecoins, issued by entities that hold reserves to back the value.
- NFTs (Non-Fungible Tokens): Unique tokens representing digital collectibles or rights to a real world asset. While fungible assets like bitcoin or dollars are interchangeable, non-fungible assets are one-of-a-kind and not interchangeable. The NFT represents ownership or proof of authenticity for a specific item—usually digital content like art, music, video clips, or collectibles.
- Tokenized Securities & Real Estate: Blockchain-based versions of stocks, bonds, and property ownership.
- DeFi Assets: Instruments used in decentralized finance, such as lending protocols or yield farming.
- Environmental Assets: Like carbon credits, tokenized and traded on-chain.
- CBDCs: Central Bank Digital Currencies—state-backed digital money, not cryptocurrency. CBDCs are digital forms of a country’s official currency issued and backed by its central bank—like the Federal Reserve (U.S.), European Central Bank, or the Bank of England.
It’s important to note that according to the IRS, digital assets are treated as property, not currency. This includes cryptocurrencies, stablecoins, and NFTs. Convertible virtual currencies, the term adopted by the IRS, are subject to taxation when used, sold, or traded. In short, any use of crypto that results in gain or exchange triggers a potential tax event.
What is a Crypto Wallet?
Wallets are a key concept in crypto. Wallets don’t store cryptocurrency directly—they store the keys to access it, specifically the public and private keys. There are two main types of wallets used: custodial wallets, which are managed by exchanges or service providers, and non-custodial (un-hosted) wallets, which are controlled solely by the individual(s). The lack of a central authority in non-custodial wallets adds complexity for regulators and tax investigators.
The Role of VASPs in Crypto
Virtual Asset Service Providers (VASPs) are the institutions and platforms enabling the crypto economy. They facilitate the exchange, custody, transfer, or issuance of digital assets like cryptocurrencies. They play a central role in the digital asset ecosystem and are often the main points where users interact with crypto in a way that can be visible to regulators and law enforcement. Types of VASPs include:
- Crypto centralized exchanges
- Custodial services
- OTC desks
- Decentralized exchanges (DEXs)
- Bitcoin ATMs
- Investment funds
- Mixing services (used for anonymizing funds)
Because VASPs are the primary bridges between the traditional financial system and the crypto world, reporting from VASPs is essential for providing insights to authorities.
How a Crypto Transaction Works
A crypto transaction is conducted via several steps. First, Person A initiates a transaction to send crypto to Person B’s crypto address (public key). Next, the network approves the transaction. Once approved, it gets bundled into a block. This block is then validated and added to the chain. Once added to the blockchain, the transaction is completed and recorded publicly.
This all happens in a decentralized manner, outside traditional banking infrastructure, which creates both transparency and enforcement challenges.
Transparency Challenges of Crypto Transactions
While blockchains are public ledgers, that transparency is often contextually obscured.
- Pseudonymity Instead of Anonymity: Transactions are tied to wallet addresses, not names or tax IDs. Without linking a wallet to a known individual or entity, the data remains informational but not actionable.
- Obfuscation Tactics: Users can intentionally disguise transactions using mixers (tumblers), which combine and mix funds from multiple users to hide origin and/or destination, privacy coins (e.g., Monero, Zcash), as well as chain hopping, which involves going from one blockchain and token to create a break in visibility.
- Smart Contract Complexity: On platforms like Ethereum, transactions may occur between smart contracts, not people. Internal contract-to-contract transfers can be hidden in seemingly unrelated activity, complicating tracing.
Enforcement Challenges for Tax Authorities
Even when activity is visible, acting on it legally and operationally can pose major hurdles, starting with ownership attribution. The biggest challenge is identifying who controls or owns the crypto sitting at a given wallet address. Without data from exchanges, VASPs, or off-chain metadata, enforcement efforts often hit a dead end. In addition, many crypto actors operate across borders or in jurisdictions with loose regulations or no reporting obligations. Another major challenge is the sheer volume of raw data contained in the blockchain. Without automation or advanced analytics, it's difficult for tax authorities to prioritize or contextualize what they’re seeing. This, combined with the 24/7, global nature of crypto means that traditional audit workflows and manual enforcement can’t keep pace with the speed of digital asset movement.
IVIX Crypto Leads: OSINT in Action
To help tax authorities uncover hidden crypto activity, IVIX leverages open-source intelligence (OSINT) to:
- Detect revenue-generating behavior on-chain
- Match public activity to taxpayer identities
- Surface high-impact cases of potential noncompliance
As crypto becomes more deeply embedded in global financial activity, tools like IVIX enable tax authorities to stay ahead—bringing visibility, accuracy, and scale to crypto-related tax enforcement.
Final Thoughts
Cryptocurrency is far past being a fringe technology —it’s an evolving financial infrastructure with global implications. For tax authorities, understanding the basics is just the beginning. By combining regulatory clarity, modern investigative techniques, and tools like IVIX, governments can adapt to this new reality and close the compliance gap in the digital age.
Learn more about AI-driven tax compliance at IVIX.ai
