virtual currency

One more reason not to spend your bitcoin

March 26, 2014: 5:00 AM ET

The IRS on Tuesday said that bitcoin will be taxed like property, creating another hurdle for its widespread use as a currency.

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FORTUNE -- Be thankful he doesn't take it all, George Harrison advised us about the Taxman nearly 50 years ago.

Those words are cold comfort to bitcoin boosters, who learned Thursday that the IRS expects users of the virtual currency to report their bitcoin transactions and pay capital gains taxes on their holdings, just as they would on a stock or a bond. The problem for enthusiasts of the virtual currency is that not only will they have to give the Feds a chunk of whatever capital gains they realize on their bitcoin holdings, the taxation of bitcoin as a currency will also constitute a serious hurdle for its widespread use.

Bitcoin, by design, is deflationary. After the 21 millionth bitcoin is mined, no more will ever be created. This distinguishes it from both fiat currencies, like the dollar, and even gold, the supplies of which grow over time. The problem is that as the economy and productivity grow, bitcoin will naturally become more valuable, creating a psychological incentive for people to hold onto rather than spend their bitcoin. This doesn't disqualify bitcoin from being a widely used currency, but it is an impediment.

MORE: Gold vs. bitcoin: An apocalyptic showdown

And now that the IRS has officially said that it will tax it as property, there's just one more speed bump in the road to bitcoin's world domination. After all, taxpayers only have to cut the government in on their gains after they sell their assets, a stricture which happens to promote broadly beneficial behavior like long-term investing. It's not such a great tax treatment, however, for a young currency that many expect to steadily increase in value but is also trying to achieve widespread use as a currency. In other words, the capital gains tax is an incentive for bitcoin users to hold onto, rather then spend, their bitcoins.

And as I've written earlier, the IRS's tax treatment of bitcoin has embedded in it the irony that your bitcoin tax bill will be directly proportional to the dollar's inflation. And since fear of dollar inflation is one argument in support of the use of bitcoin, the taxman stands to benefit even if bitcoin enthusiasts turn out to be right.

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