FTA: Taxation: How do governments collect taxes on transactions in Bitcoin? The answer is they don't, and they can't.
Though many Bitcoin fans don't quite realize it, Bitcoin's radical transparency could in fact be a tax-collector's wet dream. Every public-key, balance, and transaction is public.
A government that wants to coopt and efficiently tax Bitcoin could announce the following policy, based on the idea of 'tainted' or 'clean' balances:
"You can make your Bitcoin legal inside our jurisdiction by registering your public keys. (No, we don't need your private keys.) All transactions between registered keys are great, just make sure they match up with your tax filings, because we can see the endpoints.
"You should not receive money to your registered address(es) from an unregistered address. If you do, you can file a disclosure with 30 days, identifying the origin and nature of the transaction, paying all applicable taxes, and then the balance is yours to keep."
"If you do not, the entire amount that's mixed with the unregistered-origin balance is subject to forfeit. Your registered keys with any such balance will be blacklisted, making your previously-registered balances unspendable until you come back into compliance."
Any above-ground business would then stick with clean balances. Both clean and tainted coins could circulate in the same blockchain, but rarely mix... and would have different de facto values. (Would a clean or dirty satoshi be worth more? I'm not sure!) Trying to buy above-ground things with dirty money would face the same 'laundering challenge' as today: making it look like legitimate income via front operations.
Except, the blockchain would be a perfect record of earlier related transactions. That means big-data traffic analysis, and occasional meatspace busts discovering the identities of unregistered keys, would create a very strong map of unsanctioned economic activity -- much better than is possible with physical cash.
It's even more simple than that: There's nothing about paper money that enables tax collection either. And yet somehow, taxes continue to exist.
Bitcoin is only a currency, not an entire financial system. It is a replacement for pieces of paper or shiny metal with doodles of George Washington stamped on them. It is not a replacement for banks, or credit cards, most other ephemera that people have constructed on top of currency. In point of fact, people are having to re-invent financial institutions in order to make Bitcoin more useful. And it's those institutions, not the underlying currency, where government attaches taxation.
It may become more feasible in the Bitcoin era to run a financial institution that plays entirely outside the US's jurisdiction. Nonetheless, there would be a large market for legitimized (and taxed) financial institutions, to provide services to the large number of entities that the government would take a hard look at anyways. My gut is that two parallel economies is an unstable situation, and the shadow-economy would not receive must traction compared to the legitimized one.
> My gut is that two parallel economies is an unstable situation
Parallel economies are not only inevitable, they can be long-term stable whenever you can't deal in some (desirable) goods in the legitimate economy. Black markets are very difficult to root out and always have been.
> the shadow-economy would not receive must traction compared to the legitimized one.
Depends on how essential the black market is to getting what people view as the essentials of life. In middle-class First World countries, it's pretty marginal, because most salarymen don't really want heroin that badly. In the 1970s Soviet Union, if you didn't trade on the black market you simply could not get certain goods Americans would regard as utterly mundane, such as bananas. The USSR had a horrible time with black markets and goods disappearing from store shelves and being hoarded in peoples' apartments.
This would, of course, lead to any individual, or entity, simply keeping 2 sets of keys. One legit, taxed, & one gray/untracked. That way, they could play either the clean or dirty markets.
But, they still couldn't launder, or cross between dirty & clean easily. They'd still need a collaborative cleaner in between... Such cleaners are easily built in the model you mention. (Out of country, with hands in both clean/dirty channels.)
They'd still need a collaborative cleaner in between... Such cleaners are easily built in the model you mention. (Out of country, with hands in both clean/dirty channels.)
Not really, the government could just say any out of country transfer needs to be done through a registered service. So if your aunt wants to give you money, has to go through "Bit Western Union" or whatever.
Shame, because then its destroying almost free transfers as well. Essentially nothing is gained, but the government can easily track everything.
Bitcoin is not, practically speaking, going to replace the dollar or euro. This ambition projected onto it by anarchist promoters and alarmist detractors does not have a practical base. Instead, it is competing to be the floating alternative currency of choice. The question of a state taxing on the basis of Bitcoin is thus mis-placed.
The best case for Bitcoin would be inheriting the transactional characteristics of cash, i.e. facilitating transactions that one wishes to keep anonymous (or at least pseudonymous), and asset characteristics of gold, i.e. a fixed supply store of value. It competes solidly as a lightweight and comparatively secure alternative to both.
>The best case for Bitcoin would be inheriting the transactional characteristics of cash, i.e. facilitating transactions that one wishes to keep anonymous (or at least pseudonymous), and asset characteristics of gold
It definitely already has the first, but whether its volatility reduces to a level comparable with national currencies remains to be seen.
Even if it never achieves relative price stability, it could still make a good global money transmission system. People will continue to save in national currencies, and just convert to BTC to send money overseas, or use buy other currencies with lower fees, or buy stuff from global BTC merchant sites.
Your client/wallet detects it and offers a pop-up with registration or forfeiture options. Up to a certain amount (per person, per year) you can probably just pay a small excise tax (less than 100% forfeiture) to 'clean' it. Larger amounts without explanation would mean a visit from the taxman or Justice Department, however.
Genuine question, what happens then? And would the IRS necessarily see these regular deposits as inherently dirty, or merely unknown? If I were to make structured payments over a long period of time, low enough that they were unnoticed each time, how much pleading of ignorance would it take before the IRS decided that the person really did not intend for that to happen?
And could not someone disposit dirty money into their own account and plead the same? Even if you have to forfiet the money (if you haven't already accidentally spent it...) simply holding on to money temporarily can be avantageous.
>And would the IRS necessarily see these regular deposits as inherently dirty, or merely unknown?
Well, the logical thing is that would be perceive those as potentially dirty and have an inquiry. They might act legally as thinking they are "merely unknown", but they would be suspect of them nonetheless.
>If I were to make structured payments over a long period of time, low enough that they were unnoticed each time, how much pleading of ignorance would it take before the IRS decided that the person really did not intend for that to happen?
Well, if that was the case, why didn't the person protest the sudden influx of money over that "long period of time"?
That law would fail because there's no way to prove the transaction didn't come from someone who wants to cause trouble for the registered person but whom the person doesn't actually know. Suppose you are angry at a merchant who takes bitcoin:
If it's money they're not expecting, no problem: they just declare and forfeit it to the tax authorities, like a bag of cocaine-drenched cash that was found in their store.
If it's money given to them in payment for goods/services, they reject it as non-legal tender. "I'm sorry, sir, we can't take that form of payment, do you have another?"
Wouldn't this open up the possibility of a DDoS-type attack performed by having millions of transactions of 1 satoshi (0.00000001 BTC) in dirty coins flung at the merchant by someone's botnet? It would force the merchant to reject each one at a computational cost, whether by giving the money back or by transferring it to the government.
Interesting problem, but I don't think it will actually be that big of an issue. The merchant could generate a new wallet for every customer, and simply "dump" any wallet under attack by said customer.
This must be why hackers never write these kind of polemics. If they take such a strong position on something like this, they end up seeing other perspectives which falsifies that position. They would have to tack on a "...Maybe" at the end of their title, rework their premise or otherwise end up sabotaging their article's readership.
public keys are only available after you make a transaction and usually the bitcoin clients create a new address for each new transaction such that the public key for the account which actually holds the coins is never revealed.
The constant generation of new balnace-holding addresses on demand, that are not typically shown to the user unless they dig, is an arbitrary choice of the Bitcoin-QT software, not a requirement of the protocol. In the protocol/blockchain, you can see every public key that has ever received any balance. You can have all your 'change' returned to a small set of pregenerated/registered addresses.
So the government just says, "Here, use one of these 12 wallet programs, they are certified as automatically compliant by the IRS. Using other software makes compliance your own headache."
again, that's not true.
Only addresses from which transfer have been made from have their public key revealed in the blockchain, until then, there is no need for it.
> How do governments collect taxes on transactions in Bitcoin? The answer is they don't, and they can't. Crypto-currency's strong protections on anonymity make it impossible for any state to know who is buying what, who is paying whom, who earns what, and who has what in savings.
BS! The state seems to be surviving just fine with its "inability" to track who is buying what with cash, and it could easily require and enforce documentation of large purchases (such as houses, cars, etc. as it already does btw).
> 2. Police:It would be almost impossible for states to detect certain crimes. One of the major alleged uses of Bitcoin -- though, of course, one can never truly know -- is buying illicit drugs.
Ohhhh noooo!! Cry me a river!!
You mean the batshit insane war on drugs that has destroyed countless lives will become even more ineffective than it already is?!? Please oh please, don't throw me into the briar patch!
Every one of these points applies equally to cash. Might as well write a second article titled: "Cash: An Existential threat to the modern liberal state"
BTW, there's nothing liberal about the war on drugs, the very existence of which is a cruel affront to basic human liberties.
> In a world where many transactions are anonymous, it’s unclear how governments could even compile accurate economic data, without which macroeconomic policy is impossible.
How exactly does having a public history of every transaction ever made somehow make it "impossible" to glean any useful economic data from it?
Add to it knowledge of certain transactions (such as those that go through companies), and you start to get a pretty clear picture of exactly what's going on.
>Can the government stop me from buying something with USD? Not a chance.
What? Of course they can. They can get a warrant and bust into your house and put you in jail if they have basis to believe you have bought something they think you shouldn't have (drugs, child porn, slaves, and tons of other things).
You're getting way off track here. The assertion was that the government is afraid that it can't stop you from spending bitcoins, the implication being that it can with cash. Bitcoin vs. USD doesn't solve your ability to purchase weaponized measles.
Generally I agree with you, but in some cases a government does interfere to limit, inhibit, discourage, or prevent purchasing to varying degrees. They make it very hard. Controlled substances for example.
They can even do it automatedly, such as freezing the ability to withdraw or deposit funds electronically.
Sure, but also notice how they never (in history) tried to control your dollars in such a manner.
If they had set their mind to do just that, I bet they would succeed. For one: forbid all cash, arrest at once anyone using or accepting it (or any self issued barter system) and only allow credit cards and e-money.
The right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated, etc., etc.
I'm not sure why that second sentence is there, it doesn't really make much sense. The rest of the point is valid, especially regarding money laundering.
There's a long list of prominent names being investigated or (not) prosecuted (basically scape-goating single employees): GS, Barclays, HSBC, UBS, Deutsche to name the most prominent ones.
And the (so far officially) biggest fish - Wachovia - and how this was (not) prosecuted, nobody really hold accountable, no (real) funds confiscated. A quick reminder on the size of that "business" (300 times bigger than Bitcoin even on the current blown-up total Bitcoin circulation):
"... Wachovia was fined $50m and made to surrender $110m in proven drug profits, but was shown to have inadequately monitored a staggering $376bn through the casa de cambio over four years, of which $10bn was in cash..."
All this is going on for decades. And please also don't forget: Like individuals or (private) companies, governments and politicians are using the same means to make illicit funds appear or disappear.
Your ISP "deliberately" routes child pornography over their networks all the time--that doesn't make them distributors of child pornography.
HSBC provides a banking service. Unlike with ISPs, they are responsible for overseeing how their service is used, to prevent money laundering. Failing to oversee the employees who failed to follow the regulations designed to prevent HSBC's service being used for money laundering is not the same thing as actually money laundering (juicy reporting aside).
HSBC knew what they were doing, that is things were explicitly illegal, and profited from that.
Who actually launders money then? Hint: it's not mobsters since their craft is illegal by itself and therefore no separate law for laundering would be needed.
> HSBC knew what they were doing, that is things were explicitly illegal, and profited from that.
The whole point is that the government couldn't prove that HSBC knew what was going on. The only thing they could prove was that the internal controls were broken (and that they knew they were broken and did nothing to fix it).
And yet, if it was some poor black kid caught on the wrong side of the tracks, the government/justice system could happily put his ass in jail despite them not being able to prove anything or him being innocent. As has happened time and again...
By and large, the government doesn't put poor black kids in jail without proof. A lot of my friends are public defenders working with these sorts of people, and by and large they commit the crimes they're accused of committing. The problem isn't that the government jails these people without proof, it's that you and I as voters, along with "just say no!" moms, etc, have continually voted for "tough on crime" laws that punish these people vastly out of proportion with what they did. But they did do it, and the police have proof because it's easy to prove "poor black kid" crimes. It's easy to prove it with evidence like "you tried to sell drugs to an undercover cop" or "we found the stolen car at your house."
With white collar crime the situation is different. Those laws make otherwise innocuous acts and omissions criminal to achieve broader social purposes. There is nothing intrinsically wrong with saying an incorrect fact to a shareholder, or making a killing on a lucky trade, or getting the better end of a big deal. All those things only become wrong with proof of criminal intent (you knew the fact was wrong and intended to defraud investors--you didn't just make a mistake or restate a bad projection, you had inside information about the trade--you didn't just get lucky, you didn't disclose information you knew to be material to your counter-party).
We require intent for these things, because they are otherwise quite ordinary. They happen all time. People make mistakes all the time. People get lucky on trades all the time. People get the better of a deal all the time. It's only intent that makes them wrong.
But intent is intrinsically hard to prove. If you want to nail a "poor black kid" for grand theft auto, you just have to prove that he has the car and it's someone else's car. The intent requirement (that he didn't do it involuntarily) is easy to prove from circumstances. If you want to nail a banker for insider trading, you not only have to prove that the trade physically happened (which is easy), but you have to prove that the banker knew insider information. And proving what was inside someone's head is hard.
How is that the proper response? If one person gets away with running a red light, do we just turn them all off?
The travesty of HSBC getting away with their crimes should be a reminder of the value of the rule of law and an impetus to fight even harder against those that would think themselves above it.
If this person is a minister of interior affairs then yes, we should just turn them all off.
And HSBC is something like that. It's exactly the bank that "we all the citizens" should trust in order to not be "anti-democratic" as another article put it.
And you know what, we're not going to trust HSBC or any other bank, no more.
The only way you could think bitcoin is a threat to state revenue is by misunderstanding methods of taxation. Income and corporate taxes are determined almost entirely by self reporting and laws that shift tax burdens from one entity to another which require disclosure. It's relatively easy to evade taxes as long as you operate in a closed loop where no one reports even with modern financial instruments.
The problem only comes when you want to use the money to buy things from taxpayers, which is, you know, most business. This is such a problem that money laundering is primarily concerned with finding ways to pay taxes not to avoid them, so that people can pay for houses and such. Bitcoin actually makes this far more difficult than USD because of the encoded transactional history - just ask anyone sitting on the large piles of stolen bitcoins that have yet to be retransfered.
The methods of enforcement would change, for sure. But anyone who thinks that revenue offices would be unable to model monetary distribution via the blockchain hasn't been paying attention to what US security forces have been doing with the databases of how groups interact based on who they call (association graphs).
I wonder to what extent it may contribute to BitCoin's deflation: drug dealers make money on Silk Road, can't readily transfer it out of BitCoins, and probably think there's a good chance BitCoins will continue to become more valuable anyway, so they leave the money sitting in BitCoins.
The other datapoint may be dead wallets. I think it's very likely there are a good number of wallets from the early days of bitcoin where mining was still possible with normal hardware. A lot of people probably tried bitcoin out, mined a couple (which would now be worth hundreds of dollars) and then lost their wallet because there was nothing you could really do with them.
Makes me wonder whether we will ever see the day when people will try to fake ownership of dead wallets. It should be possible to figure out which wallets are dead. Not sure whether it's possible or feasible to fake ownership, though.
Then again, if it IS possible and if the people who predict four digit dollar values for a single BTC end up being right, the incentive would surely be there.
There are a lot of dead Bitcoins around. This thread [1] documents about 70,000 lost Bitcoins, and you can be sure there's a lot more.
The other way to lose Bitcoins, apart from losing a wallet or forgetting its password, is to make a transaction to a bad address (as in, a valid-according-to-the-protocol address that isn't anybodies).
If I understand how it works correctly, you wouldn't fake ownership of a wallet per se; you would need to come up with private keys to match the public keys of the transactions that belong to that wallet, which I believe is equivalent to breaking SHA256. That would be unexpected. Also, there's no way to tell if a wallet is dead or just not in use (that is, all you can know is that there are transactions that have not been spent yet, and if the same address is used to receive multiple transactions you have additional information that indicates the wallet is not in use… but it can never indicate that it's dead).
If you managed to claim ownership of a dead wallet, there's nothing at all stopping you from claiming ownership of an in-use wallet too. But SHA256 is looking pretty secure right now.
As for the way Bitcoins will inevitably be lost over time, it's generally considered in the Bitcoin community [2][3] that there's nothing to worry about (it will just add a bit more deflationary pressure). I don't like this aspect of the currency — money disappearing into the void with no hope to correct for mistakes might make it perfect for computers, but it's not so good for humans.
As for tracking stolen Bitcoins, if the transaction hashes of the thefts were made public, an exchange should be able to tell if the Bitcoins that somebody is trying to turn into real money were once stolen. This is because the blockchain contains the entire history of Bitcoins — the way Bitcoins are spent is by taking the Bitcoins from a previous transaction and making a new transaction based on them; all this information is stored in the blockchain[4]. Some work has been done[5][6] at looking at what can be discovered by looking at the blockchain — it's not nearly as anonymous as many think it is.
"The volume of transactions in Bitcoin is growing only slowly, relative to the massive increase in demand for the currency"
The author states this without presenting data. He is wrong. In fact, data shows the opposite:
- The exchange rate increase by 5x between February (low of $20) and March (high of $100)
- BitPay alone recorded a merchant transaction volume increasing by 7.6x between February ($687k) and March ($5.2M): http://www.marketwatch.com/story/bitpay-eclipses-silk-road-i... (and this is just BitPay - there are many more Bitcoin-accepting vendors who make sales without using BitPay - so total transactions increased by a lot more than 7.6x, maybe 10x, 20x, who knows)
Therefore the volume of transactions is increasing faster than the exchange rate. How can a Bloomberg article (edit: opinion piece) be so wrong about such a stupid simple fact that can be easily found? https://news.ycombinator.com/item?id=5499377 is right: a lot of journalists get a lot of facts wrong about Bitcoin.
Edit: BitPay is not the only datapoint. Many other metrics and merchants generally show big increases in transaction volume in the short past:
> BitPay alone recorded a merchant transaction volume increasing by 7.6x between February ($687k) and March ($5.2M): ... so total transactions increased by a lot more than 7.6x, maybe 10x, 20x, who knows)
your math is not good.
one provider having a large percent increase does not imply that the total market had a larger percentage increase. its entirely possible that BitPay gained a larger share of bitcoin transactions to achieve these numbers.
your argument is like saying: people using Google Chrome have increased by 1.2x over the past year, therefore, people using the internet must have increased by a lot more, maybe 5x or 10x, who knows.
You are right. I assume that the share of the Bitcoin transactions that are handled through BitPay were roughly the same in February and March.
This may be only an assumption, but I do believe it is correct. The other data points I added to my post seem to confirm it: trades and transactions are widely increasing everywhere.
The datapoint I cited was the most concrete irrefutable one. Firstly, BitPay is a big enough payment processor that their growth generally reflects accurately enough the growth of Bitcoin (their market share is actually slighly decreasing over time, as other payment processors sprang up in the recent past). Secondly, all other datapoints show as well that the volume of transactions increases:
If I'm not mistaken, 60% of BitPay's revenue from February and March came from Avalon ASIC devices being sold through BitPay. Avalon have now completely sold their 3 planned batches so BitPay's April figures should be a lot lower.
It might have been a once off for them as even if other ASIC manufacturers use BitPay, the demand will surely be lower as the ROI of ASIC devices will take much longer after the current ASIC batches in production get on the network and push the difficulty up.
This is precisely why I give numbers from BitPay, SR, casinos, etc, to show that these transactions are associated to actual spendings on goods and services.
Yes and this is my point. If the exchange rate doubles while the volume remains the same (say 100k BTC per day), then the economy is effectively increasing. It means people are spending twice the USD despite merchants halving their BTC prices (they generally index their BTC prices depending on the exchange rate).
"which, for many of its libertarian-anarchist advocates, is the whole idea"
The politics the community built around is for me the only reason why it sucks right now, the idea is interesting and it can certainly have some use. Selling all that I have.
EDIT: Ultimately what I hate about it is that the almost anywhere you go do discuss it there's this tribal mentality of believers vs. deniers. What about those guys in 2009 that thought it was a good idea to work as a currency and does not care about libertarianism/keynesianism talk?
"Taxation: How do governments collect taxes on transactions in Bitcoin? The answer is they don't, and they can't."
Grossly misleading.
You tax something at the point at which it gets exchanged into an externally viewable good or service. If either party refuses to disclose the value of the transaction, then the state just assigns one and uses its monopoly on force to collect.
That said, an increasing dependence on opaque stores of value would likely shift taxation away from income and towards consumption.
I've been a bitcoin supporter. But there is a twinge in me that remembers government, properly set up, can often protect the weak from the strong. Extremely wealthy corporations and individuals moving around anonymous money would make it impossible to tax and impossible to know where political contributions were coming from. I don't know the answer-- I flip flop back and forth between total openness for everyone and total secrecy for everyone.
On the contrary I believe, suppose bitcoin explodes national fiat currency as I saw a couple of guys wishing, once governments put some regulation, double booking accountting for companies who will have no incentive to avoid taxes and pay a lot later and the fact you can trace all transaction would kill any anonymity unless it remain a currency for black markets.
Crypto-currencies might be, but I don't think Bitcoin is an existential threat to the modern liberal state.
The anonymity that every mainstream article claims Bitcoin has is not nearly as strong as it's made out to be[1][2][3].
The built-in deflationary aspect of Bitcoin seems to prevent it from being used as a "serious" currency. Hiding money under your mattress should never be the optimal approach to making more money. (It might not prevent people from using the currency, but it's highly sub-optimal.)
The fragility of the currency concerns me (by which I mean the way it's possible to lose massive amounts of money by losing a file or forgetting a password). Maybe this is a technical problem that will be solved with a more mature ecosystem, but I like the way that a real bank always has ways to access money when bad things happen (at least in a functioning banking system). This thread[4] documents the loss of about 70,000 Bitcoins, which is worth about ten million dollars today. Related to this, if somebody hacked the EFF's Twitter account and posted that they were accepting Bitcoin donations on some address, a lot of Bitcoins would disappear into somebodies wallet. You could argue that Bitcoin is a more perfect sort of system, but it's not without downsides.
Maybe another crypto-currency will come along and solve these problems. I think I hope it does. But I don't see Bitcoin supplanting modern state-backed currencies. I find it hard to see Bitcoin being used more widely than by the idealogues, the speculators, and those who find utility in it (like Silk Road, but not just that).
Macroeconomics is the part of this that isn't FUD. The BTC money supply will remain slightly deflationary regardless of what's in your national best interests. It's not unlike being in the Euro, except that we have pitiless automation playing the part of Germany. You might want to devalue, or print money to cover your pension obligations or restart a stagflation death-spiral, but BTC does not offer you any means to do this.
The old way of maintaining control local macroeconomics was to demand that "you may use whatever variety of wooden doubloons you please, but you pay your taxes in USD". For simplicity, people use USD for everything. However if the economy starts to run on BTC, this rule's traction fails, USD becomes funny-money you buy at the government's gate, and its inflation saps the government rather than the taxpayer.
Wow, the financial press is falling in love with writing about Bitcoin.
Now that it's been linked to Cyprus there's an increased probability of Bitcoin being discussed in reference to future Eurozone economic events. Which means more mainstream awareness & more potential adopters.
I have a hard time seeing Bitcoin going away in the near future. Even if it's a bubble, and I have my doubts about that, odds are we have yet to reach the peak.
It's political nature also holds a lot of potential. There are some very, very discontent people all over the world, both Western and non-Western. Segments of the Greek population have latched onto neo-nazism -- is it really that unrealistic that another desperate population might latch onto Bitcoin?
The OP is not to be taken seriously, thanks to deep ignorance about how currency works in general, and how bitcoin works in particular.
In 1998, Paul Krugman described the fatal flaw that will inevitably sink any currency that includes it; a flaw that Bitcoin's designers have overlooked.
I was just reading some posts about potential BitCoin issues:
http://www.loper-os.org/?p=1009http://www.loper-os.org/?p=939
If the conclusions about the vulnerabilities of BitCoin are correct, then I'm not sure it can qualify as an "existential threat"
Bitcoin is analogous to gold. To the extent it is more of a "threat" than gold, it is because moving bitcoin across national borders is easier. You also don't have to assay it.
This article is alarmism. There is no theory of how bitcoin will facilitate more tax evasion or transactions for contraband, than cash or, or bearer bonds, or gold do.
No, it's not. The government can throw you in jail if you don't pay your taxes. Money is a get out of jail free card. That's what makes money valuable.
Though many Bitcoin fans don't quite realize it, Bitcoin's radical transparency could in fact be a tax-collector's wet dream. Every public-key, balance, and transaction is public.
A government that wants to coopt and efficiently tax Bitcoin could announce the following policy, based on the idea of 'tainted' or 'clean' balances:
"You can make your Bitcoin legal inside our jurisdiction by registering your public keys. (No, we don't need your private keys.) All transactions between registered keys are great, just make sure they match up with your tax filings, because we can see the endpoints.
"You should not receive money to your registered address(es) from an unregistered address. If you do, you can file a disclosure with 30 days, identifying the origin and nature of the transaction, paying all applicable taxes, and then the balance is yours to keep."
"If you do not, the entire amount that's mixed with the unregistered-origin balance is subject to forfeit. Your registered keys with any such balance will be blacklisted, making your previously-registered balances unspendable until you come back into compliance."
Any above-ground business would then stick with clean balances. Both clean and tainted coins could circulate in the same blockchain, but rarely mix... and would have different de facto values. (Would a clean or dirty satoshi be worth more? I'm not sure!) Trying to buy above-ground things with dirty money would face the same 'laundering challenge' as today: making it look like legitimate income via front operations.
Except, the blockchain would be a perfect record of earlier related transactions. That means big-data traffic analysis, and occasional meatspace busts discovering the identities of unregistered keys, would create a very strong map of unsanctioned economic activity -- much better than is possible with physical cash.