I've been hanging around Zcash since before the genesis block, since 2016. I bought a bit to play with very early on, joined the Zcash forum, and did some GPU mining with my kid for fun. Unlike many critics of the devfund, I always thought that it was a cool idea and a worthwhile experiment. In 2022, after seeing consternation in the community grow as the price continued to fall year after year, I had the goofy idea to try to save the Zcash project myself by building this goofy website. After getting free2z off the ground a bit, we decided to apply for a ZCG grant starting in 2022. After 8 years of following and investing in Zcash and the last 2 years pouring all my free time into free2z to try to turn Zcash around, it's only been in recent weeks that I've recognized what I consider to be a substantial problem with the current devfund operations.
Common criticisms
The devfund has been widely discussed and criticized. But, it appears that my specific realization is unique. Let's look at a summary of common criticisms according to GPT4 with web search.
Prompt: I'm going to write a blog post, "The Real Reason Why the Zcash Devfund is a Catastrophe". I want you to help me research and think it through. I think I have a unique insight into the topic as a recipient. First, can you summarize traditional criticism of the Zcash devfund?
The Zcash Development Fund (DevFund) has faced various criticisms since its inception, primarily revolving around governance, allocation, and transparency issues. Here's a summary of traditional criticisms
Centralization Concerns: Critics argue that the DevFund introduces a level of centralization into what is supposed to be a decentralized project. The control over the funds can potentially give disproportionate power to the Zcash Foundation or Electric Coin Company (ECC), the main entities behind Zcash, thereby influencing decision-making and governance in ways that might not align with the wider community's interests.
Allocation and Distribution: There has been debate over how the funds are allocated and distributed among different stakeholders, including developers, the ECC, and the Zcash Foundation. Some community members have expressed concerns that the allocation is not equitable or transparent, leading to questions about prioritization of projects and initiatives funded by the DevFund.
Lack of Transparency: While the Zcash Foundation and ECC have made efforts to be transparent, critics argue that there's still a lack of detailed reporting on how funds are being spent. This includes calls for more detailed financial reports, project outcomes, and the decision-making process behind fund allocation.
Impact on Decentralization and Security: Some argue that the existence of a centralized fund could impact the decentralization and security of the Zcash network. There's a fear that reliance on a central fund for development could make the project more vulnerable to regulatory pressures, censorship, or other forms of interference.
Community Engagement and Decision-making: There have been concerns about the level of community engagement and the processes used to make decisions regarding the DevFund. Critics feel that the community's voice is not adequately represented in decision-making processes, leading to decisions that might not reflect the broader interests of Zcash users and stakeholders.
Sustainability and Long-term Viability: Questions also arise about the sustainability of the DevFund model. Critics wonder if reliance on such a fund for ongoing development and support is viable in the long term, especially considering the volatility of cryptocurrency markets and the potential for decreased funding over time.
As a recipient, your unique insights into these criticisms, especially regarding the operational realities, the impact on project development, and the broader Zcash ecosystem, could provide a valuable perspective on the DevFund's effectiveness and areas for improvement.
I think the AI summary is basically on point with what I have heard over the years. And, indeed, it does not directly hit the particular point I want to discuss and emphasize.
Devfund Taxes: a simple hypothetical
Let's take a simple hypothetical case and look at how the ZCG grants really work. Let's say some starry-eyed, US-based developer has a great idea for a killer Foobar widget that is sure to make Zcash better, improve the community, improve the narrative, make Zcash super attractive. Whatever it is, it doesn't matter. It's a great idea. This developer decides to apply for a grant for $100,000 worth of Zcash from ZCG. Let's say Zcash is at $100 to make things simple. This idealistic developer has a simple plan: work his ass off for free, receive the grant and mostly give it to worthy people to try Zcash out. He gets 1000 Zcash valued at $100,000. Awesome! He starts sending 1 ZEC to anyone who has a good idea, people in need, people who help do things for the Foobar widget project. Everything is going great. This developer already earns a good income at their day job and they don't really care about profits and income right now - they are in it for the long-term. Maybe someday the granted ZEC will be worth a lot more and they can take some income or personal reward at some point in the future. Sounds good right? Everyone is happy.
Not so fast.
That 1000 ZEC is treated as $100,000 (USD) worth of income. What our intrepid developer didn't realize is that he owes the IRS $35,000 (based on his decent normal income). Let's say he distributed 500 ZEC and the price went down to $50. In this catastrophic case, the developer owes the IRS $35,000 and only has $25,000 worth of ZEC left. To comply with his tax obligations, he has to sell the remaining 500 ZEC and come up with another $10,000 out of his own pocket! Oops! In this pathological case, this poor schmuck worked their @ss off for 100s of hours only to have to liquidate everything and pay a substantial sum out of their own pocket to cover the tax bill. Since they were forced to liquidate everything, they had to contribute to the continued decline of the ZEC market. People think the Foobar widget is OK. But, the widget didn't cause a large increase in ZEC demand and the price continued to go down, so the community isn't happy with it, "Hey, we gave you $100,000 and your widget didn't do sh!t. What a crappy idea!" The community doesn't necessarily take into account that they didn't give the developer $100,000 - they gave them 1000 ZEC with a $35,000 tax liability.
The General Pathology of the Devfund
The above case is a bit contrived to illustrate the point. But, the actual functioning of the devfund is the same across the board. A lot of ZEC must be liquidated to pay taxes. Please correct me if I'm wrong on anything here. I'd love to be wrong.
Let's take a peak at Zcash Foundation's ProPublica page for 2022.
I think the people at the Zcash Foundation do a great job, I like them personally. But, the fact is that devfund org salaries are numerated in fiat. To meet these payrolls, ZEC must be sold. How much must be sold just for taxes? Let's look at what a hypothetical salary of $325,000 means in total cost and taxes.
Using some hypotheticals with some help from GPT4. The total cost is about $340,000 including the mandatory employer contributions.
Federal Income Tax: $80,773.55
State Income Tax: $15,554.15
Social Security Tax: $9,932.40
Medicare Tax: $4,703.64 (including additional Medicare tax for income over $200,000)
Total Taxes Paid: $112,096.03
Employer Contributions:
Social Security: $9,932.40 (matching the employee contribution)
Medicare: $4,711.53 (not including additional surtax)
Net Income after Taxes: $212,836.97
$340,000 worth of ZEC must be sold to pay a salary of $325,000 and the employee walks away with about $213,000.
Almost $130,000 worth of ZEC must be sold, just to pay the taxes.
At $25 per ZEC, that's 5200 ZEC that must be sold, just to pay the taxes.
Looking at all of the ZF salaries, let's use a nice round figure of say 25%.
Just the income tax on the ZF salaries caused about a quarter of a million dollars worth of ZEC to be sold in 2022?
The total tax liability for the Devfund
Zcash has changed a couple of times. What started as the Founder's Reward changed into the Devfund. There are so many variables in play, estimating the USD value of the devfund for it's entire life is a challenge. I forced GPT4 to give me an estimate and it came up with $63,000,000. I've heard rumors of $100,000,000. GPT4's estimate seems like it is in the ballpark. With a tax liability of say 25%, we give a very rough estimate that $15,750,000 worth of ZEC had to be sold just to pay the taxes on the devfund income.
Current Grants and Market Dynamics
Every Zcasher probably has pet grants that they like to hate on as failures. I'm sure some reading this even hate Free2Z. Afterall, Free2Z has done nothing to stem the collapse of the ZEC token price. What a waste!
Let's look at a couple of current grants. I don't know the specifics of how these organizations are structured for tax compliance. But, let's think about them a bit.
Zcash Media
Zcash Media made an awesome video that is highly relevant for this discussion. In particular, rewatch the video and think about "the double coincidence of wants" at minute 1:
Zcash Media has an ongoing grant: $900,000 in 3 milestones
$300,000 worth of ZEC to be paid upon the completion of 8 glossy educational videos. It looks like 37 Laines is an LLC. GPT4 says there are a wide variety of ways that LLCs can choose to treat their income tax. It seems reasonable to expect that no less than 20% will need to be paid to the IRS. If anyone knows a way to lessen this burden let me know! After grappling with this for quite some time, it looks like an expensive nightmare no matter what. The current rate for a C Corp is 21%. Doing better than this seems like a big challenge. Of course, you can spend it all and expense it all and not pay taxes. Again, there are a lot of variables at play here. But, it seems reasonable to assume that of this $300,000 milestone, at least $50,000 should be liquidated to pay taxes. At $25 each, something like 2000 ZEC might need to be sold just to cover the taxes for this one milestone. That's easily enough to drop the price of ZEC by a percent or two. If they need to liquidate the full ~12,000 ZEC to pay expenses, that could be enough to drop the price by 10-25%.
Qedit
The Qedit folks are some of the brightest people in the world, awesome developers, fun to hang out with. They have done some awesome work getting ZSAs (Zcash Shielded Assets) going - doing real work helping to expand the Zcash protocol. They have completed one grant and proposed another:
The expected budget is roughly $215k per month of work, covering a team of about 8-9 engineers and contributors.
Going back to our simple hypothetical, to me it sounds pretty good - transfer the ZEC from ZCG to Qedit and let them build important features. But, the big problem is that the grant is numerated in dollars and paid in ZEC. Going through a corporation and through payroll to pay salaries, it seems likely that essentially all of the ZEC will need to be liquidated. And probably half of the proceeds will need to be given to a nation-state. Again, correct me if I'm wrong! I would love to be wrong here! Perhaps Qedit plans to cover the taxes with their own treasury and hold all of the ZEC. That would be amazing! But, if Qedit needs to sell the ZEC, the open market simply can not support this. The open market can't even support the taxes. The only way it would work is to raise the fiat from investors who are willing to hold the ZEC. There is not enough buyside liquidity on the open market to support this monthly expense paid in ZEC.
Numerated in Dollars and Paid in ZEC
Ironically, part of the problem (in addition to the very existence of governments and income taxes), is "the double coincidence of wants" described in the famous Zcash Media video. If people wanted the ZEC to hold, if governments wanted the ZEC to hold, then ZEC could be used as the unit of account, "the money." But, salaries are not usually paid in ZEC and governments do not accept their portion of the allocated ZEC to hold. The government forces the devfund recipients to sell their ZEC in order to pay their taxes in legal tender fiat currency.
In the US tax code, accepting a ZCG grant is exactly like getting paid in dollars and buying the ZEC as a speculative investment. Read it again and think about it. In the simple hypothetical example of the naive schmuck getting a $100,000 grant of ZEC at $100/each, it's as if the person received $100,000 and bought 1000 ZEC with it! They owe the taxes on $100,000 USD of income. If the price goes up before they sell, they are also on the hook for capital gains. If the price goes down, they may be able to claim some capital losses. If they don't sell some of the ZEC (likely 20-50% depending on all of the income tax variables), they will have to pay the tax liability out of pocket.
The Future of the Devfund
The devfund is the main reason why the price of ZEC has sunk so low. It doesn't matter how cool the videos are, how awesome the website is, how rigorously tested the ZSAs are, how great the privacy is, how cutting-edge the cryptography is. Liquidating millions of dollars worth of ZEC to pay millions of dollars worth of fiat to governments was possible in earlier eras without the market losing all hope in ZEC as an investment. But, those days are gone and no matter how good the tech is, how awesome the new features are, how committed the community is, the market can not support selling millions in ZEC to pay government income taxes.
Here's what everyone should do: circle the wagons to prepare for the end of the devfund.* The devfund orgs should do everything they can to keep all the ZEC they have. Don't spend it. Don't fund anything. The only exception is the core engineering to define and maintain "The Zcash Codebase" and prepare it for being a "normal" open source project. With the funds that are left, ZF, ECC, and Qedit can make zebra awesome, make the mobile SDK awesome, work on basic fundamentals like making it easy to get started and run zebra + lightwalletd.
Any ZCG grants should be judged strictly on how much ZEC will need to be sold. It doesn't matter how talented the people are or how good the idea is if they need to sell ZEC to get it done. If someone has an idea for what to do with ZEC other than sell it, that should be given priority. Tax implications should be considered. If someone lives somewhere where they don't have to liquidate to pay taxes, they should be considered much more strongly than someone who lives in a location where they would have to liquidate most of the grant to pay taxes. The market can not bear more ZEC liquidations to pay taxes.
Other ideas in brief
Thinking about this problem with forced liquidations to cover taxes definitely has me leaning towards completely abolishing the devfund. But, I think there could be other approaches that I haven't thought out completely.
- If any block reward simply must be counted as income and taxes paid, maybe a 1% bounty program that the community can vote to fund - strictly for contributions to The Zcash Codebase™ for health, security, basic maintenance, protocol upgrades.
- If only non-profits were eligible and they had a plan for how to use the ZEC without selling it, maybe I'm OK with a larger devfund up to maybe the existing 20%
- Some creative structure that avoids taxable events (perhaps until sold?)
Death and taxes they say are certainties. I'm not necessarily trying to 100% avoid taxes. But, the current tax code is a monstrocity where the ZEC income is taxed off the top. If only the grants weren't taxed unless the ZEC were sold. It would be so much more just. Unfortunately, we definitely don't live in a just world. The government gets their cut first. If this is the only way we can structure the devfund - that 20-60% of every ZEC emitted will need to be sold just to cover the taxes - then the only answer is to let the devfund expire and prepare for that event in November.