![]() ![]() The concept of governance tokens was popularized by Compound’s COMP. They are used to incentivize cryptocurrency holders to use their assets as collateral to allow “Yield Farmers” to ramp up their potential earnings. In recent years, governance tokens have become more common. DeFi rewards taxes: governance and incentive tokens This stance argues that true tax ownership is not transferred upon creation of LP tokens. ![]() You’ll incur capital gains or losses depending on how your crypto has changed since you originally received it.Īggressive approach: Treat exchanging cryptocurrency for LP tokens as equivalent to a deposit, which is considered a non-taxable event. As a result, some investors choose a conservative approach to tax reporting, while others choose a more aggressive approach.Ĭonservative approach: Treat exchanging cryptocurrency for LP tokens as a crypto-to-crypto exchange. The IRS has not released any guidance about providing liquidity to liquidity pools. Here’s an example of an interaction with a DeFi protocol where the user recognizes capital gains, capital losses, and ordinary income. Example: How common DeFi transactions are taxed As noted earlier, profits from this activity will likely be taxed as capital gains or ordinary income depending on the specific nature of your transactions. When you lend your cryptocurrency out, you are liable to pay taxes on any income that you receive as a result of your lending activity. Until then, it’s widely expected that prominent crypto companies will lobby against the bill in the courts. However, the crypto provisions of the bill do not go into effect until January 2024. It’s possible that this bill could have a huge impact on how the DeFi ecosystem operates in the United States. After all, since these protocols are decentralized, there’s no party that has the capability to do proper reporting. The infrastructure bill, signed by President Biden in November 2021, requires that any party that facilitates a cryptocurrency transaction provide 1099 tax reporting information to the user and the IRS.Īt this point, it’s not clear whether these requirements will apply to DeFi protocols who, as it stands today, might not have the capability to send 1099s. However, this could change in the near future. The tax implications for DeFi can be inferred from these guidelines as well as previous legal doctrines.Īt this time, most DeFi protocols do not report to the IRS. While the IRS has not released any direct guidance on DeFi specifically, they have released general guidance on cryptocurrency. If you’re not aware of the tax implications of crypto, we recommend starting out with our article: The Complete Guide To Cryptocurrency Taxes. Ordinary income: When you earn cryptocurrency through any means whether that is mining, staking, or various forms of interest, you recognize income based on the fair market value of the cryptocurrency at the time it is received. That means if you’re interacting with DeFi protocols, you may incur capital gains and income tax liability.Ĭapital gains: When you sell, exchange, or otherwise dispose of your cryptocurrency, you incur capital gains or capital losses depending on how the price of your crypto has changed since you originally received it. and many other countries, cryptocurrencies are treated as property for tax purposes. We’ll continue to update this guide as more regulatory updates are released. We’ll also cover the tax implications of some of the most popular DeFi protocols.ĬoinLedger serves more than 250,000 investors worldwide, and our team of tax experts carefully tracks the latest developments in tax policy. In this article, we dive into these questions and explore how common DeFi transactions are taxed including lending, borrowing, yield farming, liquidity pools, and earning. ![]() ![]() With this flurry of DeFi activity comes the fated question: What are the tax implications for DeFi? How can investors report DeFi transactions on their tax returns? Right now, it’s estimated that there’s more than eighty billion dollars locked up across all DeFi protocols. ![]()
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