As cryptocurrency continues the battle for mass adoption, with growing fundamental usage milestones and real-world applications maturing, there is one indicator that could significantly hasten crypto’s true arrival in the mainstream. This is just how many national revenue services and taxmen are shifting their sights onto crypto assets and on those benefiting from their trade.
The good news is that more countries are now requiring their citizens to pay their dues from all their crypto or DeFi trading. From the US and the UK, all the way down to Singapore and New Zealand, if you trade in crypto, you have to pay your taxes, just as you would trading any other asset or commodity.
That’s a good thing for crypto as there are few other signals of a government’s recognition and acceptance of something as nascent as crypto.
What’s Taxable for DeFi traders
On the other hand, for many crypto traders, it can be a daunting process of compiling all of your cryptocurrency transactions to calculate and report the taxes you owe. Popular centralized crypto exchanges, especially those that are also regulated by certain jurisdictions, have developed certain tools and formats over the years, helping their users generate reports that can fit the preferred formats of various tax entities.
This has made it a lot easier for users for which jurisdictions see crypto tax as applicable as capital gains tax — realized only when they actually sell the crypto they bought as profit or loss. These tools help traders to track their net capital gains or losses by calculating their cost basis (as purchase price).
DeFi Tax Challange
But DeFi traders face an entirely new challenge in calculating their tax obligations, since, by architectural definition, there is no platform or service that stores your user transaction history in DeFi. In fact, in many cases, there isn’t even a user account to identify your trades because many DEXs now are only front-end interfaces, just like PlasmaFinance.
Thus, the onus lies completely on the users themselves to maintain records of their own transactions, downloading and formatting their transaction histories from their crypto wallets, and identifying which events are taxable, and which aren’t.
In the following section, we will attempt to help readers understand some of the considerations they must make to identify their personal tax obligations.
Where you come from, where you earn
As a general rule of thumb, you first owe taxes to the country you are a citizen or resident of. This then means that how you pay your taxes, how much of it, and what is taxable, depends on the taxation laws of that country. So the first step for you as a DeFi trader is to find out:
- If your country considers crypto trading a taxable activity.
- If profit any other form of crypto activity in DeFi is also taxable — this means liquidity mining, lending, liquidity pooling, staking, and even hodling could all be taxable events IF they generate profit.
- The various tax deadlines and timeframes for reporting (in general, this is a calendar year, but some countries have a different format).
If you want an example of what’s probably the strictest yardstick at the moment, then you might want to have a look at the US’s Internal Revenue Service (IRS) guidelines on crypto taxation. Following this probably means you’ll be treading on safe territory, since the US treats crypto as property, requiring citizens to report all crypto transactions — whether they buy, swap, earn fees, get airdrops or earn lending interest. Each comes with its own taxable conditions and percentages, so they can get pretty complicated if they’re not tagged precisely.
In other words, all crypto and DeFi activity is for sure taxable if you are a US citizen.
Who should pay the tax – Resident or Citizen?
The next commonality with taxes is that you are generally also expected to pay taxes in the jurisdiction you earn from. So, if you’re not a citizen but are a resident of a country and/or are earning from there — then you should also expect to be paying crypto taxes from DeFi activities conducted where you are a resident.
If you owe tax because of your nationality and/or residence, you really can’t avoid it. During a recent interview with the public (AMA), Anthony Antonopoulos has posed a question that supposes a person attempts to bypass this requirement by residing and operating offshore by using a DEX while in international waters. In this instance, while that operation doesn’t fall under any jurisdiction, at some point, the trader or the DEX would have to eventually come into national waters, and at that point, tax obligations apply. In other words, you can hide, but not forever.
There are some exceptions
Obviously, owing taxes both to the country you are a citizen of and the country you are resident of or are earning from, could put you in a tough situation where you have to pay taxes to multiple countries. Known as “double taxation” (though it also refers to multiple instances of taxation).
A US citizen, for example, must always pay taxes to the US IRS, regardless of where they are or where they are earning from. As such, US citizens who decide to reside abroad often have to bear the burden of double taxation — whereby they pay taxes to both the USA and the country they are resident in.
In another example, a person earning from Estonia has to pay taxes in Estonia, regardless of whether they are resident there or not (if you’re a remote employee of an Estonian company, for example). At the same time, that employee still owes their own country taxes and has to pay twice as most countries require residents to pay taxes, whether they earn abroad or remotely.
Tax Treaties and DeFi Tax
Naturally, many countries have made economic agreements that ensure citizens of their nations aren’t unnecessarily burdened by tax obligations. Known as Tax Treaties, these are specific bilateral tax agreements between countries that specify which country you should pay tax to. Estonia and the Netherlands, for example, have a tax treaty that would allow a Dutch resident to work remotely with an Estonian company, and choose whether to pay taxes in the Netherlands or Estonia.
For US citizens, there is a full list of US Tax Treaties available on the IRS website. Similarly, most other countries requiring their citizens to pay tax regardless of earning situation will also have their own national tax treaties, so it’s important to find out which those are for your country of nationality.
Because the IRS guideline for crypto taxation is probably the most complete and meticulous one out there at the moment, there are already now quite a few crypto tax tools out there that stand designed to help traders easily format and manage their tax filings. One such tool is TokenTax, which promises to “populate your Form 8949” (used to file capital gains to IRS) in a format that’s also compatible with Turbo Tax, another popular US tax software. Another is Cointracker, which lets you connect your wallets to it and spits out a nicely formatted report for tax filing purposes.
Good Recordkeeping is the key
However, if you’re not paying taxes to the IRS or a major supported country, then you most likely will have to manage your own reports — so make sure you do your best to maintain good record keeping. For example:
- Remember all the private keys of your wallets so you can download the transaction history of your wallets. This is actually also important for Proof of Funds requests that may come from your revenue collection entity.
- Make it a habit to download or request annual transaction histories of any buying or selling with fiat, whether it’s at a crypto exchange or P2P. Track all your transactions from and to DeFi, including any fiat on/off ramps!
- If interacting off-chain, then maintain your own records manually or request transaction history from the Layer 2 network (this should be possible).
The good news is that crypto taxation is still a somewhat grey area for many jurisdictions, never mind DeFi taxes. So there’s probably still plenty of time for you to get your DeFi trading affairs in order. Bear in mind, some DeFi activities probably already fall under general crypto tax regulations — as we mentioned before. DeFi lending is probably an obvious case, with any interest earned at least filed under “additional income” in most jurisdictions.
In any case, your country should have free resources in their revenue collection departments so you should consider consulting them if you’re unsure. We wish you good luck with meeting your crypto tax obligations.
This article is an opinion piece by Ilia Maksimenka and not professional tax advice. Because crypto is still a maturing industry while DeFi itself is still very much a niche sector, it is likely that precise tax obligations will vary from person to person, depending on their situation and jurisdiction. Decentralized exchanges and other forms of DeFi platforms may also present additional layers of consideration that will require a nuanced understanding of these obligations. There is no way to ascertain a one-size-fits-all solution and that’s why you should seek professional advice if unsure — most countries’ revenue collection services should have free resources you can engage for guidance.