The Comprehensive Guide to Defi Taxes (2022)

How Is Defi Taxed?

Even though the IRS has not issued detailed advice on DeFi, they have issued broad bitcoin guidelines. These principles and earlier legal concepts can be used to deduce the tax consequences of DeFi.

How Does DeFi Differ from Conventional Banks?

Cryptocurrency DeFi, short for decentralized finance, is a field of cryptocurrency that aims to provide access to financial services, including trading, lending, and borrowing, without the fees or delays associated with the traditional rent-seeking middlemen (i.e banks, financial institutions, etc.).



Ethereum is home to several prominent DeFi applications; however other chains, such as Solana and Avalanche, also have DeFi implementations. Several unique technology breakthroughs, such as AMM and Liquidity Pool, support the "decentralized" characteristics of many of today's most popular DeFi platforms to be implemented.

Is The IRS Aware of Any Defi Protocols?

Most DeFi protocols do not file tax returns currently. This, however, may be about to change.

In November 2021, President Biden signed the Infrastructure Bill, which mandates that any party that enables a cryptocurrency transaction to disclose the user and the IRS with 1099 tax reporting information.

At this moment, it's not evident if these rules will apply to protocols like DeFi, which may not be able to send out 1099s. It's impossible to report on these protocols because they are appropriately decentralized. If this measure becomes law, the DeFi environment in the United States might be dramatically altered.

However, at the earliest, the bill's crypto measures won't take effect until January 2024. It is widely assumed that significant crypto businesses would fight the action in court.

If you are using multiple exchanges at the moment, it is best to consolidate and bring your crypto to a single exchange. This will make tax reporting a lot simpler in the long run. If you haven’t connected with a tax professional to iron out your unique situation yet, now is the time to do it.

The Tax Treatment of Defi Platforms

Some of the essential tax considerations for DeFi protocols are outlined here. Remember that the IRS has not yet issued any DeFi tax guidelines. Please remember that the following descriptions are based on the current IRS crypto rules and reflect a cautious tax stance.

V2 of Uniswap

It is possible to trade/swap between cryptocurrencies using Uniswap's decentralized trading platform and make money by contributing cryptocurrency to liquidity pools. If the price of the coins you're giving away has increased or decreased since you first acquired them, then the gain or loss you make on the trade will be taxed.

Liquidity pool tokens reflect your portion of the pool when you contribute. An income tax is due, and any gain or loss will be included in that total. When you join one of these pools, it's like exchanging your coin for the Uniswap liquidity pool token. The value of tokens in the UNI liquidity pool increases as interest is accrued. Any center gain or loss you make or lose when you withdraw from the liquidity pool are returned to you in the form of UNI liquidity pool tokens.

Uniswap V3

For the first time, Uniswap V3 will provide liquidity providers with non-fungible tokens (NFTs) instead of LP tokens. A taxable event occurs when a liquidity position is wrapped up in an NFT. Depending on the price of tokens you wrapped, you'll be able to see either gains or losses.

Interest in the pool will make your NFT more valuable. Your capital gains/losses will be based on the price of your NFT when you exit the liquidity pool and exchange it for the underlying position you own. You can learn more about NFT taxes here.

Sounds like a lot? Connect with a tax pro for a free one hour consultation to find your best course of action. The less tax you pay, the better!

Compound

Borrowing, lending, and earning interest are all made possible using the decentralized system known as Compound. Taxes are levied on exchanging tokens like cETH for ETH (you dispose of your ETH when exchanging it for cETH). As you lend, the value of your cTokens rises. Returning your cTokens for the underlying asset results in a profit. The fair market value of any COMP obtained as a reward for utilizing this platform is taxable income.

Aave

Using Aave, users may give liquidity, earn interest, and borrow money. When minting aTokens, you're subject to capital gains or losses on the crypto asset you swap away, depending on how much its price has risen or fallen since you first got it.

aTokens are awarded to you because of interest earned on loans. When you get aTokens, you earn money based on those tokens' current fair market value. Users can stake AAVE in return for STK AAVE tokens, generating capital gains when they enter and quit the network. AAVE tokens earned because of holding STK AAVE are taxed as ordinary income at their fair market value when received.

Maker

ETH as well as other cryptocurrencies could be used as collateral for loans utilizing Maker and its Oasis platform. DAI can be earned by either locking ETH or other cryptocurrencies as collateral or storing DAI.

Making a trade from one cryptocurrency to another on Maker is a taxable event that results in capital gains or losses, just like trading on a centralized exchange. When DAI is received, the fair market value of the DAI is taxed at that time.

On Maker, the use of cryptocurrency as collateral doesn't result in a taxable event; nevertheless, if a position is liquidated, the underlying assets will be subject to capital gains/losses depending on their value at the time of liquidation.

Balancer

A cryptocurrency trading and swapping platform like Uniswap, Balancer allows you to participate in liquidity pools and exchange cryptocurrencies. Trades on centralized exchanges, like Balancer, result in capital gains or losses that must be reported as ordinary income. Balancer liquidity pool transactions are taxable events that result in capital gains or losses for the account holder.

The BAL tokens generated by Balancer Pool Tokens are also handed to liquidity providers regularly. When you get BAL tokens, the fair market value of those tokens at the time of receipt counts as regular income.

OlympusDAO

In contrast to other stablecoins, OlympusDAO's OHM token is unique in that its value is derived from its treasury and market demand, unlike other stablecoins. OHM stakers are rewarded by rebasing the coin.

Get Ready for Defi Tax 2022

Being prepared is paramount for those who wish to stay in the good graces of the IRS. Not filing your taxes on time can lead to many serious consequences. Failing to file your taxes correctly can lead to even more.

However, this doesn’t mean that you have to lose all your gains to a crypto tax. Instead, connect with a tax pro to minimize the IRS’s impact on your hard-earned crypto. There are a few methods which we have devised to help you pay zero crypto taxes, and we would like to share them with you.