Traditional Finance

In traditional finance, almost every transaction gets recorded by a financial institution and reported to both you and the IRS on a tax form, typically starting with the number 1099. For example, when you earn interest you get a 1099-INT, when you receive dividends you get a 1099-DIV, and when you trade stocks you get a 1099-B. You can easily use those forms to report the income (or loss) on your tax return each year.

Decentralized Finance

But what do you get when you participate in the upside-down world of crypto and decentralized finance (DeFi)? Right now, nothing.

Up until the fall of 2021, the US Congress had yet to pass any laws whatsoever to address cryptocurrency reporting. The limited tax reporting guidance that any US government entity provided were a handful of FAQs issued in 2014 and 2019. However, with the passing of the Infrastructure Bill (HR 3684), Congress finally defined what a “digital asset” is, who a “digital broker” is, and what reporting requirements they have.

Under this law, a “digital asset” means any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology. In other words, if you’re using a blockchain to hold value, it’s a digital asset. A “digital broker” is any person who receives payment for regularly providing any service effectuating transfers of digital assets on behalf of another person. So, for example, Coinbase or Crypto.com or any other provider that helps you get into crypto would be considered a digital broker.

The law modified an existing section of the tax code that requires stock brokers to report their investors’ trades on form 1099-B at the end of each year to include digital brokers. Starting January 1, 2023 all digital brokers will be required to report trades to their users and to the IRS (even though the IRS may already know what crypto trades you made) on form 1099-B, so you can expect to receive your first form 1099-B in January or early February of 2024.

DeFi, however, remains unclear. When you earn money peer-to-peer using smart contracts, who – if anyone – is responsible for reporting? And what is the tax treatment of earning yield? Time will tell what lawmakers end up deciding.