The U.S. Department of the Treasury and the IRS issued final regulations on digital asset transactions in 2024. The introduction of these regulations is a result of the Infrastructure Investment and Jobs Act's push for strengthened cryptocurrency tax regulation, aiming to standardize the tax reporting processes for cryptocurrency and decentralized finance (DeFi) transactions, significantly enhancing tax compliance levels.

The regulation specifically imposes clear requirements on DeFi brokers. It clearly defines the reporting obligations of DeFi brokers, stating that they must disclose relevant transaction details in detail. This means that DeFi brokers need to accurately record various information involved in transactions, including transaction amounts, types of transaction assets, and information about both parties involved. Additionally, the regulation requires DeFi brokers to collect users' 'Know Your Customer' (KYC) information to better trace the source and destination of transactions, identify potential risk behaviors, and ensure that the entire transaction process operates within a legal and compliant framework.

Ultimately, this regulation is set to officially take effect on January 1, 2027. To provide relevant practitioners with sufficient adaptation time, the regulation specifically sets a transition period. During this period, starting from 2026, brokers will need to begin collecting data that meets the requirements of the final regulations according to the IRS's vision. The purpose of this is to give brokers ample time to adjust their business processes, technical systems, and related arrangements so that they can smoothly comply with all regulatory requirements after the regulations take effect, avoiding chaos or violations in the new regulatory environment.

However, while these requirements in the regulations are intended to strengthen oversight from a tax compliance perspective, they have also sparked considerable controversy within the industry. Some practitioners believe that this may negatively affect transaction efficiency and innovation. For example, in an already complex cryptocurrency trading environment, adding more reporting and information collection tasks may complicate the transaction process further and potentially limit the development space for some emerging trading models or financial instruments. Of course, on the other hand, the essence of DeFi is decentralization, and the release of this document can be seen as completely stripping away the essence of DeFi, abandoning the meaning of decentralization. Therefore, whether the regulation can ultimately be successfully implemented remains to be seen.

Next, let's take a closer look at the core content of this document and its potential impact on digital asset transactions:

1. New Information Reporting Requirements

The regulation primarily imposes information reporting requirements on brokers. Brokers are defined as individuals preparing to sell in their daily business, including custodial and non-custodial digital asset brokers. This mainly includes the following categories:

• Custodial Digital Asset Trading Platform Operators: These platform operators are responsible for safeguarding clients' digital assets and facilitating transactions between clients.

• Digital Asset Custodial Wallet Providers: These wallet providers are also responsible for safeguarding clients' digital assets.

• Payment Processors (PDAPs): These processors are responsible for handling payments of digital assets, such as payments made through blockchain networks.

• Digital Asset Self-Service Terminals: These terminal devices allow users to conduct transactions of digital assets directly.

Broker Reporting: Brokers are required to report in detail the total income of clients from digital asset transactions. This includes not only profits from traditional cryptocurrencies like Bitcoin and Ethereum but also emerging digital asset transaction gains, such as proceeds from non-fungible token (NFT) transactions. Additionally, adjusted base information is included in the reporting scope, which may involve initial investment costs and various expense adjustments during the transaction process. The IRS hopes that through this comprehensive reporting requirement, the tax authority can gain a more accurate understanding of income from digital asset transactions. Previously, some clients may have exploited the anonymity of digital asset transactions for unreported income operations, but now this reporting system by brokers can control income reporting from the source of transactions.

In the real estate transaction market, when it comes to payments made using digital assets, real estate reporters are also assigned corresponding reporting responsibilities.

2. Clear Definitions and Classifications

The regulation clarifies the definition of digital assets and the categories of custodial and non-custodial industry participants.

Specifically, in this document, digital assets are clearly defined as value representations recorded on a cryptographically protected distributed ledger, distinguishing this feature from cash. This form of value recording based on cryptographic technology and distributed ledger technology is key to differentiating digital assets from traditional assets. It encompasses a wide variety of types, with cryptocurrencies being the most well-known, such as Bitcoin and Ethereum. It also includes stablecoins, NFTs, and others.

At the same time, the document meticulously distinguishes between custodial and non-custodial digital asset industry participants and clearly defines their respective responsibilities and obligations.

Custodial participants bear the responsibility of asset custody in the entire digital asset transaction chain. They need to ensure the secure storage of digital assets, employing advanced encryption technologies and security protection mechanisms to prevent theft or tampering of digital assets. During the transaction process, custodial participants must also conduct preliminary reviews of the legality and compliance of the transactions, such as verifying the identity information of the parties involved and tracking the source and destination of the digital assets.

Non-custodial participants, while not directly responsible for asset custody, play an important role in transaction facilitation and providing market information related to digital assets. They need to comply with relevant market competition rules, ensuring that the transaction information provided is true, accurate, and complete, without engaging in fraudulent, market-manipulating, or other improper behaviors, and they must actively cooperate with regulatory authorities by providing necessary transaction data and information for supervision and management.

3. Tax Implications

Digital asset transactions are clearly regarded as taxable events under the new regulations. Whether it is the exchange between cryptocurrencies, investment gains from digital assets, or transactions involving non-fungible tokens (NFTs), as long as there is a transfer of value and generation of income, they fall within the scope of taxation. The IRS believes that taxpayers must accurately report these transactions on their federal income tax returns. This may lead investors to consider not only the risk and return when participating in investments but also potential cost deductions such as initial investment costs and transaction fees.

4. Requirements for Brokers' Technology and Operations

• System Upgrades: With the updates to regulations related to digital asset transactions, brokers and other industry participants face challenges and demands for system upgrades. The new reporting requirements involve more detailed and comprehensive collection, organization, and analysis of transaction information. For example, brokers not only need to record traditional transaction amounts and basic information but also pay attention to specific types of digital assets, transaction timestamps, the source and target addresses of related digital assets, and other complex information. Existing transaction systems may not meet these new requirements in terms of data structure design, data storage capacity, and information processing logic. Therefore, to ensure accurate reporting of relevant information as required, they must upgrade their existing transaction systems. This may involve adopting more advanced database management systems to support the rapid storage and efficient querying of vast amounts of transaction data; introducing intelligent algorithms to automatically identify and classify different types of digital asset transactions for accurate extraction of required reporting information; and optimizing the system's user interface for staff to easily input and review new information fields.

• Data Retention: The document clearly states that brokers need to retain transaction-related information for at least seven years, which raises higher standards for brokers' data management capabilities. The volume of data related to digital asset transactions is enormous and continues to grow, and long-term data retention necessitates sufficient storage space to accommodate this data. Additionally, to ensure data integrity and availability during the seven-year retention period, effective data maintenance work is required, such as regularly backing up data to prevent data loss and establishing data indexing for quick retrieval of specific transaction data. This not only requires brokers to invest more in hardware resources, such as server storage space, but also necessitates a certain investment in human and material resources to manage the data lifecycle. Moreover, when tax authorities require this data for audits or tax enforcement activities, brokers must be able to quickly and accurately provide the relevant data, which poses strict tests for brokers' internal management processes and data response mechanisms.

5. International Coordination

In today's globalized context, the cross-border nature of digital asset transactions is becoming increasingly prominent. The document released by the U.S. Department of the Treasury and the IRS mentions coordination of information reporting rules with other countries. Cross-border digital asset transactions, due to their involvement with different countries' laws, regulations, tax policies, and regulatory environments, have always been a regulatory challenge. Different countries may have varying definitions, classifications, and tax treatments for digital assets, which can lead to regulatory loopholes. For instance, certain digital asset transactions may evade tax or compliance scrutiny in some countries due to ineffective regulation.

Therefore, by coordinating information reporting rules, the U.S. government hopes to establish a more unified information sharing and communication mechanism between countries. For example, when it involves cross-border digital asset transactions between U.S. investors and investors from other countries, the regulatory authorities of both countries can more efficiently obtain the true information about the transactions based on the coordinated rules. This helps ensure the transparency of cross-border digital asset transactions and avoids illegal trading behaviors caused by information asymmetry. Additionally, consistency in rules can reduce market distortion caused by policy differences among countries, allowing digital assets to be traded according to unified and fair standards in the global market, promoting the healthy and orderly development of the global digital asset market. Furthermore, such international coordination can enhance the efficiency of international tax cooperation, prevent taxpayers from exploiting regulatory differences for tax evasion, and maintain the effectiveness of the global tax system.

Overall, due to the anonymity of cryptocurrency transactions, their cross-border nature, and the complexity of transaction forms, the IRS believes that there has historically been a significant amount of unreported income and erroneous reporting. Therefore, this regulation primarily establishes information reporting responsibilities for various participants, such as brokers needing to report client transaction information, and real estate reporters being required to report real estate transactions involving digital asset payments, with the hope of establishing a comprehensive transaction information tracing system to enhance tax compliance levels.

For practitioners in the cryptocurrency industry, the accelerated pace of compliance progress may benefit the industry's development in the long term, but gradually straying from the mission of decentralized finance may pose more challenges for industry practitioners.