The U.S. Treasury and the IRS issued the final regulations on digital asset trading in 2024. The introduction of these regulations is a result of the Infrastructure Investment and Jobs Act pushing for strengthened tax regulation of cryptocurrencies, aimed at standardizing the tax reporting process for cryptocurrency and decentralized finance (DeFi) transactions, significantly improving tax compliance levels.
The regulation places clear requirements on DeFi brokers. It clearly defines the reporting obligations of DeFi brokers, stipulating that they must disclose detailed transaction information. This means that DeFi brokers need to accurately record various information related to transactions, including transaction amounts, types of traded assets, and information about both parties involved. At the same time, the regulation requires DeFi brokers to collect 'Know Your Customer' (KYC) information from users to better trace the sources and destinations of transactions, identify potential risk behaviors, and ensure that the entire transaction process is conducted within a legal and compliant framework.
Ultimately, this regulation is set to take effect on January 1, 2027. To allow relevant practitioners sufficient adaptation time, a transition period has been specifically established. During this period, starting in 2026, brokers will need to begin collecting data that meets the final regulatory requirements, as envisioned by the IRS. The purpose of this is to give brokers ample time to adjust their business processes, technical systems, and other relevant arrangements, thereby ensuring that they can smoothly comply with all regulatory requirements after the regulation takes effect and avoid chaos or violations in the new regulatory environment.
However, while these requirements in the regulation aim to strengthen oversight from a tax compliance perspective, they have also sparked considerable controversy within the industry. Some practitioners believe that this may affect the efficiency of transactions and the enthusiasm for innovation to some extent. For example, in an already complex cryptocurrency trading landscape, adding more reporting and information collection tasks could make the trading process more cumbersome and may restrict the development space of some emerging trading models or financial instruments. On the other hand, the essence of DeFi lies in decentralization, and the release of the 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 trading:
1. New information reporting requirements:
The regulation primarily imposes information reporting requirements on brokers. Brokers are defined as those who are prepared 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 customers' digital assets and facilitating trades between customers.
• Digital asset custody wallet providers: These wallet providers are also responsible for safeguarding customers' 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 directly conduct transactions of digital assets.
Broker reporting: Brokers are required to provide detailed reports on clients' total income from digital asset trading. This not only includes profits from traditional cryptocurrencies such as Bitcoin and Ethereum but also covers emerging digital asset trading revenues, such as those from non-fungible token (NFT) transactions. Additionally, adjusted baseline information is also within the reporting scope, which may involve initial investment costs and various fee adjustments during the trading process. The IRS aims to enable the tax authority to more accurately grasp the income situation in digital asset trading through these comprehensive reporting requirements. Previously, some clients might have used the anonymity of digital asset trading to engage in unreported income operations, while now, this reporting system from brokers can control from the source of the transactions.
In the real estate transaction market, when it involves the use of digital assets for payment, real estate reporters are also assigned corresponding reporting responsibilities.
2. Clear definitions and classifications:
The regulation clarifies the definition of digital assets and the scope of participants in both custodial and non-custodial sectors.
Specifically, in this document, digital assets are clearly defined as value representations recorded on a cryptographically protected distributed ledger, distinguishing this characteristic from cash. This form of value recording based on cryptographic and distributed ledger technology is key to differentiating digital assets from traditional assets. It encompasses a wide variety of types, among which cryptocurrencies are the most well-known, such as Bitcoin and Ethereum. It also includes stablecoins, NFTs, and more.
At the same time, the document meticulously distinguishes between custodial and non-custodial digital asset industry participants, clearly defining their respective responsibilities and obligations.
Custodial participants bear the responsibility for asset custody throughout the digital asset trading chain. They need to ensure the secure storage of digital assets, employing advanced encryption technologies and security measures to prevent theft or tampering of digital assets. During the trading process, custodial participants must also conduct preliminary reviews of the legality and compliance of transactions, such as verifying the identity information of both parties involved and the source and destination of the digital assets traded.
Non-custodial participants, while not bearing direct responsibility for asset custody, play an important role in facilitating digital asset trading and providing market information. They must comply with relevant market competition rules, ensuring that the trading information provided is true, accurate, and complete, avoiding fraud and market manipulation, and actively cooperating with regulatory agencies by providing necessary trading data and information for supervisory management.
3. Tax implications:
Under the new regulations, digital asset trading is explicitly considered a taxable event. Whether it is the exchange between cryptocurrencies, investment income from digital assets, or transactions involving non-fungible tokens (NFTs), as long as there is a transfer of value and the generation of income, they fall within the taxable category. The IRS believes that taxpayers therefore need to accurately report these transaction situations on their federal income tax returns. This might lead investors, in addition to considering risk and return, to also take into account possible cost deductions, such as initial investment costs and transaction fees.
4. Requirements for brokers' technology and operations:
• System upgrades: With the update of regulations related to digital asset trading, brokers and other industry participants face the challenges and demands of system upgrades. The new reporting requirements encompass more detailed and comprehensive collection, organization, and analysis of trading information. For example, brokers not only need to record basic information such as traditional transaction amounts but also pay attention to complex information such as specific types of digital assets, transaction timestamps, and the source and destination addresses of relevant digital assets. Existing trading systems may not meet these new requirements in terms of data structure design, data storage capacity, and information processing logic. Therefore, to ensure accurate compliance with reporting requirements, they must upgrade their existing trading systems. This may involve adopting more advanced database management systems to support the rapid storage and efficient querying of massive trading data; introducing intelligent algorithms to automatically identify and classify different types of digital asset transactions, thus accurately extracting the required reporting information; and optimizing the system's user interface to facilitate staff in entering and reviewing new information fields.
• Data retention: The document clearly stipulates that brokers must retain information related to transactions for at least seven years, setting a higher standard for brokers' data management capabilities. The sheer volume of data generated from digital asset transactions is large and continues to grow, and long-term data retention means sufficient storage space is needed to accommodate this data. Additionally, to ensure the integrity and availability of the data during the seven-year retention period, effective data maintenance work is required, such as regularly backing up data to prevent 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 certain human and material costs to manage the data lifecycle. Furthermore, when tax authorities need this data for review or tax enforcement activities, brokers must be able to swiftly and accurately provide the relevant data, which poses strict challenges to brokers' internal management processes and data response mechanisms.
5. International coordination:
In today's globalized context, the cross-border nature of digital asset trading is becoming increasingly prominent. The document released by the U.S. Treasury and the IRS mentions coordination of information reporting rules with other countries. Cross-border digital asset trading has always been a regulatory challenge due to the involvement of different countries' laws, regulations, tax policies, and regulatory environments. Differences in how various countries define, classify, and handle the taxation of digital assets may lead to regulatory loopholes, such as certain digital asset trades evading taxes or compliance checks 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, in cross-border digital asset transactions involving U.S. investors and investors from other countries, the regulatory agencies of both countries can more efficiently obtain accurate transaction information based on the coordinated rules. This helps ensure the transparency of cross-border digital asset transactions and prevent illegal trading behaviors arising from information asymmetry. Furthermore, consistency in rules can reduce market distortions caused by policy differences between 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. Moreover, this international coordination can enhance the efficiency of international tax cooperation, preventing taxpayers from exploiting regulatory differences between countries to evade taxes, thereby maintaining the effectiveness of the global tax system.
Overall, due to the anonymity of cryptocurrency trading, its cross-border nature, and the complexity of trading forms, the IRS believes that there have been many instances of unreported income and erroneous reporting in the past. Therefore, this regulation mainly aims to establish a relatively complete transaction information tracing system by specifying the information reporting responsibilities of various participants, such as brokers needing to report client transaction information, and real estate reporters being responsible for reporting real estate transactions paid with digital assets, thereby enhancing tax compliance levels.
For practitioners in the crypto industry, on one hand, the acceleration of compliance progress is beneficial for the industry's development in the long run, but on the other hand, gradually deviating from the mission of decentralized finance may bring more challenges to industry practitioners.
