In 2024, the U.S. Treasury and the IRS issued the final regulation on digital asset trading. The issuance of this regulation is a result of the Infrastructure Investment and Jobs Act, which promotes the strengthening of cryptocurrency tax regulation, aimed at standardizing the tax reporting processes for cryptocurrency and decentralized finance (DeFi) transactions and significantly enhancing tax compliance levels.
Article author, source: FlowHarbour Research
In 2024, the U.S. Treasury and the IRS issued the final regulation on digital asset trading. The issuance of this regulation is a result of the Infrastructure Investment and Jobs Act, which promotes the strengthening of cryptocurrency tax regulation, aimed at standardizing the tax reporting processes for cryptocurrency and decentralized finance (DeFi) transactions and significantly enhancing tax compliance levels.
This regulation specifically imposes clear requirements on DeFi brokers. It explicitly defines the reporting obligations of DeFi brokers, requiring them to 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 assets, and information about the parties involved. At the same time, the regulation requires DeFi brokers to collect 'know your customer' (KYC) information to better track the sources and destinations 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 take effect on January 1, 2027. To provide relevant practitioners with 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 allow brokers ample time to adjust their business processes, technology systems, and other related arrangements so that they can smoothly comply with all regulatory requirements after the regulation takes effect, avoiding confusion or violations in the new regulatory environment.
However, while these requirements in the regulation are intended to strengthen oversight from a tax compliance perspective, they have also sparked considerable controversy within the industry. Some practitioners believe that they may affect transaction efficiency and innovation to some extent. For example, in an already complex cryptocurrency trading environment, adding more reporting and information collection work may make the transaction process more cumbersome and could limit the development space for some emerging trading models or financial instruments. Of course, on the other hand, the essence of DeFi lies in decentralization, and the release of this document can be said to completely strip 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.
New information reporting requirements:
This regulation mainly 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. The main categories include:
1. Custodial digital asset trading platform operators: These platform operators are responsible for safeguarding customers' digital assets and facilitating transactions between customers.
2. Digital asset custodial wallet providers: These wallet providers are also responsible for safeguarding customers' digital assets.
3. Payment processors (PDAPs): These processors are responsible for handling payments involving digital assets, such as through blockchain networks.
4. Digital asset self-service terminals: These terminals allow users to directly conduct digital asset transactions.
Broker reporting: Brokers are required to report in detail the total income customers earn from digital asset transactions. This not only includes profits from traditional cryptocurrencies like Bitcoin and Ethereum but also encompasses emerging digital asset trading income, such as from non-fungible token (NFT) transactions. Additionally, adjusted basic information is also within the reporting scope, which may involve the initial investment cost and various fee adjustments during the transaction process. The IRS hopes that through this comprehensive reporting requirement, the tax department can more accurately grasp the income situation in digital asset transactions. Previously, some clients might have utilized the concealment of digital asset transactions to operate unreported income, but now this reporting system from brokers can control from the source of transactions.
In the real estate transaction market, when it involves using digital assets for payments, real estate reporters are also assigned corresponding reporting responsibilities.
Clear definitions and classifications
The regulation clarifies the definition of digital assets and the scope of custodial and non-custodial industry participants.
Specifically, in this document, digital assets are clearly defined as value representations recorded on encrypted distributed ledgers, which distinguishes them from cash. This form of value recording based on encryption technology and distributed ledger technology is key to differentiating digital assets from traditional assets. It encompasses a rich variety of types, with cryptocurrencies being the most well-known types, such as Bitcoin and Ethereum. Additionally, it also includes stablecoins, NFTs, and others.
At the same time, the document carefully distinguishes between custodial and non-custodial digital asset industry participants, clearly defining their respective responsibilities and obligations.
Custodial participants bear the responsibility of asset custody throughout the digital asset transaction chain. They need to ensure the secure storage of digital assets, use advanced encryption technologies and security protection mechanisms to prevent theft, tampering, and other issues. During the transaction process, custodial participants must also conduct preliminary checks on the legality and compliance of transactions, such as verifying the identity information of both parties involved in the transaction and tracking the source and destination of the digital assets.
Non-custodial participants, while not bearing direct custody responsibilities, play important roles in transaction matching and providing market information regarding digital assets. They must adhere to relevant market competition rules, ensuring that the transaction information they provide is true, accurate, and complete, and must not engage in fraud, market manipulation, or other improper activities. They are also required to actively cooperate with regulatory authorities by providing necessary transaction data and information for supervision and management.
Tax implications
Under the new regulations, digital asset trading is explicitly regarded as a taxable event. Whether it is the exchange of cryptocurrencies, investment gains from digital assets, or transactions involving non-fungible tokens (NFTs), as long as value transfer occurs and gains are formed, they fall within the taxable scope. The IRS believes that taxpayers need to accurately report these transactions in their federal income tax returns. This may lead investors, in addition to considering risk and return when participating in investments, to also consider potential cost deductions, such as initial investment costs and transaction fees.
Requirements for broker technology and operations:
1. System upgrades: With the updates to regulations related to digital asset trading, brokers and other industry participants face challenges and needs for system upgrades. The new reporting requirements cover more detailed and comprehensive collection, organization, and analysis of transaction information. For instance, brokers not only need to record basic information such as traditional transaction amounts but also must pay attention to specific types of digital assets, transaction timestamps, and the source and destination addresses of related 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 reporting of relevant information as required, they must upgrade their current trading systems. This may involve adopting more advanced database management systems to support the rapid storage and efficient querying of massive transaction data; introducing smart algorithms to automatically identify and classify different types of digital asset transactions, thereby accurately extracting the required reporting information; and optimizing the system's user interface to facilitate staff in entering and reviewing new information fields.
2. Data retention: The document clearly stipulates that brokers need to retain transaction-related information for at least seven years, raising higher standards for brokers' data management capabilities. The volume of data from digital asset transactions is vast and continually growing, and long data retention means needing sufficient storage space to accommodate this data. Additionally, to ensure the integrity and availability of the data during the seven-year retention period, effective data maintenance work must be conducted, such as regular backups to prevent data loss and establishing data indexes 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 investing certain human and material resources to manage the data lifecycle. Furthermore, when tax authorities require this data for audits or tax enforcement activities, brokers must be able to provide relevant data quickly and accurately, which poses strict tests on brokers' internal management processes and data response mechanisms.
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 coordinating information reporting rules with other countries. Cross-border digital asset trading, due to its involvement with the laws, regulations, tax policies, and regulatory environments of different countries, has always been a regulatory challenge. Different countries may have discrepancies in their definitions, classifications, and tax treatment of digital assets, which can lead to regulatory loopholes. For instance, certain digital asset transactions might evade tax or compliance scrutiny in some countries.
Therefore, by coordinating information reporting rules, the U.S. government hopes to establish a more unified information sharing and communication mechanism among countries. For example, in cross-border digital asset transactions involving U.S. investors and investors from other countries, the regulatory authorities of both countries can more efficiently obtain real transaction information based on the coordinated rules. This helps ensure the transparency of cross-border digital asset transactions and avoids illegal trading activities arising from information asymmetry. At the same time, the consistency of rules can reduce market distortions caused by policy differences among countries, allowing digital assets to be traded in the global market according to unified and fair standards, 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 and maintaining the effectiveness of the global tax system.
Overall, due to the anonymity, cross-border nature, and complexity of cryptocurrency transactions, the IRS believes that there have been many instances of unreported income and erroneous reporting in the past. Therefore, this regulation mainly establishes reporting responsibilities for various participants, such as brokers needing to report customer transaction information, and real estate reporters being required to report real estate transactions involving digital asset payments, hoping to establish a more complete transaction information traceability system to enhance tax compliance levels.
For practitioners in the cryptocurrency industry, on one hand, the accelerated progress of compliance may help the industry's development in the long run, but on the other hand, gradually deviating from the mission of decentralized finance may pose more challenges for industry practitioners.