The recent Internal Revenue Service (IRS) reporting rule designating decentralized finance (DeFi) front-ends as brokerages has sent shockwaves through the crypto industry. Alex Thorn, the head of research at Galaxy Digital, outlined three potential options for DeFi if the IRS rule is not backtracked.

According to Thorn, DeFi services and applications can comply with the IRS reporting requirements and accept the designation as a brokerage, attempt to block users from the United States, or abandon smart contract upgrades and revenue generation. Thorn wrote:

"DeFi applications with no front-end website, non-upgradeable contracts, and that receive no ‘consideration’ from the disposition of digital assets —i.e., collect no fees — could be exempt from being designated ‘brokers’ under the proposal."

"Said another way, extremely decentralized applications are not in a position to know and thus could not comply with broker reporting requirements," Thorn continued.

Following the IRS' final reporting rule, crypto industry advocacy groups and executives mobilized and voiced widespread criticism that culminated in litigation against the IRS.

Final IRS reporting rule. Source: Internal Revenue Service

IRS reporting rule faces intense opposition

The IRS issued the final rule change on Dec. 27, 2024. According to the agency, "Trading front-end service providers" will be treated as brokerages — a definition that includes decentralized exchanges. If finalized, the change will take effect in 2027.

Crypto industry executives called on Congress to block the rule and characterized it as government overreach. Consensys attorney Bill Hughes called out the timing of the rule in a social media post:

"This rule has been ready to go for a while now. They dump it on the last Friday of 2024, in the middle of a holiday stretch on purpose, obviously —as if we wouldn’t notice or make an absolute ruckus over it."

A joint lawsuit was immediately filed against the Internal Revenue Service by Texas Blockchain Council, the Blockchain Association, and DeFi Education Fund on Dec. 27.

"This case is about unlawful and unconstitutional overreach by the Department of the Treasury and the Internal Revenue Service," the lawsuit filing read.

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