Demystifying DeFi Tax With Koinly
DeFi Pulse, a leading authority on the DeFi space, calculates that the combined value of all deposits within DeFi protocols hit over US$100 billion at its peak in late 2021.
However, after the recent market crash, DeFi’s total deposits now sit just shy of US$40 billion – a 60% reduction, in line with the broader drop in the crypto market.
When it comes to DeFi taxes, guidance can be inconsistent, with tax offices around the globe racing to stay up to speed with the rapidly changing sector.
“DeFi tax all comes down to the specific transaction you’re making and how the protocol you’re using works,” said Danny Talwar, Australian Head of Tax at crypto tax platform Koinly.
DeFi protocols like Maker, AAVE, Compound, Synthetix and others mean everything from staking to liquidity mining, yield farming, and more are all taxable. However, understanding the implications of your actions in the DeFi world can be confusing even for seasoned crypto investors. Koinly’s how-to guide is here to break it down.
Yield farming taxes
If you’ve been Yield Farming, the taxes you may have to pay depends on how the DeFi protocol you’re using works. Receiving tokens in exchange for your assets likely dictates a Capital Gains Tax event.
“An example would be swapping ETH for a yield-generating token and depositing this into a liquidity pool. The taxable event in this scenario would be selling/swapping your ETH into another token, creating a capital gain or loss,” Talwar stated.
“Conversely, if you’ve received new tokens after depositing your digital assets in order to generate yield, this would likely be viewed as additional income. These tokens would be subject to Income Tax, as the tokens are considered as income from a taxation perspective.”
“However, if you then sell these tokens, not only are they considered income, but you’ll also have capital gains or losses upon selling them. Essentially a double whammy,” he said.
It’s important to note the fair market value of your tokens at the point you received them. This will dictate the amount of income received, so if you hold off from selling and the price of the token decreases, you’ll still owe Income Tax at the value, you received them.
Staking can refer to two different kinds of activities in the DeFi space – staking as part of a Proof of Stake (PoS) consensus mechanism – like SOL, AVAX or ADA – or staking tokens in DeFi protocols to earn rewards. This is an important distinction, as the two may have different tax implications – depending on how the DeFi protocol works.
“If you’re staking as part of a PoS consensus mechanism – for example, using Chorus One to stake SOL – you’ll need to pay Income Tax on your staking reward and Capital Gains Tax on any profits when you later sell, swap, spend or gift staking rewards,” Mr Talwar continued.
If you’re staking in DeFi protocols – you’ll pay tax. However, depending on how the DeFi protocol you’re using works will dictate what type of tax you’ll be up for.
Similar to the yield farming example, if you’re ever swapping one digital asset for another, this will result in capital gains tax. In contrast, if you’re depositing a token to earn another, this will mean you’re up for income tax.
How to calculate, report and file your DeFi crypto taxes in 5 steps
Now you know more about how DeFi is taxed – you can see how complex crypto tax reporting can be. Save yourself hours of pain and use crypto tax software like Koinly to calculate and file your crypto taxes in five simple steps.
Sign up free to Koinly and connect all your wallets, exchanges and blockchains. Koinly supports over 700+ integrations, allowing you to connect wallets, and addresses, exchange APIs or import CSV files of your transaction history.
Grab a coffee and let Koinly do its stuff. Koinly will consolidate your entire crypto transaction history and identify which transactions are taxable and which aren’t. It’ll then calculate your cost basis, capital gains or losses and the fair market value of any crypto income on the day you received it.
Download your crypto tax report. Koinly can generate a huge variety of reports to make filing your crypto taxes simple. Then just download the tax report you need when you need it.
Use your crypto tax report to file your preferred way. Hand your reports over to your accountant, upload your crypto tax report to your tax app or file by post.
Relax – you’re done for another year.
About Koinly: Whether it’s Crypto, DeFi or NFTs, Koinly saves you valuable time by reconciling your holdings to generate a compliant tax report in under 20 minutes.
Sign up today and see how much you owe!
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