IRS Demands KYC for DeFi in “Unlawful” Tax Reporting Rule
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With just four days left in 2024, the Internal Revenue Service (IRS), the tax and revenue enforcement agency of the U.S. government, finalized its broker rule, which will require know-your-customer (KYC) for DeFi front-ends by 2027.
The document, which is set to be published on Dec. 30, states that trading front-end service providers are to obtain identification information from users, report crypto and NFT positions to the IRS, and withhold services from users that do not comply.
In this case, “trading front-end service” includes any service that “with respect to a sale of digital assets, receives a person’s order to sell and processes that order for execution.”
This move is a strong-armed approach meant to ensure proper and maximum tax reporting within the United States. While tax reporting laws require participants to report their transactions to the IRS, forced KYC procedures is likely to cut down the number of active decentralized finance (DeFi) users, and suck money out of the ecosystem.
“Clear information reporting rules that require reporting of gross proceeds from a sale of digital assets in DeFi transactions will help the IRS identify taxpayers who have engaged in these transactions,” the document says. “These rules will also remind taxpayers who engage in DeFi transactions that the transactions are taxable, thereby reducing the number of inadvertent errors or noncompliance on their Federal income tax returns.”
Part Two
This document is considered part two of its crypto broker reporting regulations. Part one was published on June 28, primarily targeting centralized exchanges and asset custodians.
The reporting rules, which will be finalized before 2025 began to circulate at the beginning of 2024, with some claiming these regulations will lead to the death of DeFi.
Based on the definition provided, trading front-end services is a broad term which may include marketplaces, but could expand into indexing or RPC node providers. The only parties that are definitively excluded are validators, miners, and infrastructure providers that do not facilitate transactions.
DeFi protocols are built on public blockchains and can be accessed permissionlessly via non-custodial wallets. Users can trade directly via smart contracts, or through front-ends like apps and websites that facilitate use. Requiring KYC procedures on front-ends to access DeFi would upend the entire sector, as it is purposely built not to collect and hold user data.
Ecosystems can become significantly more centralized if nodes and services are forced to shut down, and liquidity will be strained as volumes and contributions diminish due to an outflux of non-compliant users.
Trump Card
President-elect Donald Trump, who is set to take office in January 2025, is behind DeFi platform World Liberty Financial. The project’s associated wallet has also been on a buying spree, allocating to blue-chip DeFi tokens such as AAVE, LINK, ONDO, and ENA - none of which require KYC - in a potential show of support towards the industry.
Jake Chervinsky, the chief legal officer at Variant Fund took to social media to speak on the rules, calling them “unlawful” and a “dying gasp of the anti-crypto army on its way out of power.”
The IRS will publish the document before the end of year, leaving the DeFi industry with an uphill battle to fight, and eyes will be turned towards Congress under the new presidential administration.
“Terrible ruling aimed at kneecapping DeFi in the final days of the current admin. Hopefully it’s thrown out using the congressional review act and if not it likely won’t stand up to legal challenges,” said Hayden Adams, the CEO of Uniswap Labs, on X.
Uniswap is preparing for its own legal battle with the U.S. Government after being served a Wells Notice from the Securities and Exchange Commission (SEC) in April.
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