Page 71 - BusinessWest February 21, 2022

By Brendan Cawley, EA Wand Ian Coddington, CPA
hile cryptocurrency has been around since 2008, its popu- larity has soared over the past two years as people dove into new interests during
the pandemic. Whether you used your time in lockdown to learn how to bake banana bread or mine Dogecoins, it’s important to note that the latter may have come with some tax impli- cations.
If you dipped your toes in the virtual currency waters, you may now be wondering — how will my transactions during the year affect my tax return? Our goal here is to give some basic insight into the crypto market, decentralized finance (‘DeFi’), and how the transactions along your cryptocurrency journey can affect your tax return this year and beyond.
What Is Cryptocurrency?
The IRS currently views cryptocurrency as a type of virtual currency. Virtual currency, such
as Bitcoin, Ether, Roblox and V-Bucks, to name a few examples, is a digital representation of value, rather than a representation of the U.S. dollar or a foreign currency (‘real currency’), that functions as a unit of account, a store of value, and a medi- um of exchange.
Cryptocurrency uses cryptography to secure transactions that are digitally recorded on a dis- tributed ledger, such as a blockchain. The block- chain technology allows participants to confirm transactions without the need for central clearing
BRENDAN CAWLEY
IAN CODDINGTON
ing, and investment options for their customers. Services often come with fees and can result in delays to accessing or withdrawing funds.
By using blockchain technology, users can validate transactions from peer to peer within a matter of seconds. Transactions can take place all around the world across computer networks without the need of a central authority. This is where DeFi comes in, where users can engage in contracts for lending, borrowing, and other financial services at the click of a button. These contracts are created through algorithms, rather than underwritten by a loan officer. Additionally, fees associated with central banks and the delay in completing certain transactions are no longer an issue.
There are several popular DeFi platforms, such as UniSwap, PancakeSwap, Fantom, Aave, and SushiSwap, to name a few. These platforms offer different services to consumers: staking, liquidity pools, yield farming, along with traditional lend- ing and borrowing. Investors who have gotten
in at the initial stages have been seeing massive returns on their investments. Services such as yield farming and liquidity pools lock in crypto- currency assets to facilitate blockchain transac- tions and pay participants rewards in the form of cryptocurrency. However, the IRS has not deter- mined specific guidance on the treatment of spe- cific transactions within the DeFi space.
Consumers and investors are tempted to par- ticipate in the Defi market by varying annual percentage yields (APY) of 3% to 15%, sometimes even more. This is a far cry from the 0.01% APY that you might get in your local bank’s saving account or the 1% APY in a certificate of deposit. The riskiness involved in these transactions, as
“The landscape of cryptocurrency and digital assets is evolving daily. The variety of investment options continues to expand, as does the number of investors.
authority.
With that in mind, decentralized finance
(DeFi) has quickly become the hottest trend in blockchain technology, but it comes with its own uniquely complicated and confusing tax situa- tions. And if learning how to navigate cryptocur- rency and DeFi wasn’t complex enough, you have to do so with very little IRS guidance.
What Is Decentralized Finance?
When you think of centralized finance, you might think of banks, such as Bank of America or JPMorgan, which traditionally offer savings, lend-
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