Are there any tax issues in participating in Defi projects?

Original title: "Viewpoint | Is there any tax problem in participating in Defi project?" "

Original Source: Encryption Valley

DeFi has reshaped the existing financial system, but the solution is still similar to before. This is actually more useful than it sounds because it shows us which systems are working and why they are working the way they are. But there are also some real innovations in DeFi and blockchain, allowing transactions and interactions that are simply not possible in traditional finance.  

Including atomic transactions, flash loans and tokenized certificates.

Tokenization of DeFi 

My favorite is tokenization of certificates . When your bank is well funded, you can use assets such as stocks, mutual fund shares, cars, etc. as collateral to participate in other financial transactions. DeFi not only decentralizes this logic, but takes it a few steps forward.

Take Yearn’s yUSD as an example, a high-yield, high-risk USD stablecoin. Here's what happens next:

You deposit your stablecoin (e.g. USDT) into Yearn, which feeds Compound and Aave. In return, you get a "receipt" called yUSDT. At any time, you can go to Yearn with the "receipt" and withdraw your original USDT + interest from Yearn.

Your yUSDT will be put into the Curve Y pool, which is a stablecoin liquidity pool that only trades yToken. But from the user's point of view, they can trade with common stablecoins and fund pools. In return for yUSDT, Curve will issue you yCRV representing your share of the pool.

Finally, you can deposit yCRV into the yUSD fund pool, and the fund pool will use them to automatically claim and sell CRV (Curve’s native Token, which is paid to LP), to get more yCRV. It issues yUSD as a "receipt" for any profits accumulated during the yCRV+ period.

So the user's original USDT deposit is used in three different protocols at the same time, and earns them three sources of income (Compound/Aave interest, Curve transaction fees, Curve’s CRV rewards). While this also magnifies the risks, including those of the economy and smart contracts, this is still a major innovation.  

The hidden tax problem of Tokenization

Because Tokenization is easy to implement and Very practical, so it has become the implementation standard for all DeFi projects. For example, users get cToken on Compound, aTokens on Aave, UNI-LP Token on Uniswap, and so on.  

An issue that has not received as much attention so far is how these transactions are affected by the tax. I recently finished my 2019 crypto tax report and used the opportunity to look ahead to 2020 trends. In the process, I have interacted with many different DeFi systems. Among them, I asked my (German) accountant about transactions such as tokenization events, and his advice was: these transactions are likely to be subject to taxation.  

For example, when you deposit ETH into Compound and get cTokens in return, this may constitute selling ETH for cETH, thereby realizing the capitalization of ETH gain (or loss). The same is true when you decide to exchange cETH back to ETH. This logic of Token  taxation can also be applied to US citizens.  

Now I want to disclose a few things. I'm neither a tax lawyer nor an accountant, and I don't think issuing a token should constitute an exchange. After all, how is that any different than when you deposit cash in the bank (transfer from a "cash account" to a bank account)? I've always been very conservative when it comes to taxes. So I think everyone should be aware that in all of DeFi, taxes have a negative impact on transactions.  

Token Contract VS. Non-Token Contract 

The core of this One question is what constitutes an actual exchange. Why does ETH appear to be transferred by Token in some transactions but not in others?  

When people start getting into crypto, they naively think they have a token for their account. But in fact, his account and balance are Token. Token is an entry in the Token contract database deployed on Ethereum. This contract consists of a graph of accounts + balances and a set of functions for updating the graph. When you want to trade a token, instead of sending a message to the recipient, you send a message to the token contract asking to debit your balance and credit someone else's.  

Think from an accountant's perspective: 

You transfer Token A to smart contract, and remove it from your account.

You will receive a "receipt" token, which will be added to your account.

I think this could easily be read as a sales process, especially considering that both are happening! But what if we stop after step 1? This is the case for tokenless contracts. For example, when you stake UNI-LP tokens in Uniswap DAO, you will not get any "receipt" Token.  

In fact, the way they track your claim on the underlying collateral is the same as the way they track the Token contract. There is a database somewhere in the contract storage, which has the same account and Token balance map. You can also send a message to the contract and ask it to return the collateral to you.  

Should we believe, then, that the question of taxation depends entirely on whether the contract in question is an ERC-20 token contract or something else? Review Take a look: 

I think it is indeed possible that a "receipt" Token could constitute a taxable event, at least in the absence of better guidance.

We don't know if this means tokenless contracts are taxable, but that doesn't seem to be the case.

If you engage in these transactions, please discuss this with your accountant. When it comes to taxes, it's better to be safe than sorry.

But if the Token contract is taxable, and the Token-less contract is not (logically speaking, it should not be), then the contract can record the transaction on the chain To improve UX for users and tax authorities.

Increased customization 

First, contracts like Compound and Aave can increase A checkbox that allows the user to decide whether to receive a "receipt" token. This will allow them to make choices consistent with their own local regulations.  

Instead of manually updating all contracts and adding more options, there can also be a higher-level gateway, which itself is token-free and supports There are "receipt" tokens without passing them to the user. For example, you can deposit and withdraw ETH in Aave through the gateway without touching aETH itself.  

In fact, nothing that happens inside the Token-less contract does not seem to generate a taxable event, which also greatly benefits exchanges such as Uniswap or Balancer So its LP. If you have liquidity in these pools, the market will constantly rebalance you as the price moves randomly. All of these transactions would constitute sales if they occurred on a CEX. But since a Token represents your share in the fund pool, so similar to previous LPs 

sell their pair of Tokens, such as ETH + USDC , in exchange for LP Token, so as to establish a cost base;

After that, sell LP Token with (hopefully) more ETH and USDC, so as to achieve a sale instead of Millions of possible occurrences in between.

I know this post raises more questions than it answers, but I hope you agree that treating credentials stored in ERC-20 Token contracts Credentials in non-token contracts don't have any real logical justification. I also hope that if you regularly transact with tokenized credentials, you can work with your local accountant or tax attorney to find your own answers.

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