IRS Draft Form Raises Alarm for Crypto Users as DeFi Addresses May Be Exposed

Amidst the release of the IRS's draft Form 1099-DA, the crypto industry is grappling with the potential implications for DeFi users. The form suggests that American DeFi users may be subject to reporting their self-custodial wallet addresses to the government, raising concerns that DeFi's pseudonymity and privacy features could be undermined. This has sparked debate within the crypto community, with some experts expressing hope that future versions of the form will exclude such reporting requirements.

Draft IRS Form Raises Alarm in Crypto Industry

Washington, D.C. - A draft version of a new Internal Revenue Service (IRS) form has sparked widespread concern within the cryptocurrency industry, with provisions that could potentially require American users of decentralized finance (DeFi) protocols to disclose their self-custodial wallet addresses to the federal government.

1099-DA Form and Broker Classification

The document, Form 1099-DA, is scheduled to become mandatory for filing in 2025 for any crypto transactions deemed by the IRS to have originated from a broker. The definition of "broker" in this context remains uncertain. Crypto exchanges are expected to be designated as brokers, but concerns have been raised that the IRS may also classify DeFi traders as brokers.

Self-Custodial Wallets Implicated

The draft 1099-DA form includes a section where filers are asked to specify the type of broker involved in the crypto transaction. One option is "Unhosted Wallet Provider," which refers to self-custodial crypto addresses not associated with any third-party entity. This has led legal experts to conclude that the IRS intends to classify DeFi protocols, which operate on automated software and prioritize user privacy, as brokerage firms similar to traditional financial institutions.

Impact on DeFi and Pseudonymity

The prospect of DeFi users being forced to disclose personal information comparable to traditional brokerage customers has alarmed many in the crypto industry. Builders and traders fear that such a move could undermine the concept of pseudonymity, a fundamental aspect of DeFi.

"The inclusion of open source wallet software providers who do not broker transactions in any way as 'brokers' is unconstitutional under both the First and Fourth Amendments," declared a spokesperson for Coin Center, a crypto lobbying group. "We urge future versions of the form to exclude this provision."

Public Comment and Ongoing Concerns

The IRS's intention to expand its definition of "broker" to encompass crypto firms and projects was first announced last fall, triggering a period of public comment that lasted several months. During that time, crypto lobbying groups implored the IRS to reconsider the definition, arguing that it could stifle DeFi development in the United States. Decentralized exchanges (DEXs) would face significant challenges in obtaining personal information from their anonymous user bases.

However, the draft 1099-DA form suggests that the IRS has not been swayed by these concerns.

Legal Challenges and the Future

Shehan Chandrasekera, head of tax strategy at crypto tax service CoinTracker, expressed pessimism in the aftermath of the draft form's release, stating, "I don't think crypto will be pseudonymous or privacy-preserving anymore, at least in the U.S."

However, not all legal experts share this view. Jake Chervinsky, Chief Legal Officer of crypto venture firm Variant Fund, reminded followers on social media that the IRS does not have the final say on whether DeFi users should be considered brokers.

"Good news: Rules that make literally no sense at all rarely survive scrutiny in the courts," Chervinsky tweeted. "Great news: We really like filing lawsuits."

The ultimate resolution of this issue will likely be determined in the judicial system, as has been the case with many other unresolved questions in the crypto space.