IRS Targets DeFi Platforms with New Reporting Rules

The regulations are part of the 2021 Infrastructure Investment and Jobs Act, which aims to close tax loopholes in the crypto industry by expanding the definition of “broker”

The Internal Revenue Service (IRS) is targeting decentralized finance (DeFi) platforms with new reporting rules as part of the 2021 Infrastructure Investment and Jobs Act.

The legislation, which aims to close tax loopholes in the crypto industry, expands the definition of “broker” under section 6045 of the Internal Revenue Code to cover central exchanges, non-custodial wallets, smart contracts, and many more DeFi applications. To that end, the IRS coined the term “digital asset middlemen.”

To cover intermediaries of cryptocurrency transactions even when these never come into their hands. It implies that trustless systems such as smart contracts would need to satisfy the requirements from the service.

"The definition of 'broker' in Section 6045 of the Internal Revenue Code is broad and is intended to apply to any person who is required to report information on behalf of another person with respect to one or more transactions in digital assets," an IRS official told.

The new rules require the brokers to report “gross proceeds,” the amount brought in from a transaction, without expenses such as fees.

In essence, platforms will need to devise systems to track and report every transaction, which is a huge challenge in decentralized systems that are expected to respect privacy and self-sovereignty.

This change may lead to increased transparency and higher compliance costs for platforms, pushing the latter to charge more or adapt their services. Smaller DeFi platforms will suffer from new requirements, leading them to migrate to other places that do not have such strict laws or to close down completely.

Some see these changes as a move toward legitimizing the crypto industry. However, others see them as a threat to the decentralization and anonymity principles that are crucial to the DeFi ecosystem.

Ultimately, the future of the DeFi ecosystem will depend on how well it can balance the demands of regulatory compliance with the principles that underpin its decentralized nature. Only time will tell what form this balance will take.