US Crypto Broker Rules: Bitter Medicine or Deadly Poison?

Author: TaxDAO

An Overview of the Evolution of U.S. Crypto-Asset Tax Regulation and

Reporting Requirements

Looking back at the history of tax regulation of crypto-assets in the United States, its evolution path is relatively clear. In 2014, the IRS issued Notice 2014-21, which officially defined cryptocurrency as property rather than currency and established a corresponding tax treatment framework. In 2021, the signing of the Infrastructure Investment and Jobs Act (IIJA) requires that all transactions involving crypto assets must be reported, and Form 8300 is introduced, which expands crypto asset transactions to the reporting scope of Form 1099, and also expands the reporting scope of crypto assets. Tax supervision of transactions has been raised to a new level. With the IRS's draft on brokers' reporting of digital asset sales and transactions recently finalized, the U.S.'s tax supervision of crypto assets has entered an unprecedentedly stringent stage.

The "Gross Income Reporting Requirements for Brokers who Regularly Provide Digital Asset Sales Services" (hereinafter referred to as the " Reporting Requirements ") is an important document developed by the United States Internal Revenue Service (IRS) to standardize tax reporting on digital asset transactions. The “Reporting Requirements” details a series of tax reporting requirements that brokers must follow when providing digital asset sales and trading services to clients. It clarifies the definition of a broker to include traditional digital asset trading platforms, payment processors, custodial wallet providers, and decentralized finance (DeFi) service providers that automate transactions through software or smart contracts. This means that even if a DeFi platform does not directly hold customer private keys or digital assets, as long as it provides core services such as transaction interfaces, order processing and execution, it must comply with corresponding tax reporting regulations. In addition, the "Reporting Requirements" also stipulates specific matters such as report content and format, reporting time and frequency, etc., providing clear operational guidelines for brokers, and also provides a basis for the IRS to monitor digital asset trading activities and supervise tax compliance. .

Form 1099-DA is a tool used by the IRS to deal with the increasingly frequent transactions of crypto assets and the difficulty of tax supervision. Its comprehensiveness and detail are eye-catching. The form requires brokers to not only disclose in detail the date and type of transaction (e.g., buy, sell, exchange, etc.), but also to accurately report the transaction amount, covering total proceeds and possible gain, loss and cost basis information. It is particularly critical that brokers provide comprehensive information about investors, including names, addresses, social security numbers, and by extension the specific type and amount of digital assets and their fair market value.

A must-do when good medicine tastes bitter?

The introduction of new regulations has imposed stricter tax reporting requirements on crypto asset brokers. In order to meet strict reporting standards, brokers must fully implement KYC (Know Your Customer) policies, which will lead to a significant increase in their operating costs and make compliance more difficult. The entire industry is therefore facing new challenges.

From an anti-money laundering perspective, the lack of transparency in crypto-assets may constitute a vulnerability in the financial defense line. Money laundering activities disrupt the normal order of financial markets and provide financial cover for various criminal activities. As an important participant in the financial market, the transaction data and customer information held by brokers are an important data basis for anti-money laundering monitoring. Strict reporting requirements can help promptly detect and block money laundering routes, thereby inhibiting the growth and spread of financial crimes.

The low transparency of cryptoassets can also be problematic when it comes to counter-terrorism financing. Terrorist financing is the economic basis for the continuation and expansion of terrorist activities. As participants in financial activities, brokers have the obligation and ability to monitor and report suspicious transactions and provide key intelligence to counter-terrorism departments to cut off terrorists' funding sources and maintain national security and social stability.

Reporting requirements for crypto-asset brokers are also particularly important in terms of anti-tax evasion. Tax evasion will weaken the country's fiscal foundation and undermine tax fairness and market order. As a part of the tax collection and administration system, the reporting obligations followed by brokers help tax authorities accurately identify tax evasion behaviors, strengthen tax management, and maintain the fairness and authority of the tax system. Therefore, increasing the transparency of crypto assets, through broker reporting requirements, is an important measure to combat these potential issues.

Compliance pain or deadly poison?

The “Reporting Requirements” have had a significant impact on the DeFi field. DeFi, with its decentralization and anonymity, provides flexible and efficient financial services outside the traditional financial system. However, the strengthening of supervision may seriously challenge these characteristics. On the one hand, Form 1099-DA requires brokers to disclose investors’ wallet addresses and transaction quantities. The implementation of the resulting KYC policy will weaken the anonymity of DeFi, forcing investors to change their trading habits, provide true identity information, and reduce transaction costs. Privacy. On the other hand, in order to meet reporting requirements, DeFi platforms need to invest more resources and energy to collect, organize and report user transaction data. This will undoubtedly increase operating costs, indirectly affect the autonomous operation of smart contracts, and increase the need for human intervention. Adversely affects the autonomous operation and decentralized governance of smart contracts. More importantly, the "Reporting Requirements" may have a profound impact on the DeFi ecosystem. It challenges DeFi's core mission of popularizing the ease of use of currency and payment methods and promoting the globalization and decentralization of financial services. If DeFi becomes transparent and de-anonymous, its market appeal and development potential will be greatly reduced.

The "Reporting Requirements" not only affect DeFi, but also create waves in the entire encryption industry. The new regulations put crypto-asset brokers under dual pressures of compliance and operating costs, forcing them to devote more resources to meeting regulations. This may cause small or start-up brokers to withdraw due to unbearable costs, and market competition and industry reshuffle will intensify. At the same time, the new regulations have triggered controversy over privacy, data security, and constitutional rights; the new regulations also pose a potential threat to the innovation and development of the encryption industry. The crypto industry urgently needs a loose and flexible regulatory environment to stimulate innovation. However, the compliance pressure and increased costs brought about by the new regulations may inhibit the industry's innovation momentum.

To a certain extent, the crypto broker rules are like a bitter medicine, aiming to improve tax transparency, combat illegal activities, and ensure tax fairness and market order. However, the eagerness of its operation also makes people worry about whether it will become a fatal poison that puts the encryption industry in a desperate situation. It is undeniable that the implementation of this rule is indeed a bit hasty. In the context of the rapid development of the encryption industry, how to find a balance between encouraging innovation and strengthening supervision is an urgent problem that needs to be solved. In addition, considering the pro-crypto asset attitude of the Trump administration, Trump may veto the "Reporting Requirements" before the effective date, leaving more relaxed development space for the encryption industry.

Of course, what we must face is that if this rule comes into effect, it will inevitably have a certain impact on the decentralized finance (DeFi) industry. As an emerging force in the crypto field, the core of decentralized finance lies in decentralization and autonomous operation. The strengthening of tax reporting requirements will undoubtedly increase the operating costs and compliance difficulties of DeFi platforms, and may even force them to change their original business models. However, this may be a pain that the crypto industry must go through as it grows. Historically, the encryption industry has always shouldered the mission of decentralization, and the government's centralized supervision has always been an unavoidable pressure in its development. Although each tightening of regulations may cause the industry to experience some twists and turns, the resilience and innovation capabilities shown by the encryption industry have always allowed it to rise from the ashes. Although the future development path is full of uncertainties, the encryption industry still has broad prospects and unlimited possibilities.