DeFi Uses and Their Tax Implications
By Eric Coombs, Leo Chomiak & Garrett Van Houtteghem, Grant Thornton
Whether by coincidence or consequence, the COVID-19 pandemic period was accompanied by an explosive growth in the use of decentralized finance protocols. After the total amount of value of this sector grew to 14 times its size from the start to the end of 2020, the sector quadrupled in size through 2021. Clearly, more investors are finding value in what was once a fringe investment option.
Decentralized finance, or DeFi, is a way to use blockchain-enabled protocols and cryptocurrencies to undertake financial transactions, in many ways substituting for the roles traditional financial institutions typically play. The attraction of DeFi is that doing so doesn’t require the regulated steps involved in traditional financial transactions, giving users a higher level of control and speed. DeFi enterprises also tend to forgo fees and other charges for transactions associated with banks. The use of DeFi protocols also often results in better returns than users can obtain as compared to using traditional financial institutions for similar transactions (which is also accompanied by some increased inherent risks in the use of the technology).
“When you go to a bank or a securities broker, you have to fill out personal identification information, go through a client acceptance process, etc.” said Leo Chomiak, a partner in International Tax for Grant Thornton. “In crypto, you don’t have that.” Increasingly, companies may turn to blockchain and DeFi options to handle some business financial operations, like basic treasury functions. It also means, Chomiak said, that it can be more difficult to account for when complying with a company’s tax obligations.
A wealth of options
To see why, it helps to have a sense of what is possible in DeFi. Eric Coombs, Grant Thornton’s national tax leader for Asset Management, said a typical DeFi transaction could go like this: Let’s say there is $50,000 sitting in a savings account earning less than 1% interest a year. Using that $50,000, a user could purchase a digital asset – buying the equivalent of $50,000 in stablecoins (which are meant to replicate the value of a dollar on the blockchain), and depositing those stablecoins onto a DeFi platform to earn somewhere in the neighborhood of 3% annual interest, thus tripling the return.