DeFi, or decentralized finance, has experienced unprecedented growth over the last few years, resulting in a market cap of approximately $85 billion as of October 2021. Built on blockchain technology and cryptocurrency, DeFi has the potential to revolutionize finance by allowing users to borrow, lend, trade, and execute other financial transactions without a centralized authority or financial intermediary. Despite its popularity, the IRS has yet to issue specific guidance on how DeFi transactions should be viewed from a tax perspective. Fortunately, Notice 2014-21, which the IRS originally issued in 2014 and updated this year, can shed some light on how certain transactions conducted on DeFi platforms should be taxed.
In this posting, we will briefly explain what DeFi is and the tax implications of common DeFi transactions, including staking, lending, and yield farming/liquidity mining. It is important to note, however, that the taxation of DeFi transactions is an evolving area and future IRS guidance could supersede or clarify the principles laid out by the Service in Notice 2014-21.
What is DeFi?