DeFi Taxes in Australia - Complete Guide 2024

What is DeFi?

Decentralised Finance, or DeFi, is a transformative sector within the blockchain space, aiming to recreate and improve upon the conventional financial system. DeFi eliminates intermediaries like banks and brokers by allowing people to conduct financial transactions directly with one another through smart contracts on the Ethereum blockchain. It encompasses various activities designed to make financial transactions more accessible, efficient, and affordable.

Common DeFi Activities:

• Staking
• Lending
• Borrowing
• Providing Liquidity
• Earning Token Rewards
• Earning Interest
• Bridging
• Wrapping
• Paying Gas Fees

Understanding DeFi

DeFi aims to create a more open and accessible financial system. Technologies like blockchain and smart contracts allow users to engage in various financial activities directly with each other without the need for intermediaries. The peer-to-peer nature of DeFi speeds up transactions and reduces costs for everyone, making financial services more inclusive.

Whether you're looking to earn interest on your crypto holdings, borrow funds, or trade assets, DeFi platforms offer various services. However, it's essential to understand the risks involved, including market volatility and smart contract vulnerabilities. As with any financial activity, due diligence and a thorough understanding of the mechanisms are crucial.

Does the ATO know about my crypto?

The belief that crypto transactions are 'untraceable' and invisible to the ATO is a myth. The blockchain is a transparent ledger, open to anyone, making it a poor choice for evading taxes. It's the opposite of a hiding spot; it's a spotlight on every transaction you've ever made.

Crypto mixers like Tornado Cash might seem like a secret escape route, but they're not. The IRS has its ways, dealing with complex cases of tax evasion regularly. Using mixers isn't just risky; it could lead you straight into legal hot water.

Don't forget about know your customer (KYC) requirements for crypto exchanges, either. Both domestic and international crypto exchanges collaborate with tax authorities around the world, and have data sharing agreements which means they must report your activities to the ATO. They keep detailed records of your transactions, making it easier for the ATO to follow the money trail, even if it's been through a mixer.

In short, yes, the ATO likely knows about your crypto, or at least has the means to find out. The blockchain's transparency, combined with the ATO's growing tech-savviness and the reporting duties of exchanges, makes your crypto activities more visible than you might think. It's safer to assume the ATO has your name on a list and report your crypto transactions accordingly. Compliance is your best strategy in the crypto tax game.

How does the ATO treat DeFi activities?

The ATO recent updated its web guidance to include many common DeFi activities. The web guidance is non-binding, which means you can opt to take an alternate view. However, if you decide to go this route, you should get expert professional advice as it could land you in hot water down the track.

Here are some common DeFi activities and their potential tax treatment, considering the web guidance from the ATO.

Activity 1: Staking

Staking in the context of DeFi involves locking up a certain amount of cryptocurrency (in this case, Ethereum or ETH) to participate in maintaining the operations of a blockchain system. It's akin to depositing money in a bank to earn interest; here, you're depositing crypto to earn rewards, often in the form of additional tokens.

Example of Staking Activity: Imagine you bought 5 ETH earlier this year for $10,000, and now they're worth $15,000. You decide to stake these 5 ETH in a DeFi protocol. This move is strategic to earn staking rewards, enhance the security and efficiency of the blockchain network, or both.

Tax Treatment of Staking Deposits: According to the ATO’s updated web guidance, depositing your ETH into a smart contract for staking is considered a disposal event, thereby triggering Capital Gains Tax (CGT). The capital gain would be the difference between the cost basis ($10,000) and the fair market value at the time of staking ($15,000), resulting in a $5,000 taxable gain. This approach assumes that by staking your ETH, you've effectively disposed of them and should thus report the transaction as a sale.

This is the default tax treatment on Crypto Tax Calculator, however, if you opt to go for an alternate stance, you can change the tax treatment for staking deposits under ‘Tax Settings’. It is highly recommended that you discuss your situation with a tax professional if you opt for an alternate tax treatment as it may put you at a higher risk of underreporting which can carry significant penalties.

Taxation of Staking Rewards: Once your staked ETH begins generating returns (be it token rewards, interest, or other incentives), the ATO will treat these earnings as income comparable to earning interest in a traditional savings account.

You must report this income based on the market value of the tokens at the time they were received. If the value of these rewards decreases over time, you may be able to offset other capital gains in the current or future tax year, but losses cannot be used to offset income.

If you're not careful, this situation can lead to a scenario where the tax owed is greater than the current value of the rewards if their value has dropped significantly from when you claimed them to when you sold them.

Staying on top of your taxes throughout the year is critical in ensuring you don't get caught in this tax trap.

Activity 2: Liquidity Pools

Liquidity pools are a foundational component of many DeFi protocols, allowing users to pool their resources to facilitate trading, lending, and other activities. Users deposit their crypto assets into a shared pool, which is then used to execute trades or loans on the platform. In return, they often receive fees or rewards based on their contribution.

Example of Liquidity Pool Activity: Consider you've spent $2,000 to acquire 3 ETH and some stablecoins. Over time, the value of these assets increases to $2,500. You decide to contribute them to a liquidity pool on a DeFi platform to earn trading fees or other rewards.

Tax Treatment of the LPing: According to the ATO’s updated web guidance, the deposit of your assets into a liquidity pool is a taxable event. Here, you'd calculate your capital gain based on the difference between the cost basis ($2,000) and the market value at the time of the deposit ($2,500). This results in a capital gain of $500, which would be subject to taxes. This view assumes that by depositing your assets into the pool, you've effectively sold or disposed of them.

This is the default tax treatment on Crypto Tax Calculator, however, if you opt to go for an alternate stance, you can change the tax treatment under ‘Tax Settings’. It is highly recommended that you discuss your situation with a tax professional if you opt for an alternate tax treatment as it may put you at a higher risk of underreporting which can carry significant penalties.

Additional Considerations for Liquidity Pools: When you withdraw your assets from the liquidity pool, the disposal of any LP or receipt tokens could trigger another capital gain or loss event. For instance, if the value of the withdrawn assets is less than the value at the time of depositing (say you receive assets worth $2,300 back from an initial $2,500), you would incur a capital loss of $200.

Furthermore, any additional token rewards or interest earned from the liquidity pool are viewed as income at the market value at the time of receipt. This income must be reported and will be taxable. Later, when you sell these reward tokens, you'll also need to account for any capital gain or loss from the sale.

Using the example, if you earned $100 worth of tokens and later sold them for $150, you'd report $100 of income and a capital gain of $50.

Activity 3: Lending and Borrowing

DeFi allows you to lend and borrow crypto assets in a matter of seconds from anyone, anywhere in the world, in an entirely peer-to-peer and trustless manner. Trustless lending and borrowing is one of DeFi's major financial breakthroughs; however, if you engage in these activities, you must beware of the potential tax consequences.

Event 1: Lending You lock 1 ETH you purchased a few years ago for $20 into a DeFi lending protocol. At the time of deposit, 1 ETH is worth $100. In return, you receive 5 'receiptETH', a protocol token representing your contribution.

Tax Treatment: The ATO treats crypto-to-crypto trades as taxable, which means exchanging ETH for receiptETH could be considered a taxable event. This view is based on the idea that crypto-to-crypto trades are taxable, as per IRS guidance. Since you exchanged ETH (cost basis $20, market value $100) for receiptETH, you would recognize a capital gain of $80. The argument is that by locking up ETH and receiving receiptETH, you have effectively disposed of your ETH and acquired a new asset, triggering a capital gains tax event.

This is the default tax treatment on Crypto Tax Calculator, however, if you opt to go for an alternate stance, you can change the tax treatment under ‘Tax Settings’ or make the ETH to ReceiptETH trade a non-taxable swap. It is highly recommended that you discuss your situation with a tax professional if you opt for an alternate tax treatment as it may put you at a higher risk of underreporting which can carry significant penalties.

Event 2: Borrowing: Suppose you collateralise your lending position, borrowing against it. The act of borrowing, in general, is not considered a taxable event. The funds (or tokens) received from a loan aren't generally considered income; they're a debt obligation you will eventually need to repay. Therefore, receiving tokens as part of a borrowing agreement would not be taxable under usual circumstances.

Navigating Lending and Borrowing in DeFi: The tax treatment of lending and borrowing in the DeFi space is nuanced and can vary widely based on the user's activities and the ATO's interpretation of these activities. Both conservative and aggressive tax positions have their rationale and associated risks. Users must carefully consider their situation, keep detailed records, and consult with a tax professional to navigate the complexities of DeFi taxation effectively.

Activity 4: Yield Farming

Yield farming is an advanced DeFi strategy where users stake or lend their crypto assets to earn rewards. It often involves navigating multiple liquidity pools and protocols to maximize returns.

Event 1: The Deposit Imagine you have 100 ETH, initially acquired for $10,000. You decide to venture into yield farming and deposit your 100 ETH, now worth $20,000, into a smart contract on a DeFi platform.

Tax Treatment According to the ATO’s updated web guidance, the deposit of your ETH is a taxable event. Here, you'd recognize a capital gain of $10,000 (the difference between the $20,000 value at deposit and the $10,000 original cost). This gain reflects the increased value of your ETH and is reported on your tax return, leading to an immediate liability.

This is the default tax treatment on Crypto Tax Calculator, however, if you opt to go for an alternate stance, you can change the tax treatment for staking deposits under ‘Tax Settings’. It is highly recommended that you discuss your situation with a tax professional if you opt for an alternate tax treatment as it may put you at a higher risk of under reporting which can carry significant penalties.

Event 2: The Rewards After a month of participation, you receive 1 TOKEN as a reward, valued at $1,000 at the time of receipt.

Tax Treatment Receiving the 1 TOKEN, valued at $1,000, is treated as income. You'd report this as income immediately, taxed according to your bracket.

Event 3: Selling the Rewards At some point after claiming, you decide to sell the TOKEN. When you sell, the TOKEN is valued at $1,500.

Tax Treatment In this situation, you have a capital gain of $500, the difference between the sale price and the TOKEN's value when received. This gain is reported as capital gains and taxed accordingly.

Activity 5: Wrapping Tokens

Wrapping tokens is a process used in DeFi to make various cryptocurrencies compatible with smart contracts or decentralized applications. Wrapping is especially common when a blockchain's native token, such as Ethereum's ETH, must be wrapped into a different token standard that makes it compatible with smart contracts. For instance, ETH can be wrapped into WETH, an ERC-20 token, allowing it to interact with Ethereum's DeFi ecosystem.

Example of Wrapping Tokens: Consider that you own ETH and want to engage with a DeFi protocol on the Ethereum network. Since smart contracts on Ethereum require the ERC-20 version of ETH, you decide to use a service to wrap your ETH into WETH.

Tax Treatment From a conservative viewpoint, wrapping ETH into WETH could be considered a taxable event. This perspective treats the conversion of ETH to WETH as a disposition of the original asset (ETH) and the acquisition of a new asset (ETH). Since crypto-to-crypto trades are considered taxable events according to ATO guidance, this conversion might trigger capital gains or losses based on the difference in value between your BTC's cost basis and the market value at the time of conversion.

However, there is an alternative view that argues that there is no market price difference between wrapped tokens and that wrapping tokens is not intended to be a disposal.

If you opt to go for the alternate stance and want to treat wrapping as a non-taxable event on Crypto Tax Calculator, you can change any wrapping event from a taxable “Trade” to non-taxable “Swap”. It is highly recommended that you discuss your situation with a tax professional if you opt for an alternate tax treatment as it may put you at a higher risk of underreporting which can carry penalties.

Activity 6: Bridging Tokens

Bridging tokens is a process that involves transferring assets from one blockchain to another. Bridging is necessary when users want to use the functionalities of different blockchain platforms that aren't natively compatible with one another. A bridge locks the tokens on the original blockchain and creates a corresponding representation on the target blockchain.

Example of Bridging Tokens: Consider that you own Bitcoin (BTC) and want to engage with a DeFi protocol on the Ethereum network. Since BTC doesn't operate natively on Ethereum, you decide to use a service like Ren to bridge your BTC onto Ethereum by turning it into Wrapped Bitcoin (wBTC). This service essentially locks your BTC in escrow and issues wBTC, which can be used on Ethereum.

Tax Treatment There is one perspective that views bridging as a taxable event akin to a crypto-to-crypto trade. From this perspective, bridging your BTC is seen as disposing of your original BTC and acquiring a new, different asset (wBTC). This transaction could trigger a capital gains tax, calculated based on the difference between the cost basis of the LTC and its market value at the time of the bridge.

However, there is an alternative view that argues that there is no market price difference between wrapped tokens and that wrapping tokens is not intended to be a disposal.

By default, bridging events are treated as non-taxable by Crypto Tax Calculator, however, if you want to be conservative, you can opt to make them taxable. It is highly recommended that you discuss your situation with a tax professional to know which treatment is most suitable for your situation.

Activity 7: Gas Fees

In the world of DeFi, almost every transaction you make requires the payment of a transaction fee known as a gas fee. These fees can fluctuate significantly and have seen considerable increases with the rise of activities like yield farming. Understanding how these fees impact your tax obligations is crucial.

Transaction Fees on Sales: Let's say you sell 1 ETH for $100 but incur a $5 gas fee to complete the transaction. In this scenario, the gas fee directly relates to the sale and thus reduces your total proceeds. Your net proceeds from this transaction would be $95 ($100 - $5). When calculating capital gains or losses from this sale, you'll use the net amount after the gas fee as the selling price.

Transaction Fees on Transfers: When it comes to transferring tokens, the treatment of gas fees can be a bit more complex. For example, if you purchase 1 ETH for $10 on an exchange and then transfer it to a different wallet, incurring a $2 gas fee, the ATO could view this $2 as a separate disposal of capital assets to cover a personal expense.

Essentially, you're using a portion of your asset (ETH) to pay for the cost of transferring the remainder. This means that instead of simply adding the $2 to the cost basis of the ETH, you might need to recognize a small capital gain or loss based on the value of the ETH at the time you used it to pay the gas fee.

Stay Compliant and Avoid Audits

Maintaining accurate records is your first line of defence against audits and tax headaches. Each DeFi transaction, no matter how minor it seems, leaves a digital trail that the ATO can follow. Neglecting this crucial aspect of your financial journey can lead to a chaotic tangle of information come tax season, making an audit more than a remote possibility. It's not just about staying compliant; it's about protecting yourself.

Traversing the DeFi landscape is no walk in the park. You're dealing with many block explorers, each presenting data in a different format. Your transaction history becomes a complex web, spanning multiple wallets and chains, with activities like staking, wrapping, and liquidity pooling. Trying to piece together this puzzle for tax purposes manually is a daunting task prone to errors and oversights.

Crypto Tax Calculator was built from the ground up to handle complex DeFi transactions automatically, so you don't need to spend hours trolling block explorers and battling with hundreds of manual spreadsheets. Seamlessly import your on-chain transactions, watch our smart tax engine automatically label your on-chain activity and generate your accountant-approved tax report that can be filed directly with the ATO via myTax or given to your accountant.

DeFi taxation is a complex and continuously evolving area. Consulting with a tax professional is always a wise decision if you need clarification on something.

Disclaimer *Please note that this Guide is for general information purposes only and represents the opinions of Crypto Tax Calculator and our experienced crypto tax professionals. We note that some topics outlined by this Guide have not been clarified by the ATO and remain debated amongst professionals. Ultimately, the ATO could release further guidance on these topics which conflicts with the information outlined by this Guide. The ATO could also publish views that retrospectively change the tax implications outlined by this Guide. If you rely on information contained in this Guide, you do so at your own risk.

This Guide should not be used as or in substitution for legal, financial or taxation advice. An attorney-client or tax advisor-client relationship is not created by viewing this Guide, or by purchasing or using the software from Crypto Tax Calculator. Any assumptions and default positions of the Crypto Tax Calculator software for transactions are not advice or endorsement that the position suggested is accurate.

If you have concerns about how the Australia tax laws apply to your circumstances, consult a professional advisor.*