The U.S. Department of the Treasury and the Internal Revenue Service (IRS) issued final regulations on digital asset transactions in 2024. The introduction of these regulations is a result of the Infrastructure Investment and Jobs Act, which aims to strengthen cryptocurrency tax regulation, with the goal of standardizing the tax reporting process for cryptocurrency and decentralized finance (DeFi) transactions, significantly enhancing tax compliance levels.

The regulations impose clear requirements on DeFi brokers. They explicitly define the reporting obligations of DeFi brokers, mandating that they must disclose detailed transaction information. This means that DeFi brokers need to accurately record various information related to transactions, including transaction amounts, types of assets involved, and information about the parties involved. Additionally, the regulations require DeFi brokers to collect "Know Your Customer" (KYC) information from users to better track the sources and destinations of transactions, identify potential risk behaviors, and ensure that the entire transaction process operates within a legal and compliant framework.

Ultimately, these regulations are set to take effect on January 1, 2027. To allow relevant practitioners sufficient time to adapt, a transition period has been established. During this period, starting in 2026, brokers will need to begin collecting data that complies with the final regulations as envisioned by the IRS. The purpose of this is to give brokers ample time to adjust their business processes, technical systems, and other related arrangements, so that they can smoothly comply with all regulatory requirements once the regulations take effect, avoiding confusion or violations in the new regulatory environment.

However, while these requirements are intended to strengthen regulation from a tax compliance perspective, they have sparked considerable controversy within the industry. Some practitioners believe that this may, to some extent, affect the efficiency of transactions and the enthusiasm for innovation. For instance, in an already complex cryptocurrency trading environment, adding more reporting and information collection tasks could make the transaction process more cumbersome and may limit the development space for some emerging trading models or financial instruments. On the other hand, the essence of DeFi lies in decentralization, and the release of these regulations can be seen as completely stripping away the essence of DeFi, abandoning the meaning of decentralization. Therefore, whether these regulations can ultimately be successfully implemented remains to be seen.

Next, let's take a closer look at the core content of this document and its potential impact on digital asset trading:

1. New Information Reporting Requirements

The regulations primarily impose information reporting requirements on brokers. Brokers are defined as individuals or entities that prepare to conduct sales in their daily operations, including both custodial and non-custodial digital asset brokers. The main categories include:

• Custodial Digital Asset Trading Platform Operators: These platform operators are responsible for safeguarding clients' digital assets and facilitating transactions between clients.

• Digital Asset Custodial Wallet Providers: These wallet providers are also responsible for safeguarding clients' digital assets.

• Payment Processors (PDAPs): These processors are responsible for handling payments in digital assets, such as payments made through blockchain networks.

• Digital Asset Self-Service Terminals: These terminal devices allow users to conduct transactions in digital assets directly.

Broker Reporting: Brokers are required to report the total income of clients from digital asset transactions in detail. This includes not only profits from traditional cryptocurrencies like Bitcoin and Ethereum but also emerging digital asset trading gains, such as those from non-fungible token (NFT) transactions. Additionally, adjusted basic information is also within the reporting scope, which may involve initial investment costs, various fee adjustments during the transaction process, and more. The IRS hopes that through this comprehensive reporting requirement, the tax authorities can more accurately grasp the income situation in digital asset transactions. Previously, some clients may have exploited the anonymity of digital asset transactions to engage in unreported income operations, but now this reporting system from brokers can control the source of transactions.

In the real estate transaction market, when it comes to using digital assets for payments, real estate reporters are also assigned corresponding reporting responsibilities.

2. Clear Definitions and Classifications

The regulations clarify the definition of digital assets and the categories of custodial and non-custodial industry participants.

Specifically, in this document, digital assets are clearly defined as value representations recorded on a cryptographically protected distributed ledger, which distinctly separates them from cash. This form of value recording based on cryptographic technology and distributed ledger technology is key to distinguishing digital assets from traditional assets. It encompasses a wide variety of types, with cryptocurrencies being the most well-known, such as Bitcoin and Ethereum. It also includes stablecoins, NFTs, and more.

At the same time, the document meticulously distinguishes between custodial and non-custodial digital asset industry participants, clearly defining their respective responsibilities and obligations.

Custodial participants bear the responsibility of asset custody throughout the digital asset transaction chain. They need to ensure the secure storage of digital assets, employing advanced encryption technologies and security mechanisms to prevent theft, tampering, and other incidents. During transactions, custodial participants must also conduct preliminary reviews of the legality and compliance of the transactions, such as verifying the identity information of both parties involved and the sources and destinations of the digital assets.

Non-custodial participants, while not directly responsible for asset custody, play important roles in transaction facilitation and market information provision. They must adhere to relevant market competition rules, ensuring that the transaction information they provide is true, accurate, and complete, and must not engage in fraud, market manipulation, or other improper behaviors. They are also required to actively cooperate with regulatory authorities by providing necessary transaction data and information for supervision and management.

3. Tax Implications

Under the new regulations, digital asset transactions are explicitly regarded as taxable events. Whether it is the exchange of cryptocurrencies, investment gains from digital assets, or transactions involving non-fungible tokens (NFTs), as long as there is a transfer of value that results in gains, it falls within the taxable scope. The IRS believes that taxpayers are therefore required to accurately report these transaction situations on their federal income tax returns. This may lead investors to consider not only risk and return when participating in investments but also potential cost deductions, such as initial investment costs and transaction fees.

4. Requirements for Broker Technology and Operations

• System Upgrades: With the update of regulations related to digital asset transactions, brokers and other industry participants face challenges and demands for system upgrades. The new reporting requirements encompass more detailed and comprehensive transaction information collection, organization, and analysis. For example, brokers not only need to record basic information such as traditional transaction amounts but also need to pay attention to complex information such as the specific types of digital assets, transaction timestamps, and the source and destination addresses of the relevant digital assets. Existing trading systems may not meet these new requirements in terms of data structure design, data storage capacity, and information processing logic. Therefore, to ensure accurate reporting of relevant information as required, they must upgrade their existing trading systems. This may involve adopting more advanced database management systems to support the rapid storage and efficient querying of massive transaction data; introducing intelligent algorithms to automatically identify and classify different types of digital asset transactions to accurately extract the required reporting information; and optimizing the system's user interface to facilitate staff in entering and reviewing new information fields.

• Data Retention: The document explicitly states that brokers need to retain transaction-related information for at least seven years, which raises higher standards for brokers' data management capabilities. The volume of data from digital asset transactions is vast and continuously growing, and long-term data retention means that sufficient storage space is needed to accommodate this data. Additionally, to ensure the integrity and availability of the data during the seven-year retention period, effective data maintenance work must be conducted, such as regularly backing up data to prevent data loss and establishing data indexing for quick retrieval of specific transaction data. This not only requires brokers to invest more in hardware resources, such as server storage space, but also necessitates a certain amount of human and material resources to manage the data lifecycle. Moreover, when tax authorities require this data for review or tax enforcement activities, brokers must be able to quickly and accurately provide the relevant data, which poses strict challenges to brokers' internal management processes and data response mechanisms.

5. International Coordination

In today's globalized context, the cross-border nature of digital asset transactions is increasingly prominent. The document released by the U.S. Department of the Treasury and the IRS mentions coordinating information reporting rules with other countries. Cross-border digital asset transactions have always been a regulatory challenge due to their involvement with different countries' laws, regulations, tax policies, and regulatory environments. Different countries may have varying definitions, classifications, and tax treatment methods for digital assets, which can easily lead to regulatory loopholes, such as certain digital asset transactions being effectively unregulated in some countries, evading tax or compliance scrutiny.

Therefore, by coordinating information reporting rules, the U.S. government hopes to establish a more unified information sharing and communication mechanism among countries. For example, in cross-border digital asset transactions involving U.S. investors and investors from other countries, the regulatory authorities of both countries can more efficiently obtain the true information of the transactions based on the coordinated rules. This helps ensure the transparency of cross-border digital asset transactions and avoids illegal trading behaviors arising from information asymmetry. At the same time, the consistency of the rules can reduce market distortions caused by policy differences among countries, allowing digital assets to be traded in the global market according to unified and fair standards, promoting the healthy and orderly development of the global digital asset market. Furthermore, this international coordination can enhance the efficiency of international tax cooperation, preventing taxpayers from exploiting regulatory differences between countries to evade taxes and maintaining the effectiveness of the global tax system.

Overall, due to the anonymity, cross-border nature, and complexity of cryptocurrency transactions, the IRS believes that there have been many instances of unreported income and erroneous reporting in the past. Therefore, this time, by stipulating the information reporting responsibilities of various participants, such as brokers needing to report client transaction information and real estate reporters needing to report real estate transactions paid with digital assets, it is hoped to establish a relatively complete transaction information traceability system to enhance tax compliance levels.

For practitioners in the cryptocurrency industry, on one hand, the accelerated progress of compliance may help the industry's development in the long run, but on the other hand, gradually deviating from the mission of decentralized finance may bring more challenges to industry practitioners.

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