Defi Crypto Tax: How Taxes Work for Crypto Lending, Loans, and More
How tax works for decentralized finance: Taxes for crypto lending, interest, loans, cTokens, and tokenized assets
Table of Contents
With decentralized finance, or DeFi, you can earn interest on crypto you lend, or take out loans using crypto as collateral. These crypto lending platforms run on smart contracts, meaning that there’s no middleman, opening up these financial services to anyone holding crypto.
Like with any cryptocurrency activity, it’s important that you understand the tax implications. In this guide, we’ll cover the tax treatment of various decentralized financial products as well as some of the tax advantages — and things to watch out for.
- Celsius Network
- Unchained Capital
There are many options out there. You can use Bitcompare to compare supply and borrow interest rates for crypto lending and loan platforms.
If you earn interest on your crypto by lending it, then that interest is taxed at your income tax rates as per the fiat value of the crypto earned. So if you receive an interest payout of 0.01 BTC when BTC is 8,000 USD a coin, then that’s $80 equivalent in income, taxed at your marginal income tax rates — the same tax rate that is used for income like your salary and wages.
The same applies to interest received for crypto in a savings account as well.
This income is reported as other income on your 1040 Schedule 1, just like how you report crypto mining and crypto staking income. Bear in mind that you may need to file with a 1040 Schedule C instead if this income is more self employment income.
Crypto loans have noteworthy tax advantages. If you borrow using crypto as collateral, like putting BTC up for collateral to borrow stablecoins, you don’t realize any tax on that crypto set as collateral.
You can borrow crypto or stablecoins and even convert that crypto into fiat. As long as your collateral is not sold or exchanged, then no taxes will be triggered. This is useful for things like making tax payments without triggering more taxes by selling your crypto.
Keep in mind, however, that margin calls are taxable sales. If the value of your collateral crypto goes down too far, or if the value of assets borrowed increases too much compared to your collateral, then you’ll trigger a margin call.
If you get a margin call, you will need to deposit more crypto as collateral or else your collateral will be sold off, making you realize any capital gains (or losses) that you’ve had on that collateral since acquiring it.
For loan collateral to not be a taxable event, it’s also important that you receive back the same asset as the one you gave for collateral. For example, if you give bitcoin as collateral, but receive back ethereum when you close out your loan, that may be a taxable event because there was an exchange of bitcoin for ethereum.
For individuals, interest paid for loans are usually not deductible. In the case of mortgages for primary residences, student loans, and business loans, interest paid may be tax deductible, but considering the rather young state of defi, these are not common use cases at the moment.
Compound cTokens earn interest by becoming convertible into an increasing amount of its underlying asset, but the amount of cTokens in your wallet stays the same. This means that cToken interest is not paid as income tax, but rather as capital gains. If you hold cTokens for a year or longer, you can pay long term capital gains on them, meaning that you can effectively accrue interest at a lower tax rate.
But this likely means that minting cTokens is a taxable event, because let’s say you put ETH into Compound.finance - it means that it’s a trade of ETH to cToken. When you convert your cTokens back to an asset, that’s a sale of the cTokens where you will recognize any capital gain.
You can create a TokenTax-ready transaction history report for Compound using our Compound Finance Tax Document Tool.
Uniswap is a decentralized protocol that lets you swap ETH and ERC20 tokens as well as contribute your tokens to the protocol's liquidity.
Swaps made on Uniswap are taxable crypto to crypto trades, just like if you traded ETH for an ERC20. If you swap and send, that's also a taxable transaction as you are initiating a trade followed by a withdrawal.
When you pool ETH and ERC20 tokens on Uniswap, you exchange those tokens for UNI tokens which then represent your interest in the liquidity pool. This exchange is a taxable event.
You can then receive trading fees as payment for your liquidity, which you receive by receiving more ETH and ERC20 tokens back when you give back the UNI tokens; this will result in a capital gain or loss.
You can create a TokenTax-ready transaction history report for your Uniswap activities using our Uniswap Tax Tool.
Tokenized assets, like a cryptocurrency tethered to the price of Gold, are treated as property the same as other cryptocurrencies, meaning that you will recognize any capital gain or loss on the asset when you sell it.
Decentralized finance is great for those in the crypto ecosystem who want to take advantage of their assets to earn interest as well as to have liquidity and spending power without triggering taxes or interrupting long term holdings.
Investors have long since borrowed against their stock holdings to have liquid capital. Now, the same is possible for everyone via decentralized finance.
With TokenTax, you can import data from decentralized finance platforms to calculate your interest / lending income as well as to account for capital gains and losses, like collateral sell offs and exchanges between crypto and cTokens.