Does Decentralized Finance also require KYC? New regulations from the US Internal Revenue Service: Decentralized Finance brokers must report user transaction data.

The Internal Revenue Service (IRS) in the United States has introduced new regulations requiring Decentralized Finance (DeFi) brokers to collect and report user transaction data, including total earnings from digital asset transactions. This measure aims to enhance tax compliance in the emerging DeFi industry.

According to the updated rules, Decentralized Finance brokers are required to provide customers with Form 1099-DA, which includes key transaction details such as name, wallet address, and transaction amount. This puts Decentralized Finance service providers on par with traditional securities brokers in terms of tax reporting obligations, representing a significant change in regulatory oversight.

Brokers responsible for recording total income into customer wallet addresses or accounts are also responsible for reporting the transaction. This practice aligns with the existing securities broker framework, ensuring that each transaction only requires one broker to report, simplifying the reporting process and reducing potential errors.

Although the final regulations do not require reporting of transaction timestamps or wallet address information, brokers are still required to retain this data for seven years for IRS inspection. The new 1099-DA form will be used to report this information, providing taxpayers with the necessary details to accurately include the proceeds from digital asset transactions in their income.

The IRS's decision to implement these regulations highlights its commitment to improving tax compliance in the rapidly growing Decentralized Finance industry, challenging and redefining traditional financial regulations. The inclusion of non-custodial wallets (also known as cold wallets or self-custody wallets) in the definition of brokers has long been a contentious issue, as it may broaden the scope of what should be classified as a broker.

Final provisions

Form 1099-DA: Brokers must use this form to report gains from the disposition of digital assets, including cryptocurrencies, NFTs, and stablecoins.

Broker categorization: Brokers are required to specify their types, such as self-service terminal operators, digital asset payment processors, custodial wallet providers, non-custodial wallet providers, or other digital asset declarants.

Transaction data: Mandatory transaction data includes sales transaction ID (TxID), digital asset address, and sales unit quantity. Transfer-related data points include transfer in TxID number, transfer in digital asset address, and transfer in unit quantity.

Data Retention: Brokers are obligated to retain trading data for seven years for IRS inspection.

Effective date: The regulation will take effect 60 days after its publication in the Federal Register, and it is expected that these transactions will be reported starting in January 2026.

To use the Decentralized Finance platform, KYC is also required

The new regulations from the IRS pose significant challenges to Decentralized Finance platforms, which typically operate under a high degree of decentralization and anonymity. The requirements for centralized reporting and KYC (Know Your Customer) practices may force certain segments of the Decentralized Finance industry to either centralize or move overseas to evade compliance burdens. Nonetheless, Decentralized Finance platforms can still navigate this evolving regulatory environment by implementing proper compliance strategies and focusing on privacy protection technologies while adhering to their core principles.

The IRS is aligning its cryptocurrency tax reporting requirements with those of other assets, aiming to simplify and reduce Compliance taxpayers' costs while helping to close the tax gap. As Aviva Aron-Dine, Deputy Assistant Secretary for Tax Policy, said, 'These regulations will ensure that all taxpayers operate under the same rules and have the information they need to accurately file their taxes.'

This article is authorized for reprint from: "Blockchain Magazine"

'Decentralized Finance also needs KYC? New regulations from the US Internal Revenue Service: Decentralized Finance brokers must report user transaction data.' This article was first published in 'Cryptocurrency City'.