Are you making profits from DeFi in Australia? The chances are some of your gains are going to be subject to tax, whether that be Capital Gains or Income tax. Here we delve deep into Australia DeFi transactions and how to decipher which type of tax you should be paying to ATO.
How is DeFi taxed in Australia?
The ATO has finally released guidance on DeFi tax - stating that your DeFi transactions may be subject to either Capital Gains Tax or Income Tax depending on the nature of the transaction. We'll cover all the common transactions and everything you need to know in depth.
What is DeFi?
DeFi (decentralised finance) is an all-encompassing term for a variety of financial apps built on blockchain technology. DeFi hopes to provide all the services traditional centralised financial institutions — like banks or even cryptocurrency exchanges — do, but without any limitations like regulations, borders, and policies.
With DeFi, there is no bank or any other intermediary party. Funds are created from liquidity pools. Liquidity pools are crowdsourced pools of cryptocurrencies or tokens locked in a smart contract that is used to facilitate trades between the assets on a decentralised exchange (DEX). Instead of traditional markets of buyers and sellers, many decentralised finance (DeFi) platforms use automated market makers (AMMs), which allow digital assets to be traded in an automatic and permissionless manner through the use of liquidity pools.
How does ATO tax DeFi?
This all comes down to whether your crypto is viewed as an asset or assessable income. This means it all comes up to how your specific DeFi protocol works.
In brief, you'll either pay Capital Gains Tax or Income Tax on your DeFi transactions depending on the specific transaction and how your protocol works. As well as this though, the ATO is also clear that it all depends on whether you're a trader or an investor. You should seek guidance on this for your individual circumstances from an experienced crypto accountant. For the sake of brevity, we'll cover the likely tax treatment for individual investors in this guide only.
*Depending on how your protocol works you may be liable for Income Tax or Capital Gains Tax.
Let's look at different transactions in more depth.
DeFi Capital Gains
ATO taxes cryptocurrency as both capital assets and regular income. This all depends on how you earned it.
If your crypto is seen as income, you’ll pay Income Tax on it. Meanwhile, if your crypto is seen as a capital asset, you’ll pay Capital Gains Tax. Let’s break the current guidance down on both.
If your crypto is seen as a capital asset, whenever you dispose of your capital asset, you’ll pay Capital Gains Tax on any profit. Disposals of a capital asset include:
Remember, Australian gains held longer than 1 year receive a 50% Capital Gains Tax discount. In other words, HODLing is a good idea.
All this said, let's take a look at the most common DeFi transactions and when they'll be taxed as capital gains.
Trading on dexes
Trading tokens on dexes? Whether you're into ERC-20 tokens, BEP-20 tokens or even NFTs, it's all the same from a tax perspective. Trading one crypto for another is a disposal and profits are subject to capital gains tax.
CAPITAL GAINS TAX
Adding/removing liquidity from pools
As you're not disposing of an asset, you might think of adding and removing liquidity from various DeFi protocols as more akin to a transfer, but it's not quite the case because in almost all instances - you'll receive a token in return representing your stake in the pool, known as liquidity pool tokens. Similarly, when you want your asset back, you'll swap your LP tokens back for your original asset and sometimes the rewards you've earned.
The ATO says these transactions are disposals and any gain is subject to Capital gains Tax.
CAPITAL GAINS TAX
Rewards from pools and earning interest from DeFi
The way you're taxed on rewards from staking, lending, or liquidity pools all depends on how that specific DeFi protocol works and how your rewards are paid out. There are two main ways these protocols work.
1. You add to a pool and you receive tokens in return. Your rewards from your capital in the pool aren't paid out in the form of new tokens, but instead, your LP tokens accrue value. You'll only realise that gain when you remove your capital from the pool and trade your tokens back. This would be a disposal and therefore profits are subject to capital gains tax.
2. You add to a pool and receive tokens in return. You receive new tokens as a result of your capital in the pool. These new tokens are similar to interest income and as such, you'll need to pay Income Tax based on the fair market value of the new tokens in AUD on the day you received them.
In other words, earning new tokens is likely to be subject to Income Tax, while tokens that accrue value are more likely to be subject to capital gains tax
INCOME TAX/CAPITAL GAINS TAX
The tax on DeFi loans will depend on whether you're borrowing or lending crypto.
Borrowing crypto doesn't seem like a taxable event, but it might be depending on how your specific DeFi protocol works. If you need to put up collateral in order to loan crypto and you receive tokens in return representing your collateral, this would be a disposal, and any gain subject to Capital Gains Tax.
Your interest payments could potentially be viewed as spending crypto, which would be a disposal and subject to Capital Gains Tax. However, these may be deductible as costs depending on the purposes of your loan (what you spent it on) and the volume you're trading at.
Meanwhile, if you're lending crypto, chances are you'll similarly receive tokens in return representing your loaned crypto. This again, is likely to be a disposal and profits will be subject to Capital Gains Tax.
The tax on the interest you earn will depend on how your protocol pays out. Earning new tokens? Income Tax. Tokens that accrue value? Capital Gains Tax.
CAPITAL GAINS TAX
Provided you’re seen to be trading as an individual investor you’ll pay Capital Gains Tax on profits from margin trades, derivatives, and other CFDs. So you don’t pay tax when you open a position, you’ll pay tax when you close your position and realise a capital gain.
In the instance of liquidation, for example through a margin call, this is a disposal from a tax perspective and needs to be reported to ATO.
CAPITAL GAINS TAX
Transaction fees are tax deductible for capital gains. What we mean by this is any time you have to pay a fee to conduct a transaction to buy, sell or swap a crypto asset — you can add this to your cost basis (what it cost you to acquire the asset). This will reduce any capital gain later on by giving a more realistic view of the asset cost.
Transfer fees are more problematic from a tax perspective. It’s not clear whether transfer fees — for example moving tokens from one wallet to another — can be added to your cost basis. This could be viewed as a maintenance cost, which you cannot add to your cost basis.
The cautious approach to this is to treat transfer fees as a disposal and subject to Capital Gains Tax.
CAPITAL GAINS TAX
When you ‘wrap’ a token, you’re exchanging one token for another. The updated ATO DeFi guidance is clear that this is a disposal and any gain is subject to Capital Gains Tax.
CAPITAL GAINS TAX
The ATO is clear that DeFi rewards are similar to interest income. Therefore it's taxed as assessable income based on the fair market value of your tokens.
Let's take a look at the most common DeFi transactions and when they might be taxed as income under the current ATO guidance.
Staking as part of a PoS mechanism
Many DeFi protocols are built on proof of stake blockchains - like Cardano, Avalanche and Terra. In order to function, these blockchains need validators who earn rewards in return for staking.
If you're using a non-custodial wallet to stake - for example Yoroi or Daedalus to stake ADA - you'll need to pay Income Tax on your staking rewards. You'll pay Income Tax based on the fair market value of the tokens in AUD on the day you received them.
Meanwhile, there's also what's known as DeFi staking. This is where you stake crypto assets with a given protocol in order to earn rewards. Like with most of DeFi taxation, the tax you'll pay depends on the specific DeFi protocol you're using. SushiSwap is one of the best examples of this as you could potentially pay either Income or Capital Gains Tax depending on which protocol you're using on the platform.
For example, if you have SLP or KMP tokens you want to stake - you can do so and earn SUSHI tokens as a reward. As you're earning new tokens, you'll need to pay Income Tax based on the fair market value of your SUSHI tokens (in AUD) on the day you received them.
Now you want to stake your SUSHI tokens in the Sushi Bar to compound those rewards. But when you use the Sushi Bar protocol, you'll receive XSUSHI tokens in return. You don't earn new XSUSHI tokens when you stake SUSHI, instead XSUSHI tokens accrue value. You'll only realise a gain when you unstake your SUSHI by trading your XSUSHI tokens back. This transaction would be viewed as two disposals (one when you stake and one when you unstake) and you'll pay Capital Gains Tax on any profits as a result.
INCOME/CAPITAL GAINS TAX
Play to earn income
If you’re seen to be earning new tokens — for example, earning SLP or AXS tokens through playing Axie Infinity — this is likely to be seen as income and subject to Income Tax.
Meanwhile, if you’re selling or trading tokens or NFTs — like selling or trading voxel NFTs on Sandbox — this is more likely to be seen as a disposal of a capital asset and subject to Capital Gains Tax.
INCOME/CAPITAL GAINS TAX
Read next: How to play to earn and how it's taxed
The ATO hasn't issued specific guidance on token rebases.
However, where the token rebase protocol is designed to rebalance a price, we can liken it to a stock split. A stock split happens when a company splits existing shares into further shares, increasing liquidity. Most tax offices do not view this as a taxable event. Though the investor may have more shares - the shares have the same market value as the shares prior to the stock split. With this in mind, it would be reasonable to assume token rebases could be tax free provided you realise no gain or loss as a result.
However, where token rebase protocols are designed to pay out a reward, this would likely be seen as additional income and subject to tax.
What's the best Australia DeFi tax calculator?
Koinly is a crypto tax tool that calculates your crypto taxes for you, meaning you don’t have to go through the hassle of doing it yourself.
Not only does the software integrate with the transaction history of your exchange, but it calculates your taxes in a format that makes sense for your country’s tax office. Essentially, Koinly does all the boring tasks that would cost your hours and hours sitting at a computer.
Koinly will identify your different crypto transactions and apply the relevant taxes. Your data should be labelled automatically, but if it isn’t you can tag your DeFi transactions as a loan interest, received from pool or a reward for deposits. For withdrawals, you can tag your DeFi transactions as cost, interest payment or sent to pool.
We give you complete control over how conservative you’d like to be with your crypto tax reporting. How? In our settings, you can choose whether to realise gains on liquidity transactions, whether to treat other gains as capital gains and whether to treat transfer fees as disposals.
Once your transactions are imported, Koinly calculates your crypto taxes for you. All you need to do is head over to the tax reports page, where you’ll see a simple summary of your crypto taxes. Below this, you’ll find a variety of tax reports you can download and submit to ATO.
Once you’ve downloaded your tax report you can file it via MyTax or get your accountant to do it.
As a quick, final breakdown, here’s a short summary of what Koinly does:
- Imports all your trades including purchases, sales, swaps, and rewards.
- Converts your transactions into your country’s currency at fair market value (this in itself is a massive time saver).
- Deciphers which of your DeFi transactions are taxable and which are not.
- Allows you to submit a clean and accurate report to your tax office.
More questions on all things DeFi? We have you covered.
What can DeFi do?
What can't DeFi do might be a better question. DeFi apps are constantly evolving and adding new functionalities. What this means is there is an ever-growing list of transactions that investors can make with DeFi apps. Currently, this includes:
- Send money to anyone, anywhere
- Buy, sell, and trade cryptocurrencies
- Invest in stablecoins
- Loan or borrow crypto
- Earn interest and rewards through staking, yield farming, and liquidity mining
- Advanced trading like derivatives, margin, and leveraged trading
- Crowdfund and invest in new DeFi projects
- Insure your crypto investments
- Manage and grow your crypto investments automatically
- Gamble and bet crypto
What are the most popular DeFi protocols?
Let’s look at some examples of popular DeFi protocols and what they do:
- Buy, sell, and trade crypto on decentralised exchanges (Dexes) like Curve and Uniswap
- Borrow and loan crypto through decentralised lending protocols like Aave and Compound
- Buy, sell, and trade NFTs through decentralised NFT marketplaces like OpenSea
- Make margin trades, trade derivatives, options, and other CFDs through DeFi protocols like Opyn and Lyra
- Diversify and balance your crypto portfolio through DeFi indexes like Set Protocol and Index Coop
- Play DeFi games like Axie Infinity, Decentraland, and Sandbox
How do you make money with DeFi?
You can use dexes to make money the same way you would from centralized exchanges like Binance and Coinbase — by selling, swapping, and buying different crypto tokens.
Many of the cryptocurrencies used in DeFi use proof-of-stake blockchain networks. For example, the Binance Smart Chain or Polygon. In the Binance Smart Chain example, investors can stake BNB to become a delegator and are rewarded with transaction fees on the blockchain in return for validating transactions.
But one of the key ways investors make money is by providing liquidity to various DeFi liquidity pools. DeFi protocols need these liquidity pools to function, otherwise, investors using them wouldn’t be able to easily trade, sell, buy, or borrow crypto assets. As mentioned before, when you provide liquidity to a given DeFi protocol — you’re rewarded with a share of the transaction fees related to the pool you’ve invested in. This might be in the form of the crypto you provide, but more often than not it’s now provided in the form of liquidity pool tokens or governance tokens - in fact, sometimes it's both! This is known as liquidity mining. Popular examples of liquidity mining include:
- Earning CRV tokens by providing liquidity for Curve.
- Earning CAKE tokens by providing liquidity for PancakeSwap.
- Earning aTokens by providing liquidity for Aave.
As well as this, yield farming has become a popular way to make money from DeFi protocols. This comes down to the way various DeFi protocols ‘stack’. This allows investors to earn compound interest. For example, let’s say you provide liquidity to Curve and you earn CRV tokens as a reward. You can then invest these CRV tokens into Convex Finance to earn rewards on your CRV tokens as well. This is just one example of many.
The information on this website is for general information only. It should not be taken as constituting professional advice from Koinly. Koinly is not a financial adviser. You should consider seeking independent legal, financial, taxation or other advice to check how the website information relates to your unique circumstances. Koinly is not liable for any loss caused, whether due to negligence or otherwise arising from the use of, or reliance on, the information provided directly or indirectly, by use of this website.