Compound.Finance Taxes Guide

Compound.Finance, or just Compound, is another huge DeFi lending protocol that lets investors lend to earn more crypto, as well as borrow crypto using collateral. It’s attracted many investors thanks to high interest rates and the ability to increase their liquidity while still hodling. But as with all crypto investments - the tax man will want to know about your Compound investments. Learn everything you need to know about the Compound protocol, COMP tokens and Compound taxes in our guide.

What is Compound?

Compound.Finance, also known as just Compound or even COMP, is an Ethereum based DeFi lending protocol. It allows investors to deposit crypto for loans and earn interest in return, as well as borrow crypto with collateral.

Like all DeFi protocols, Compound achieves this with no third party - like a crypto exchange. Instead, it utilizes liquidity pools, also known as lending pools in this context.

How does Compound work?

There’s two main transactions you can make using the Compound protocol - lending or borrowing. We’ll look at both.

When you lend crypto on Compound, you deposit your crypto to a given lending pool. Compound has quite a few pools you can pick from including:

• AAVE
• BAT
• COMP
• DAI
• ETH
• LINK
• MKR
• SUSHI
• TUSD
• UNI
• USDC
• USDP
• USDT
• WBTC
• YFI
• ZRX

So you’ll pick the crypto you want to deposit and the corresponding supply pool to deposit it to. Once you’ve done this, you’ll be awarded a new cToken that represents your deposit - i.e. cETH, cDAI, cBAT and so on.

Your cToken(s) will accrue interest over time. But instead of being paid out more cTokens, your cTokens will increase in value relative to the underlying asset. So say you deposited 1000 DAI, you’d get cToken(s) representing that 1000 DAI. Then let’s say you earned 25 DAI over the course of a week in interest, your cToken(s) would now represent your 1025 DAI in the lending pool. 

When you want to withdraw your asset and interest from the lending pool, you simply trade your cTokens back. 

When it comes to borrowing - it’s a very similar process. To borrow on Compound, you need collateral. So you’ll still need to deposit your asset to Compound and you’ll get cTokens to represent that asset. You can then use your cTokens as collateral and borrow other cryptocurrencies against that collateral.

That’s not all though because Compound has what’s known as a dual-token system. This means as well as accruing interest in the crypto you’re lending, you’ll also earn COMP tokens. Similarly, you’ll earn COMP tokens for borrowing on Compound too. 

COMP is Compound’s native governance token. At the time of writing COMP is worth around $135, but has had historical highs of more than $900. You can buy, sell and trade COMP tokens, but they also give you voting rights on Compound protocol proposals.

How to use Compound

Compound is really user friendly compared to other DeFi protocols thanks to its simple product offering.

To get started, you’ll need a wallet. Compound supports:

• MetaMask
• Coinbase Wallet
• Wallet Connect
• Ledger

Once you’ve connected your wallet, you’ll be able to pick whether you want to supply or borrow and follow the simple steps for both. 

What can you do on Compound?

Compound lets investors:

• Loan crypto through lending pools and earn interest and COMP tokens for doing so.
• Borrow crypto from lending pools using their current assets as collateral and earn COMP tokens.
• Vote on proposals for the Compound protocol using COMP tokens.

Compound taxes

DeFi taxes - including Compound Taxes - can get complicated. The IRS and other tax offices haven’t issued guidance on DeFi tax yet. So investors are left trying to interpret the old rules and apply it to their DeFi transactions.

Do you pay taxes on Compound?

Yes. You’ll need to pay taxes relating to your Compound investments.

The type of tax you’ll pay depends on the specific transaction you’re making - but it’ll either be subject to Income Tax or Capital Gains Tax. Let’s take a look at the different Compound transactions and the tax implications.

Do you pay tax on lending crypto on Compound?

The IRS hasn’t issued any guidance on lending crypto and tax yet. However, it’s likely you’ll pay some kind of tax on your loaned crypto. Under the current rules, it all comes down to how your specific DeFi protocol works.

With Compound, when you lend crypto by adding to a lending pool, you get cTokens in return. This could be seen as a crypto to crypto trade and subject to Capital Gains Tax.

Similarly, when you want your original asset back (and the interest accrued) - you trade your cTokens back. This could be seen as crypto to crypto trade and any profit would be subject to Capital Gains Tax.

Do you pay tax on interest on Compound?

There’s no guidance from the IRS yet on earning interest in crypto. This said - other crypto rewards like mining or airdrops are seen as a kind of additional income. In those instances though, you’d be earning new coins.

When it comes to Compound, this all works differently thanks to the cTokens. You don’t earn new coins with Compound, instead the value of your cTokens increases in relation to the underlying asset. As you’re not receiving new coins, it’s less likely this could be seen as income.

Instead, you only realize a gain when you withdraw your original capital and accrued interest by trading your cTokens back. This is more akin to a crypto to crypto trade and therefore profits are more likely to be subject to Capital Gains Tax.

COMP tokens however don’t work like this. You earn new COMP tokens for lending and borrowing on the platform and you can claim these at any time. As you’re earning a new token, it’s likely that you’d pay Income Tax on COMP tokens based on the fair market value at the point you received them. 

Do you pay tax on borrowing crypto?

Like above, there’s no clear guidance on the tax implications of borrowing crypto through DeFi lending protocols. So we can only interpret the current guidance based on how the Compound protocol works.

Because you need to provide collateral to Compound to borrow crypto, you’ll receive cTokens in return for your asset. This could be seen as a crypto to crypto trade and therefore could be subject to Capital Gains Tax. Similarly, when you retract your collateral, you’ll make a further trade.

As for paying off interest, there is no clear guidance from the IRS about the tax implications of this. Spending crypto is a Capital Gains Tax event, but arguably this could also be seen as an investment expense and therefore tax deductible. You should speak to a crypto accountant for further advice.

As with above, when you borrow on the Compound protocol - you’ll earn COMP tokens which may be subject to Income Tax.

Do you pay tax on COMP tokens?

COMP tokens are treated just like any other cryptocurrency.

This means when you sell or trade COMP tokens - you’ll pay Capital Gains Tax on any profit.

Meanwhile, if you earn COMP tokens, you may need to pay Income Tax based on the fair market value at the point you receive them.

Buying COMP tokens on an exchange with fiat currency is tax free.

What do I need to report to my tax office?

It depends on where you live - each tax office has different reporting requirements for crypto, but you should keep good records of your Compound transactions regardless. 

In the US, you need to report each taxable crypto transaction on Form 8949, including:

• A description of the asset
• The date you acquired the asset
• The date you disposed of the asset
• The sale price at fair market value
• The cost basis of the asset at fair market value
• Your capital gain or loss

You’ll also need to report your net capital gain and loss on Schedule D and any crypto income on Schedule 1 and potentially Schedule C.

It’s a lot of work. If you’re an active trader on Compound and other DeFi platforms, your transactions can quickly mount into thousands per financial year. 

You’ll need good records of all your transactions on Compound with all the information - you can do this manually or with a crypto tax app. Let’s look at both.

How to do your Compound taxes

You need your Compound transaction history to do your crypto taxes. There’s two ways you can do this.

1. Use crypto tax software to get your Compound transaction history. You can connect crypto tax software to the wallet you use to interact with Compound via API. Alternatively, just add your Ethereum address to your crypto tax app (instructions here). This will automatically import your Compound transaction history to your app, identify your taxable transactions and calculate your capital gains, losses and income. 
2. Get a CSV file of your Compound transaction history. You can’t download a CSV file from the Compound platform directly, but you can use third party services like Etherscan to get a CSV file of your transaction history on Compound. You can then use this CSV file to identify your taxable transactions, capital gains, losses and income yourself.

Does Compound provide a tax report? 

No. Compound doesn't provide a tax report. But you can get a Compound tax report from a crypto tax calculator.

Does Compound supply a financial statement?

No. Compound doesn’t supply a financial statement.

How to generate a Compound tax form

You can do this manually or with a crypto tax app. Let’s look at both.

If you’re doing your taxes yourself, you need a complete transaction history from Compound for the financial year. You can get a CSV file of this using the method above. You’ll then need to identify each taxable transaction, the subsequent income or capital gain/loss and report this to the IRS using Form 8949 for capital gains and losses, Schedule D for net capital gains and losses and Schedule 1 for crypto income (and potentially Schedule C too for income).

Alternatively, use a crypto tax app to do all this for you. All you need to do is sync your Compound transactions using API. Your crypto tax app will then identify your taxable transactions and calculate any capital gains, losses and income for you. You can then download a tax report specific to your location to hand over to your tax office - for example, you can download a pre-filled Form 8949 and Schedule D.

Compound CSV export

As we said above, Compound doesn’t have an option to export a CSV file of your transaction history. However, you can use a service like Etherscan to download a CSV file or create one yourself and do your taxes manually.

Compound tax API

The easier option is to use crypto tax software to get your Compound transaction history and automatically calculate your crypto taxes via API.

Just get your Ethereum public address and enter this into your crypto tax app and your crypto tax software will do the rest. There’s instructions on how to do this here. We’ve also got instructions for specific wallets like MetaMask, Coinbase wallet and more on our integration pages.

Does Compound report to the IRS?

Anonymity is important for DeFi investors. Compound - like most other DeFi protocols, doesn’t require users to complete KYC verification to use the platform.

However, many of the wallets you’ll use to interact with Compound require KYC verification or for you to link a credit or debit card. If you’ve got transactions from your bank account linking you to crypto investments - the IRS is going to want to know about it.

Similarly, if you’re moving assets between Compound and centralized exchanges, many of these exchanges have been forced to share KYC data with the IRS to ensure tax compliance.

The best way to stay tax compliant is to report your crypto taxes accurately. 

Koinly is a Compound tax calculator & reporting tool

If you’ve been wondering is Koinly a Compound tax calculator tool, the answer is, yes! Not only can Koinly import Compound transaction history, but Koinly can also calculate your Compound taxes in a format that makes sense for your country’s tax office. As a Compound tax calculator, Koinly is able to do a bunch of impressive tasks that save you time and can even save you from paying too much taxes.

• Koinly will import all your Compound trades.
• Koinly will then convert your Compound transactions into your country’s currency, at fair market value. This in itself is a massive time saver.
• Finally, Koinly works out which of your Compound trades are taxable, and which are not - calculating your Compound gains/losses, crypto income and more. All of this is really important for being able to submit an accurate Compound tax return to your tax office.