Everything you need to know about calculating DeFi taxes with Zerion and TokenTax

Zerion and TokenTax have partnered up to make your DeFi tax reporting a blissfully easy process.

In this article, we’ll discuss:

  • Why Zerion makes it easier to compile taxes with TokenTax
  • How different DeFi transactions are taxed

Note: This article serves only as a general guideline and does not constitute tax advice. Cryptocurrency tax requirements vary across jurisdictions.

Why crypto tax is so complicated

Calculating and reporting cryptocurrency taxes requires compiling all of your transactions in a standard format across many years. You need to be able track your purchase price (the cost basis) in order to calculate your net capital gain or loss. Defi Crypto Taxes are even more challenging because it’s not always easy to download transaction histories or tell the difference between what is a taxable event and what isn’t.

It doesn’t help that most dapps and wallets have limited support for protocols which means depending on which interface you use, you’ll see wildly different numbers:

Precise DeFi portfolio tracking on Zerion compared to Metamask, Coinbase Wallet, Trust Wallet and Frontier Wallet
This wallet was viewed within a five-minute window on five different DeFi interfaces: (left to right): Zerion, MetaMask, Coinbase, Trust, Frontier

Zerion + TokenTax = DeFi taxes made easy

Zerion has spent almost two years building an interface that can track your entire DeFi portfolio from one place and show you complete transaction history. This requires complex engineering specific to each protocol and gives users a simplified view of their transactions over a period of time.

At the click of a button, you can export a CSV of your entire portfolio history, categorized by the kind of transaction taking place – such as lending, borrowing, or adding liquidity – and then further sorted into an accounting type for taxation purposes – such as deposit, income, or trade.

Wallet history on Zerion

This is where TokenTax comes in. TokenTax has developed a tool to automatically pull all of your DeFi transactions into one dashboard in a standardized format. From there, your tax liability is automatically calculated for you and tax reports can be exported in a variety of formats.

Understanding DeFi taxes

The Internal Revenue Service (IRS) released a guideline in 2014 that states that in the United States, cryptocurrencies are not treated as currency for tax purposes, but as property.

This means that any purchase, sale, or exchange of cryptocurrency is a taxable event, and must be reported on your tax returns.

Let’s take a look at how different DeFi strategies are taxed:

HODLing

This is the simplest of actions; any loss or profit you make is based solely on the price movement of the assets being held. You will be taxed on any increase in value in your asset from the time you purchased it to the time you dispose of it for fiat currency, another token, or goods and/or services.

Lending

Protocols like Compound, Maker, Aave and dYdx allow users to deposit crypto and earn interest at algorithmically variable rates. Unlike traditional banks, interest is typically earned every few seconds and at rates as high as 5%. Interest payments from most protocols — whether exchanged for fiat or not — are taxed as income at its current fiat value according to the marginal income tax rate.

However, when users earn interest on Compound, they don’t receive additional cTokens, rather, their balance of cTokens increases in value. In light of this, interest earned on Compound is taxed as capital gains.

Providing liquidity

Liquidity pools on protocols like Uniswap, Bancor, Curve and Balancer allow you to earn trading fees proportional to your deposit in an asset pool, such as ETH-DAI, each time that pair is traded. When a user deposits crypto to a DeFi liquidity pool, the protocol mints a token that represents the user’s share in the pool.

If a protocol distributes interest earnings with additional tokens, that interest is taxed as ordinary income. However, if the protocol distributes interest earnings not through additional tokens, but through an increase in value of a user’s existing token balance, that interest is taxed as capital gains.

Borrowing

Crypto loans let you put up collateral for another asset, such as BTC for DAI, according to a collateralization ratio which determines how much you can borrow and when you will get liquidated. Protocols that support this include Compound, Maker, Aave, dYdX, DDEX and Nuo. As long as your collateral is not sold or exchanged, no taxes will be triggered. This is useful for things like making tax payments without triggering more taxes by selling your crypto.

Exchanging and trading

Any trade between two cryptocurrencies or sale to fiat is a taxable event.

Staking

Protocols like 0x, Synthetix, Loopring and Kyber run on a Proof of Stake (PoS) consensus algorithm. Network validators earn block rewards based on the number of coins they are committing to stake, and for how long, as this contributes to the security of the network. In this way, staking is similar to earning interest from a bank account — the longer you hold, the more you earn. Staking rewards are taxed as ordinary income at the market value at time of receipt.

Options

Opyn and Opium allow people to take out options on stablecoin deposits as a form of insurance. Taxable amounts are the actual net capital gain or loss at the time of purchase and sale.

Automated strategies/ETFs

On protocols like TokenSets, Melonport, Idle, RAY and iearn, every user-controlled trade between cryptocurrencies or sale to fiat is a taxable event. Automatic rebalancing between cryptocurrencies on TokenSets does not count as a taxable event.

Margin trading

Margin trading involves borrowing funds in order to trade larger amounts of a specific asset, and is supported by DeFi protocols like dYdX and DDEX.

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, you’ll trigger a margin call. To prevent your collateral being sold off, you need to deposit more crypto as collateral, making you realize any capital gains or losses. Taxable amounts are the actual net capital gain or loss at the time of purchase and sale.

Lottery winnings

Lottery rewards from protocols like PoolTogether are taxed as income according to the marginal income tax rate.

We’ve prepared a handy infographic to help you navigate how taxation works for different DeFi strategies:

How do DeFi taxes work? Infographic by Zerion and TokenTax

How to prepare your DeFi taxes

Don’t get caught in the complexity of calculating your DeFi taxes. Zerion users now get a 10% discount on all TokenTax services. Simply head over to the Zerion app, and click “Calculate Taxes” under the History tab to get started.