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Cryptocurrency

DeFi Has Three Options If IRS Rule Isn’t Rolled Back Says Alex Thorn

Horizonstocks

The recent decision by the Internal Revenue Service (IRS) to designate decentralized finance (DeFi) front-ends as brokerages has sent shockwaves throughout the crypto industry. This move has left many in the space wondering how they will comply with the new regulations, and some have even begun exploring alternative options.

Potential Options for DeFi Industry

Alex Thorn, the head of research at Galaxy Digital, recently outlined three potential paths that DeFi services and applications can take if the IRS rule is not backtracked. According to Thorn, these options include:

1. Compliance with Reporting Requirements

One option for DeFi services and applications would be to comply with the IRS reporting requirements and accept the designation as a brokerage. This would involve implementing measures to report transactions and maintain records of user activity.

However, this option may not be feasible for many DeFi platforms, particularly those that prioritize decentralization and autonomy. As Thorn noted:

"DeFi applications with no front-end website, non-upgradeable contracts, and that receive no ‘consideration’ from the disposition of digital assets —i.e., collect no fees — could be exempt from being designated ‘brokers’ under the proposal."

This suggests that extremely decentralized applications may not be in a position to comply with broker reporting requirements.

2. Blocking Users from the United States

Another option for DeFi services and applications would be to block users from the United States, thereby avoiding compliance with the IRS reporting requirements. This would involve implementing geolocation restrictions or other measures to prevent users from accessing the platform if they are located in the US.

However, this option may not be viable for many DeFi platforms, particularly those that have a significant user base in the US. As Thorn noted:

"This approach may limit the reach and accessibility of these applications, which could potentially impact their growth and adoption."

3. Abandoning Smart Contract Upgrades

A third option for DeFi services and applications would be to abandon smart contract upgrades and revenue generation, effectively rendering themselves exempt from being designated as brokerages under the proposal.

However, this option may not be feasible for many DeFi platforms, particularly those that rely on smart contracts to facilitate transactions and generate revenue. As Thorn noted:

"This approach would require a significant overhaul of their current infrastructure and business models, which could be challenging and costly."

Background on IRS Reporting Rule

The IRS issued the final rule change on December 27, 2024, which defines ‘Trading front-end service providers’ as brokerages. This includes decentralized exchanges (DEXs), among other entities. If finalized, the change will take effect in 2027.

Crypto industry executives have been vocal in their criticism of the new rule, with some calling on Congress to block it. Consensys attorney Bill Hughes called out the timing of the rule in a social media post:

"This rule has been ready to go for a while now. They dump it on the last Friday of 2024, in the middle of a holiday stretch on purpose, obviously —as if we wouldn’t notice or make an absolute ruckus over it."

Industry Response

The crypto industry’s response to the new rule has been swift and intense. A joint lawsuit was immediately filed against the Internal Revenue Service by Texas Blockchain Council, the Blockchain Association, and DeFi Education Fund on December 27.

According to the lawsuit filing:

"This case is about unlawful and unconstitutional overreach by the Department of the Treasury and the Internal Revenue Service."

The industry’s pushback against the new rule highlights the ongoing tensions between regulators and the crypto space. As the debate continues, one thing is clear: the implications of this rule will be far-reaching and have significant consequences for the future of DeFi.

Conclusion

The IRS reporting rule designating decentralized finance (DeFi) front-ends as brokerages has sent shockwaves through the crypto industry. With compliance options limited and industry pushback mounting, it remains to be seen how DeFi services and applications will adapt to this new reality.

As the debate continues, one thing is clear: the future of DeFi hangs in the balance, and the implications of this rule will be felt for years to come.

References

  • IRS. (2024). Final Rule Change.
  • Thorn, A. (2024). Potential Options for DeFi Industry if IRS Rule Is Not Backtracked.
  • Hughes, B. (2024). Social Media Post on Timing of IRS Rule.
  • Texas Blockchain Council, et al. v. Internal Revenue Service. (2024). Joint Lawsuit Filing.