Decentralized finance platforms subject to IRS broker reporting regulations
Executive summary
New regulations specify which services will trigger broker reporting requirements for operators of decentralized trading platforms
The IRS has issued final regulations describing the services that will trigger broker reporting requirements for operators of digital asset trading protocols. TD 10021 (Dec. 27, 2024) Earlier this year, the IRS issued information reporting regulations for brokers who took custody of crypto and digital assets, but reserved ruling on brokers who operated decentralized finance (DeFi) platforms. TD 10000 (June 28, 2024) When issuing the regulations in June, the IRS stated that it considered DeFi operators be to be “middlemen” who offered facilitative services to customers looking to trade digital assets, but the IRS delayed ruling on which types of services would fall under the reporting regulations. In the recent December regulations, the IRS further specified that DeFi participants who fall within the definition of “trading front-end service providers” will be treated as brokers and required to report to the IRS and provide copies to their customers.
Defining a trading front-end service provider and position to know the nature of the transaction
To define who is a “trading front-end service provider,” the IRS adopted a simplified DeFi technology stack model consisting of three layers: (1) interface, (2) application and (3) settlement. In general, only persons and entities operating on the interface layer will be treated as “trading front-end service providers.” The IRS described the interface layer as enabling crypto and digital asset users to communicate with DeFi participants operating on the other layers for ultimate execution and settlement of the transaction. A likely example of a trading front-end service provider is Uniswap. The Uniswap interface facilitates user transactions with various applications, enabling token swaps and liquidity provision.
Under the regulations, persons providing front-end services on the interface layer are presumed to have access to their customers and can query them about their identity. Whether interface layer service providers will have to report on gross proceeds and possibly withhold on non-U.S. persons depends on whether they are in a “position to know the nature of the transaction.” The IRS provided some examples of when a service provider would be in a position to know the amount of the gross proceeds and have a duty to report. These include whether the provider could:
- amend or update its terms of service;
- charge fees from the digital assets disposed or received in the trade order; and,
- add to the order a sequence of instructions to query the distributed ledger to determine if the processed order is executed.
Front-end service providers cannot avoid reporting requirements by voluntarily limiting their coding ability.
Exception for certain DeFi transactions
IRS Notice 2024-57 identified several DeFi transactions that are excepted from the reporting requirements until further notice. These transactions include wrapping and unwrapping, liquidity providers, staking, lending, short sales, and notional principal contracts. The exceptions in Notice 2024-57 apply to front-end service providers as well as other brokers under the regulations.
Effective dates: Jan. 1, 2027, reporting, and Jan. 1. 2028, withholding
The requirement for front-end service providers to report applies to digital asset sales occurring on or after Jan. 1, 2027. In companion guidance providing transitional relief (Notice 2025-3), the IRS postponed to Jan. 1, 2028, the effective date for backup withholding.