Page 27 - Healthcare News Jan/Feb 2022

HEALTHY OUTLOOK
Deciphering the ‘Crypto Market’
What Are the Risks, Rewards, and Unknown Tax Implications?
By BRENDAN WCAWLEY, EA and IAN CODDINGTON, CPA
hile cryptocurrency has been around investment options for their customers. Services since 2008, its popularity has soared often come with fees and can result in delays to ac- over the past two years as people cessing or withdrawing funds.
dove into new interests during the pandemic. By using blockchain technology, users can vali-
hearing about OlympusDAO. What is OlympusD- AO? It is a decentralized reserve currency protocol based on the OHM token.
Hopefully, this example will illustrate just how quickly crypto can get complicated.
Participants seek returns through staking and bonding strategies. ‘Stakers’ stake their OHM tokens into a pool with other like-minded individu- als. Those OHM tokens are then put to work on the blockchain and earn rewards in the form of more OHM. Alternatively, those choosing to engage in the bonding strategy provide liquidity in the form of other crypto assets or DAI tokens to the Olympus Treasury. These assets are the necessary backing for new OHM minted and help to provide stability to the value of OHM. To compensate the participants for bonding, the protocol makes OHM available for purchase at a discount after a vesting period.
Now suppose the staking option sounds appetiz- ing. You open your account, you ensure you have sufficient funds, and you navigate to a centralized exchange in search of OHM. Oh no ... OHM is
not currently traded on a centralized exchange. So what do you do? You take a deep breath and turn to Google.
Quickly, you will recognize that OHM can only be purchased through a decentralized exchange (DEX) and you need the appropriate cryptocurren- cy, Ethereum (ETH), to participate. You purchase ETH on the centralized exchange for USD, which is a non-taxable event. With the ETH in hand (in your crypto wallet), you navigate to a DEX such
as SushiSwap and exchange ETH for OHM. This exchange is a capital event, and gain/loss should
be calculated. The cost basis of the newly acquired OHM should consider this gain or loss. OHM can now be staked on OlympusDAO in exchange for sOHM (‘staked’ OHM).
When OHM becomes sOHM, there is an argu- ment to say this is a property exchange and taxable again as capital gain/loss. The sOHM earns more sOHM over time, which is ordinary income upon receipt. Eventually, you might decide to cash out your sOHM. When sOHM is exchanged back to OHM, a taxable exchange has occurred again. Finally, you convert your new pool of OHM back to ETH, which, as you likely guessed, is taxable as capital gain/loss.
While this example is considered fairly simple and common, this journey alone noted five different taxable events. Keep in mind the software currently available often struggles to appropriately track
the tax basis of your crypto property and ordinary income received through each of the steps. Fur- thermore, trading fees can be challenging to track. When preparing for the 2021 filing season, consider reaching out to a qualified CPA.
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Whether you used your time in lockdown to learn how to bake banana bread or mine Dogecoins, it’s important to note that the latter may have come with some tax implications.
“The landscape of cryptocurrency and digital assets is evolving daily. The variety of investment options continues to expand, as does the number of investors.”
If you dipped your toes in the virtual currency waters, you may now be wondering — how will my transactions during the year affect my tax return? Our goal here is to give some basic insight into the crypto market, decentralized finance (‘DeFi’), and how the transactions along your cryptocurrency journey can affect your tax return this year and beyond.
What Is Cryptocurrency?
The IRS currently views cryptocurrency as a type of virtual currency. Virtual currency, such
as Bitcoin, Ether, Roblox and V-Bucks, to name a few examples, is a digital representation of value, rather than a representation of the U.S. dollar or a foreign currency (‘real currency’), that functions as a unit of account, a store of value, and a medium of exchange.
Cryptocurrency uses cryptography to secure transactions that are digitally recorded on a distrib- uted ledger, such as a blockchain. The blockchain technology allows participants to confirm transac- tions without the need for central clearing authority.
With that in mind, decentralized finance (DeFi) has quickly become the hottest trend in blockchain technology, but it comes with its own uniquely complicated and confusing tax situations. And if learning how to navigate cryptocurrency and DeFi wasn’t complex enough, you have to do so with very little IRS guidance.
What Is Decentralized Finance?
When you think of centralized finance, you might think of banks, such as Bank of America or JPMor- gan, which traditionally offer savings, lending, and
date transactions from peer to peer within a matter of seconds. Transactions can take place all around the world across computer networks without the need of a central authority. This is where DeFi
BRENDAN CAWLEY
IAN CODDINGTON
comes in, where users can engage in contracts for lending, borrowing, and other financial services at the click of a button. These contracts are created through algorithms, rather than underwritten by a loan officer. Additionally, fees associated with central banks and the delay in completing certain transactions are no longer an issue.
There are several popular DeFi platforms, such as UniSwap, PancakeSwap, Fantom, Aave, and SushiSwap, to name a few. These platforms offer different services to consumers: staking, liquidity pools, yield farming, along with traditional lending and borrowing. Investors who have gotten in at the initial stages have been seeing massive returns on their investments. Services such as yield farming and liquidity pools lock in cryptocurrency assets to facilitate blockchain transactions and pay partici- pants rewards in the form of cryptocurrency. How- ever, the IRS has not determined specific guidance on the treatment of specific transactions within the DeFi space.
Consumers and investors are tempted to partici- pate in the Defi market by varying annual percent- age yields (APY) of 3% to 15%, sometimes even more. This is a far cry from the 0.01% APY that you might get in your local bank’s saving account or the 1% APY in a certificate of deposit. The riskiness in- volved in these transactions, as well as the potential tax implications, might scare off some investors, but with a $114 billion market cap in 2022, there are plenty more who are ready to enter the DeFi space.
How Complicated Can It Get?
With the DeFi foundation laid, let’s color the conversation through a real-life example with some surprising complexities. When exploring the world of DeFi, it is unlikely you’ll venture far without
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