Accounting & Tax Cryptocurrency

Understanding DeFi Taxes in Australia

Abhinav Soomaney
by Abhinav Soomaney
5 min read
18 July 2024

Take outs:

  • DeFi Taxation: Various DeFi activities in Australia, such as lending, trading, and staking, generate taxable income. Capital gains tax applies to profits from token sales.

  • CGT Discount: Holding cryptocurrencies for over 12 months qualifies for a 50% CGT discount when sold, reducing taxable gains. 

  • Block Explorers: Tools like Etherscan help track DeFi transactions by providing details such as addresses, transaction values, and fees, ensuring accurate tax reporting.

  • Tax Complexity: Compliance with Australian tax laws for DeFi transactions is challenging due to decentralization. Using block explorers is crucial for precise reporting.

  • Income Types: Income from DeFi (interest, rewards) is ordinary income taxed upon receipt. Capital gains tax applies to profits from selling tokens, with potential discounts based on holding duration. Understanding these distinctions is key for tax planning.

Understanding Defi Taxes in Australia and How to Navigate Defi Activity Using Block Explorers

Decentralised Finance (DeFi) is a blockchain-based system that eliminates intermediaries like banks, using cryptocurrencies and smart contracts for services like lending, borrowing, and trading. DeFi aims to cut costs and boost efficiency with automation and blockchain security, revolutionizing finance. With the rise of DeFi, regulatory authorities worldwide are grappling with how to tax these new financial activities. In Australia, the Australian Taxation Office (ATO) has issued guidelines for reporting and taxing DeFi transactions. Complying with these tax obligations can be complex, particularly due to DeFi's decentralised nature.

Decentralised Finance (DeFi) encompasses a variety of financial transactions and activities conducted on blockchain networks, typically Ethereum.

Here are some key types of DeFi transactions and their taxability in Australia:

Lending and Borrowing:

Users can lend their cryptocurrencies to others through platforms like Aave, Compound, and MakerDAO, earning interest. Similarly, users can borrow cryptocurrencies by offering tokens as collateral, with interest rates and terms governed by smart contracts. Interest accrued from lending cryptocurrencies constitutes ordinary income subject to taxation. Borrowing itself isn't taxed, but interest expenses may be deductible if funds are used to generate income.

Lending and Borrowing:

Trading

1. Decentralized Exchanges (DEXs): Users can trade cryptocurrencies directly with each other without a centralized intermediary. Examples include Uniswap, SushiSwap, and Balancer.

2. Automated Market Makers (AMMs): These are a type of DEX where liquidity pools are used instead of traditional order books. Prices are determined by mathematical formulas.
Capital gains tax (CGT) is applicable when you sell, trade, or exchange cryptocurrencies. If you hold the cryptocurrency for over 12 months, you might qualify for a 50% CGT discount.
Trading

Yield Farming & Liquidity Mining:

Users contribute liquidity to DeFi protocols, earning rewards in additional tokens. This typically involves staking tokens in liquidity pools on platforms such as Yearn Finance and Curve Finance. When investors enter or deposit tokens into a Liquidity Pool, it is considered a taxable sale. Upon exiting the pool and receiving their tokens back, a new cost basis is recorded based on the spot rate of the tokens at that time. Rewards from yield farming and liquidity mining are treated as ordinary income and taxed upon receipt. CGT is applicable when you dispose off these rewards.
Yield Farming & Liquidity Mining:

Savings:

Users can earn interest on their cryptocurrency holdings by depositing them into savings platforms or protocols that generate yield, such as BlockFi or Celsius. Interest or yield earned from savings platforms is considered ordinary income and is taxable. These types of transactions are facilitated by smart contracts which are self-executing contracts with the terms of the agreement directly written into code. This automation reduces the need for intermediaries and increases transparency and security.

Savings:

Insurance:

DeFi insurance platforms provide coverage against risks like smart contract failures and exchange hacks. Examples include Nexus Mutual and Cover Protocol. Insurance payouts in cryptocurrencies may be considered ordinary income and are taxable.

Insurance:

Staking:

Users lock up their cryptocurrencies to support blockchain network operations (e.g., Proof of Stake) and earn rewards. Platforms such as Ethereum 2.0, Polkadot, and Tezos facilitate staking. Rewards earned from staking are classified as ordinary income and subject to taxation upon receipt. CGT applies when staked tokens or their rewards are sold.
Staking:

Derivatives:

DeFi platforms provide synthetic assets and derivatives trading, enabling users to speculate on asset prices, hedge risks, or gain exposure to diverse assets. Synthetix and UMA are notable platforms in this space. Profits or losses from trading cryptocurrency derivatives are typically considered business income or losses and are subject to taxation.

Derivatives:

Payments:

Peer-to-peer payments with cryptocurrencies are streamlined by DeFi protocols, ensuring low fees and rapid transactions. Initiatives such as Lightning Network and xDai Chain enhance scalability for payments. Cryptocurrency payments received are classified as ordinary income, taxable at their fair market value upon receipt. Additionally, using cryptocurrency for purchasing goods or services triggers a CGT event.
Payments:

Governance:

Participating in the governance of DeFi protocols by voting on proposals and changes. This usually involves holding governance tokens like UNI (Uniswap) or MKR (MakerDAO). Tokens received as rewards for participating in governance may be considered ordinary income. CGT applies when you sell the governance tokens.

Governance:

How to Use Block Explorers to Track Defi Activity

Block explorers are essential tools for tracking Defi activity and ensuring accurate tax reporting. They provide detailed information about all transactions recorded on a blockchain, allowing you to track and verify your cryptocurrency transactions. Here’s a step-by-step guide on how to use block explorers to track DeFi transactions:

1

Choose a Block Explorer:

Different block explorers are available for different blockchains. Some popular ones include:

  • Ethereum: Etherscan
  • Binance Smart Chain (BSC): BscScan
  • Polygon (Matic): Polygonscan
  • Solana: Solscan
Choose a Block Explorer:
2

Search for a Transaction:

Using a Transaction Hash (TxHash)

  1. Copy the transaction hash from your wallet or DeFi platform.
  2. Paste it into the search bar of the block explorer and press enter.

This will bring up details about the specific transaction, including sender and receiver addresses, value transferred, transaction fees, and status.

Using a Wallet Address:

Enter the wallet address into the search bar. This will display all transactions involving that wallet. You can filter these to find specific DeFi transactions.

Search for a Transaction:
3

Analyse Transaction Details:

For each transaction, you can view:

  • Status: Whether the transaction is pending, successful, or failed.
  • Block Number: The block in which the transaction was included.
  • Timestamp: When the transaction was mined.
  • From and To Addresses: Sender and recipient addresses.
  • Value: Amount of cryptocurrency transferred.
  • Transaction Fee: Fee paid to the miner.
  • Token Transfers: Details of any ERC-20 or ERC-721 token movements.
Analyse Transaction Details:
4

Use Advanced Features:

Many block explorers offer advanced features that can be useful for DeFi transactions:

  • Contract Interaction: See which smart contracts were interacted with during the transaction.
  • Internal Transactions: Transactions that occur within a smart contract that might not be directly visible in the main transaction list.
  • Event Logs: Logs emitted by smart contracts that can provide additional context about the transaction.
Use Advanced Features:
5

Monitor DeFi Protocols:

Block explorers often provide special pages for monitoring DeFi protocols:

  • Etherscan DeFi Tracker: View stats and transactions for various DeFi protocols on Ethereum.
  • BscScan DeFi: Similar features for Binance Smart Chain.
Monitor DeFi Protocols:

Picture showing Uniswap transactions on etherscan

Picture showing Uniswap transactions on etherscan

Conclusion

 Navigating the taxation of DeFi activities in Australia can be challenging, but with the right tools and knowledge, it becomes manageable. Understanding the taxable events in DeFi and utilizing block explorers to track and report your activity is crucial for compliance with ATO regulations. By following the steps outlined, you can ensure that you accurately report your DeFi transactions and avoid any potential issues with tax authorities.

As DeFi continues to evolve, staying informed about the latest tax regulations and leveraging technology to track your transactions will be key to successful and compliant participation in the decentralized financial ecosystem.
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