US Treasury Requires KYC for DeFi Protocols, Faces Crypto Market Backlash
- DeFi protocols will have to implement KYC by 2027.
- Regulation aims to reduce tax evasion with crypto assets.
- Measure faces criticism for challenges in privacy and decentralization.
The U.S. Department of the Treasury and the Internal Revenue Service (IRS) have published final rules which require decentralized finance (DeFi) protocols to implement Know Your Customer (KYC) procedures. The move has been met with skepticism from the cryptocurrency community, who consider the measure excessive and challenging for an industry that operates under principles of decentralization and anonymity.
Treasury/IRS has finalized their DeFi broker tax reporting rule. Trading front ends would have to track and report on user activity – both US persons and non-US persons- starting in 2027. And it applies to the sale of every single digital asset – including NFTs and even… pic.twitter.com/CtFox668yn
— Bill Hughes : wchughes.eth 🦊 (@BillHughesDC) December 27, 2024
The new regulations require brokers who act as intermediaries in crypto transactions, including DeFi platforms, to report sales and exchanges to the IRS. This includes filing tax forms, such as Form 1099, detailing information about users and their activities. The rule also applies to all transactions of digital assets, such as stablecoins and NFTs, regardless of geographic location.
While other brokers will have to comply with the requirements by January 1, 2025, DeFi platforms will have until 2027 to implement the changes due to the complexity of adapting decentralized systems.
Exclusions and Transition Period
Certain transactions are exempt from the immediate requirements, such as staking, liquidity provider operations, and lending-related activities. However, the IRS plans to regulate these transactions in future updates. To facilitate the transition, the Treasury will offer penalty relief to entities that demonstrate good faith efforts to comply with the requirements in 2025 and 2026.
Additionally, reporting obligations on associated costs will only begin in 2026. The measure is seen as an attempt to soften the initial impact of the requirements on the market.
Industry Reactions
Bill Hughes, senior advisor at Consensys, pointed out that the rules do not adequately differentiate the challenges faced by DeFi platforms versus traditional brokers. “The requirement to report information on users from both inside and outside the U.S. is a regulatory burden for an industry that relies on decentralization,” he said.
Jake Chervinsky of Variant Fund called the move “illegal” and predicted it would be challenged in court. He believes the rules represent a last-ditch effort by an administration that is losing influence over the crypto market.
Entities including the Blockchain Association are planning legal action to challenge the regulation, claiming it oversteps the Treasury’s bounds and violates the Administrative Procedure Act. Additionally, Congress could review the measures under the Congressional Review Act, which allows for the repeal of excessive regulations.
Privacy and the Future of DeFi
The requirements raise privacy concerns, as many DeFi protocols operate without centralized intermediaries. The difficulty of identifying a responsible entity to collect and report user data makes regulation particularly complex.
Still, the Treasury and IRS argue that tax transparency in the cryptocurrency sector is essential to ensuring fair competition and combating tax evasion.
Disclaimer: The content of this article solely reflects the author's opinion and does not represent the platform in any capacity. This article is not intended to serve as a reference for making investment decisions.
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