The US Department of the Treasury and the Internal Revenue Service (IRS) have recently finalized their broker rules for digital asset service providers, which includes provisions requiring DeFi protocols to conduct Know-Your-Customer (KYC) procedures. This move has sparked criticism from industry experts who believe the regulations are beyond the Treasury’s regulatory reach and potentially unlawful.
The new regulations mandate that brokers who handle digital assets on behalf of customers, including DeFi front-ends, must report sales and exchanges, as well as track and report user activity. This means that DeFi front-ends will now be required to perform KYC processes in order to comply with the new rules. While digital asset brokers are expected to adhere to these regulations by January 1, 2025, DeFi brokers have been given until January 1, 2027 to implement the necessary systems for collecting, reporting, and storing information.
Additionally, the IRS plans to address reporting rules for these entities in future regulations. Consensys senior counsel Bill Hughes highlighted that DeFi front-ends will also be required to report activity from both US and non-US persons, and the reporting will encompass all digital assets traded, including non-fungible tokens (NFTs) and stablecoins.
The rules offer brokers making good faith efforts to comply with some relief from reporting penalties and backup withholding for transactions occurring in 2025. Reporting of gross proceeds is required for transactions conducted on or after January 1, 2025, while cost-based reporting obligations will commence for transactions on or after January 1, 2026. Certain types of transactions, such as wrapping and unwrapping, liquidity provider, staking, and lending-related transactions, have been excluded from immediate reporting requirements.
However, there has been significant backlash from the community regarding these new regulations. Hughes believes that a lawsuit will be filed, claiming that the rules exceed the authority of the Treasury and violate the Administrative Procedure Act. Jake Chervinsky, chief legal officer at Variant Fund, called the rule unlawful and stated that it is the “dying gasp” of the anti-crypto army on its way out of power. He believes the rule will be struck down by either the courts or the incoming administration.
Alex Thorn, head of research at Galaxy Digital, also expressed concerns about the burdensome nature of the broker rule and suggested that it may come under review by a Congressional Review Act. Overall, the new regulations have sparked controversy within the crypto community and may face further scrutiny in the future.