The crypto space is known for innovation, with novel applications of blockchain technology including decentralized finance (DeFi) and non-fungible tokens (NFTs).

Decentralized finance refers to an array of financial products that run on public smart contract blockchains such as Ethereum or Cosmos. These applications are permissionless, meaning they don't rely on third-party intermediaries. A whole ecosystem of DeFi "money Legos" has been built in the form of decentralized applications (dapps) that enable users to lend, borrow and trade financial instruments such as derivatives.

NFTs are cryptographically unique digital tokens built atop blockchains such as Ethereum. A major application of NFTs has been unique digital artworks and profile picture (PFP) collections, with some selling for thousands or even millions of dollars. But NFTs are also used to create digital trading cards, tickets for events, in-game items for video games and records linked to physical products.

Because of their novelty and the potential complexity of the financial applications built atop DeFi and NFTs, they can present challenges when it comes to filling out your tax returns. In this article we'll look at how some common DeFi tasks are treated, as well as how to consider NFTs and play-to-earn gaming, or GameFi.

DeFi lending, borrowing, and wrapping

Using DeFi protocols as a banking alternative, you can both lend and borrow money. If you’ve earned interest by depositing crypto collateral and participating in a crypto lending operation, this interest is taxable and considered income. While any accrued interest is taxable, the crypto you used to put up as collateral is generally not taxable. However, if you deposited ETH as collateral and received a different coin when you withdrew your collateral, that would be a taxable event as this would fall under the category of a crypto-to-crypto trade.

If you put up collateral to receive a loan (such as depositing ETH to receive stablecoins), that is typically not a taxable event—provided the collateral you deposit is the same collateral you receive upon loan repayment (in this case ETH). Certain DeFi protocols have self-repaying crypto loans that use the yield your collateral earns to repay the loan over time. For this type of loan framework, it would create an income event as this would likely be considered debt cancellation income.

The wrapping of a coin or token is still a somewhat ambiguous action as the tax guidance is currently laid out. For example, you can take ETH and wrap it so it can be used in certain DeFi protocols. Called Wrapped Ethereum (wETH), it is essentially the same thing but allows for more functionality with Ethereum’s ecosystem. Some crypto tax software automatically classifies these processes as taxable events; other tax professionals interpret the wrapping of crypto as a non-taxable event. In the absence of clear-cut guidance from the IRS, the more conservative approach would be to label wrapping and unwrapping transactions as taxable events.

Crypto Tax Calculator allows you to choose the tax treatment for wrapping as either taxable or non-taxable, right down to the individual transaction. Its software was built from the ground up to handle on-chain transactions like DeFi interactions and NFT trading, integrating with over 1000 different exchanges, wallets and blockchains. You can use DECRYPT2024 for 20% off all plans with CryptoTaxCalculator.

Crypto Tax Calculator's software also integrates beyond the blockchain, adding support for individual smart contracts and protocols that exist on that chain. "This means that if you import on-chain transactions into CTC, not only does it pull in all transactions from the chain but it also automatically categorizes complex smart contract interactions for tax purposes," a spokesperson for Crypto Tax Calculator told Decrypt. "For context, this differs to other tax software tools which ‘vomit’ the raw blockchain data out in an unusable format."

NFTs and GameFi

Those who invest in NFTs would have any profitable sales treated the same way as profitable sales of Bitcoin (BTC), Ethereum (ETH), or any other cryptocurrency. Creating NFTs themselves through minting is taxable if the minting involves a gas fee or has a mint cost associated, as this would be considered a crypto-to-NFT trade.

Those who release NFTs professionally and sell them would be subject to earned income taxes and should also report business expenses. Any secondary sales royalties would also be subject to taxes. Crypto Tax Calculator is the only software that supports both ERC-721 and ERC-1155 NFTs across multiple chains; it also supports NFT creators with auto detection of royalties.

A new law that technically applies from the start of 2024 would require anyone engaged in "trade or business" to report identifying information about received crypto payments over $10,000, which could apply to sales of NFTs. However, the IRS has stated that, “This particular provision requires Treasury and the IRS to issue regulations before it goes into effect,” and it will not be enforced pending a period of public comment and review.

GameFi is a novel sector of the crypto space, in which players of play-to-earn (P2E) games receive in-game rewards in crypto tokens and NFTs, which can then be converted into fiat currency. Some GameFi titles also enable users to engage in DeFi activities such as lending or borrowing using their crypto tokens, blurring the boundaries between gaming and finance.

How play-to-earn (P2E) gaming rewards are taxed can vary based on how rewards are acquired as well as the specific gameplay mechanics of a specific title. The earning of in-game crypto assets—tokens or NFTs—would likely be considered income in most instances.