Treasury and IRS finish broker rules for DeFi, require KYC from protocols

The US Department of the Treasury and the Internal Revenue Service (IRS) have released the final version of its broker rules to digital assets services providers, which includes provisions on requiring DeFi protocols to conduct Know-Your-Customer (KYC) procedures.

Industry experts have already criticized the new provision for being unlawful and out of the Treasury’s regulatory reach.

The regulations require brokers who take possession of digital assets on behalf of customers, including DeFi front-ends as brokers, to report sales and exchanges and track and report user activity.

Since a broker must report user tax, the new rule requires DeFi front-ends to perform KYC processes.

Although digital asset brokers should comply with the new rules by Jan. 1, 2025, the obligations will only be applied to DeFi brokers by Jan. 1, 2027. The different starting periods are based on the lack of proper systems for backing up, collecting, reporting, and storing information.

Additionally, the IRS indicated that it will address reporting rules for these entities in future regulations.

Consensys senior counsel Bill Hughes highlighted that DeFi front-ends would also be required to report activity from both US and non-US persons. 

Furthermore, the reporting is applied to every digital asset traded, including non-fungible tokens (NFTs) and stablecoins, despite crypto industry players advocating for narrower definitions.

Transition period and exclusions

The rules offer brokers making good faith efforts to comply with the new rules relief from reporting penalties and backup withholding for transactions occurring in 2025. Limited relief from backup withholding will also apply to certain transactions in 2026.

Furthermore, reporting of gross proceeds is required for transactions conducted on or after Jan. 1, 2025, while cost-based reporting obligations will commence for transactions on or after Jan. 1, 2026. 

Additional reporting requirements apply to real estate professionals using digital assets for closings on or after Jan. 1, 2026.

Notably, certain types of transactions have been excluded from the immediate reporting requirements. These include wrapping and unwrapping, liquidity provider, staking, and lending-related transactions.

However, the IRS plans to issue future guidance to address these and other complex aspects of the DeFi ecosystem.

Community backlash

Hughes stated that the broker rule represents the outgoing administration “not leaving quietly.” He believes a lawsuit will be filed, claiming that the rule is beyond the authority of Treasury and violates the Administrative Procedure Act.  

Following the lawsuit, the rules will likely be reviewed by Congress, where they can be disapproved, citing the overturning of Staff Accounting Bulletin (SAB) 121.  

Jake Chervinsky, chief legal officer at Variant Fund, called the rule unlawful and said that this is the “dying gasp” of the anti-crypto army on its way out of power. He added:

“It must be struck down, either by the courts or the incoming administration.”

Alex Thorn, head of research at Galaxy Digital, stated that the broker rule is “ extremely burdensome,” adding that it will likely come into review by a Congressional Review Act.

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