New US infrastructure bill spells complications for DeFi

Late last week, Congress passed a $1.2 trillion bipartisan infrastructure bill in the United States. After much deliberation and debate, the bill passed 228-206, making funds available for much-needed upgrades to America’s critical infrastructure.

While the bill will mean funding for roads, pipelines, and the electric grid, it also has a clause on reporting financial transactions that will make life difficult for criminals operating in the digital currency sector and any business involved in decentralized finance (DeFi).

How will the rules affect DeFi and why?

What does the amendment in the new infrastructure bill say, and why does it complicate things for DeFi?

  • It brings in new reporting requirements that make it necessary for businesses to share details about senders of digital assets. The government will use these reports to investigate suspicious activity.
  • It’s an amendment to tax code section 60501. This law is designed to target criminal activity. Violations of the new rule will be a felony, unlike many other IRS reporting requirements.
  • The reporting burdens will not only apply to intermediaries (exchanges, etc.) but will apply to all businesses and could potentially include individuals. The only businesses which are exempt are banks and financial institutions which already report such information under the Bank Secrecy Act.
  • It defines cash to include “any digital asset,” so all digital currencies, NFTs, and other digital items are covered.

Note that, for the rules to kick in, five elements must be in place:

  1. A person receives
  2. Digital assets
  3. Exceeding $10,000 in value
  4. In the course of the recipients’ trade or business
  5. Unless a federally regulated financial institution is already reporting.

Where applicable, the business is then required to report information about the sender to the IRS.

Questions need to be answered

As with all laws, and especially when they apply to new technology, there will be various interpretations and disputes about when the law applies and to whom.

Questions will have to be answered, such as:

  • Will the law only apply to formal business partnerships, or is trading itself considered a business activity conducted by an individual?
  • If an individual provides liquidity to a DeFi lending pool and then cashes out by surrendering their LP tokens, how will it be possible to say who the sender of the funds was? With the way DeFi currently operates, it will be impossible to link tokens to particular accounts and wallets, let alone individuals.
  • If the tokens are not received from an individual but from a smart contract, is the DEX then the person from whom they were received? This would be strange, given that DEX’s are not legal persons.
  • Will swapping tokens within a DeFi lending pool constitute a new receipt? E.g., would swapping $10,000 of one token for $10,000 of another trigger the regulations? Would swapping $10,000 worth of digital currency for an NFT trigger the reporting requirements since this could also constitute a new receipt?
  • Is it likely that lawmakers and prosecutors will shrug and admit there’s nothing they can do since the sender is not a person, or is it more likely that DeFi will have to change to comply with the law?

It just keeps getting worse for the crypto-anarchist narrative

Places like the European Union have already passed legislation with their own strict reporting requirements. The passing of the infrastructure bill makes it official in the U.S., too. So, we now have two of the world’s largest economies with strict reporting requirements on digital assets that neuter the code is law and governments can’t touch crypto narrative.

Remember that the reporting requirements are on businesses, but the aim of the new rules is to collect information about senders of digital assets. Businesses, which are profit-seeking rational entities, are unlikely to refuse to comply with the law out of allegiance to anarchist ideals when doing so is a felony.

Slowly, we are beginning to see unravelling of the entire narrative that the early digital currency space was built on. Laws are being passed all over the world that make reporting and compliance with KYC/AML regulations necessary. Businesses like Coinbase are backing down when challenged by the law. Outspoken digital currency advocates like Changpeng Zhao are bending over backward to comply with laws and regulations as soon as they are passed.

In the end, just as U.S. Securities and Exchange Commission (SEC) Chairman Gary Gensler said, the Wild West era of crypto will come to an end. It’s happening before our eyes. Thankfully Bitcoin was designed with this end in mind, and it’s ready for the new legally-compliant era in digital assets.

Watch: CoinGeek New York panel, Investigating Criminal Activity on the Blockchain

YouTube video

New to blockchain? Check out CoinGeek’s Blockchain for Beginners section, the ultimate resource guide to learn more about blockchain technology.