Blockchain technology and digital assets are blurring lines that were previously well established, such as the definitions of money, value, currency, investments, loans, and more. The rise of digital assets has created new types of business transactions never previously envisioned by regulators. Because of this, digital assets exist in a gray area for many accounting, tax, and regulatory issues. This article reviews three types of digital asset related transactions and why the traditional financial concepts and definitions you may have learned in the past are too narrowly defined for digitized economy of the future.

The BlockFi Interest Account

Until recently, BlockFi was offering almost 10% interest on cryptocurrency deposits through a product it calls the BlockFi Interest Account. Interest would accrue daily and was paid monthly at a specified annual percentage yield (APY). Users could withdraw funds at any time. The BlockFi entity used the deposited crypto assets to offer loans to borrowers, credit cards, and other financial products. Because of this, the BlockFi Interest Account worked like a high interest rate savings account like one would keep at a bank; however, BlockFi does not have a banking license, nor does it have FDIC insurance.

BlockFi has settled a lawsuit with the SEC, agreeing to pay a $100 million penalty and cease its unregistered offers. BlockFi intends to submit a registration statement with the SEC and refers to its interest-bearing account as a lending product. However, the BlockFi Interest Accounts certainly don’t appear to fit the traditional definition of a loan, because users can withdraw funds at any time, and BlockFi can adjust the interest rates at their discretion. Either of these attributes would be a highly unusual set of contract terms for a loan or an investment.

Maple.finance

With the BlockFi Interest Account, the BlockFi entity receives funds from the user, and the BlockFi entity then utilizes those funds to generate loans to borrowers. Maple.finance handles business differently.

Maple.finance essentially automates BlockFi’s role through use of computer code (referred to as a “liquidity pool smart contract”). The flow of funds for the two financial products is as follows:

On the Maple.finance platform, the Maple.finance entity never receives crypto assets; therefore, they are essentially a nonparty to the transaction. Maple.finance simply created the computer code and tokens that allow this process to work. This added level of automation allows for higher returns to lenders because the computer code “cuts out the middleman” (the bank). Maple.finance pools post an APY of 15%-25%.

Lending pools are created and run by pool delegates who set loan terms with borrowers based on credit worthiness. Pool delegates must put up Maple tokens (MPL) as collateral for the lenders (referred to as “staking”) to create a pool. Pool delegates receive part of the loan interest for their efforts. All loans are denominated in US dollar coins (Ticker: USDC), which are stablecoins designed to always be worth $1; this reduces concerns about volatile cryptocurrency prices.

For tax purposes, the lending pool could arguably be considered an entity, and could arguably be required to file a tax return as a partnership. However, from a practical perspective, the lending pool is simply computer code running on a blockchain, and it is not capable of hiring a good lawyer to set up an entity, nor can it hire accountants to file a tax return. Furthermore, the lenders generally do not need to supply any personally identifiable information to take part in the lending protocol, so pool delegates would not be able to file a tax return or issue K-1s on behalf of the lending pool.

The Maple.finance loans offer a fixed APY; lenders have no voting rights, and loan terms are established with borrowers. Maple.finance transactions appear to have all the normal attributes of a loan, however there are several open questions. Did the lender lend to a liquidity pool, and then the liquidity pool lent to the borrower? Or should the transaction be treated as though the lender lent directly to the borrower? Where is the pool considered to be located if it only exists on a decentralized blockchain? This may sound trivial, but the location of the borrower could have tax implications for state and local tax issues, as well as international taxation and withholding issues.

Origin Dollar

Origin Dollar also uses the automated smart contract model to reduce costs and increase return to users. Individuals looking to participate in the Origin Dollar protocol simply trade one of several stablecoins for Origin Dollar Coins (Ticker: OUSD), a stablecoin that is designed to always be worth $1. The individual simply holds the OUSD in his own wallet and waits for the OUSD protocol to earn a profit.

The OUSD protocol repurposes the stablecoins deposited from users, and invests them into other decentralized finance protocols, such as liquidity pools through Aave, Curve, and Compound that earn a profit through lending (effectively earning interest) or automated market making (effectively earning broker fees).

Origin Dollar refers to OUSD as a type of savings account, but it is not FDIC insured, nor does Origin Dollar have any type of banking license. Because users can sell their OUSD tokens at any point in time, in many ways this acts like a savings account. Unlike a traditional savings account, however, OUSD interest rates usually range from 8% to 25% APY to users.

In a way, OUSD operates more like an investment, where investors share in whatever profit is earned. The investor, however, is not invested in any type of entity, because Origin Dollar never receives the user’s funds. Instead, the user is turning their funds over to lines of computer code on a blockchain; that computer code then works to earn a profit. Similar to Maple.finance, these smart contracts that run the Origin Dollar Protocol are not capable of filing tax returns or providing K-1s or 1099s to users.

Conclusion

These new investment opportunities are highly profitable compared to traditional financial savings accounts, loans, and investments. Considering the staggering levels of profitability, participants in the digital asset DeFi ecosystem will likely continue to grow. Legal and regulatory bodies need to quickly reassess the traditional definitions of financial products and provide guidance on how these transactions are to be taxed and regulated.