Stablecoin Taxes Guide - Everything You Need To Know in 2023
March 2023 was harsh on the digital asset space. Three US banks that serviced crypto industry startups entered voluntary liquidation or went into receivership. The series of failures has resurfaced underlying issues related to stablecoins. In this regularly-updated guide to stablecoin taxes, you can learn everything about the tax treatment of stablecoins and the major regulatory issues related to this type of digital asset.
Last Updated: Jun 1, 2023
What is a Stablecoin?
Stablecoin refers to a class of crypto assets that aim to maintain a stable value relative to a specified real-world asset, such as fiat currencies, gold, bank deposits, short-term market instruments, or other crypto assets. This stability is achieved through various mechanisms, including holding reserves of the underlying asset, using algorithms to regulate supply and demand, or through collateralization.
Stablecoins are an important part of the digital asset and cryptocurrency ecosystem, offering several advantages over traditional cryptocurrencies, including reduced price volatility, increased liquidity, instantaneous processing, and secure payments. They are used as a medium of exchange, a store of value, and a means of hedging against market fluctuations. Also, stablecoins have enabled peer-to-peer lending and borrowing, removing the need for an intermediary or third-party involvement.
The Different Types of Stablecoins
There are two main types of stablecoins, and how they operate varies in part based on the type of stablecoin. They're classified mainly based on the underlying mechanism for maintaining price stability.
These are backed by one or several types of reserve assets, such as fiat currencies, commodities, or cryptocurrencies. For example, a stablecoin backed by the US dollar would maintain a 1:1 ratio with the fiat currency, meaning that one stablecoin is always worth one US dollar. In theory, this type of stablecoin provides a high degree of stability.
Banks holding large amounts of cash, commercial paper, liquid assets, and other investments in reserve maintain a stable price. Holders can turn in these stablecoins anytime to redeem the underlying reference assets. These include USD Coin (USDC) and Tether (USDT).
We can further classify Asset-Backed Stablecoins into three sub-categories:
These are backed by a specific fiat currency in a one-to-one ratio. Stability is ensured by keeping fiat currencies as reserve assets with a financial institution. The stablecoin issuer maintains fiat currency in reserve in a proportionate amount that matches the stablecoins it has issued. Examples of fiat-backed stablecoins include Tether (USDT) and USD Coin (USDC).
These are stablecoins that use commodities such as gold, real estate, or metals as collateral to provide stability. Examples of popular stablecoins of this type include Paxos Gold (PAXG) or Tether Gold (xAUT). These stablecoins allow holders to participate in the gold market and enjoy the benefits of a cryptocurrency without having to physically own gold bars.
These stablecoins use one or more cryptocurrencies as collateral to provide stability. They use a mix of smart contracts on the blockchain to lock in cryptocurrency reserves instead of relying on a central financial institution to hold reserves. DAI stablecoin is a popular example of a crypto-backed stablecoin that uses this approach.
How are Stablecoins Taxed?
The IRS cryptocurrency tax treatment holds for stablecoins as well. All cryptocurrencies, including stablecoins, are considered property for tax purposes. Thus, any gains or losses from buying, selling, or exchanging stablecoins are subject to income and capital gains taxes, depending on the circumstances of the transaction.
In the sections below, we’ll explore the taxation of stablecoins in more detail. Learn how stablecoin interest is taxed, what activities trigger taxable events, and whether transferring stablecoins between wallets or converting BTC to USDC is a taxable event.
How is Stablecoin Interest Taxed?
Stablecoin interest refers to the earnings that investors receive for depositing their stablecoins into a centralized lending platform or a decentralized smart contract. The stablecoin interest rates are commonly known as yields and represent the percentage an investment can yield over time.
For instance, if an investor deposits $1,000 at a 6% annual percentage yield (APY), they could earn $60 after 12 months. One of the advantages of cryptocurrency is that investors from any part of the world can earn interest on stablecoins. It's not uncommon for exchanges to offer interest rates ranging from 8% to 12% or even more on stablecoins, making them an attractive investment option for many cryptocurrency holders.
The interest you earn on your stablecoin holdings, is generally considered taxable income. You need to report this interest on your tax return and it will be subject to the same tax rates as other ordinary income. You must keep accurate records of your stablecoin interest transactions to ensure compliance with tax obligations.
Stablecoin Taxable Events
Various taxable events can occur when you own or transact with stablecoins. These include:
Selling or exchanging stablecoins
When you sell or exchange stablecoins for fiat currency or another cryptocurrency, this may be subject to capital gains tax. The tax is calculated based on the difference between the stablecoin’s purchase and sale price.
However, if you hold the stablecoins for more than a year before selling them, the tax rate will be lower. Your short-term capital gains will be taxed at your ordinary tax rate. Depending on your income bracket, this will range from 10% to 37%. Your long-term capital gains will be taxed at 0%, 15%, or 20%, depending on your income.
Receiving stablecoin payments for goods or services
If you receive stablecoins as payment for goods or services, the value of the stablecoins at the time of receipt is your gross proceeds for the transaction. You should report this income on your tax return no different than if you received fiat in return for your goods or services.
Earning interest on stablecoin holdings
If you earn interest on your stablecoin holdings, the interest income should be reported as income based on the value of the coins at the time that the taxpayer obtains control of the coins.
Is transferring stablecoins between wallets a taxable event?
Transferring stablecoins between your own wallets, whether a hot wallet or a cold wallet, is not taxable. However, it's important to ensure you accurately report these transactions to avoid any confusion or mistakes on your tax returns. You can also use a reliable crypto tax calculator to have a peace of mind when it comes to your crypto taxes.
Is converting BTC to USDC a taxable event?
Yes, converting BTC to USDC is a taxable event. This is because using one cryptocurrency to buy another is basically a barter transaction. Essentially, you are selling your BTC at its fair market value and immediately use those funds to buy USDC. The initial transaction of selling BTC is considered a taxable disposition in which you must recognize any gains or losses. The second transaction of acquiring USDC is treated as acquiring it for fiat currency.
When you trade one cryptocurrency for another, you’re essentially doing the above transactions in one go. As a result, you must report any gains or losses on the cryptocurrency you gave up. This means that if you acquired BTC at a lower price than its current market value and then used it to buy USDC, you would need to report this gain. On the other hand, if you acquired BTC at a higher price than its current market value and then used it to buy USDC, you would report a loss, which can be used to offset other gains for tax purposes.
It's important to keep accurate records of your cryptocurrency transactions, including any conversions between different cryptocurrencies. This will make it easier to calculate your gains and losses and ensure you report the correct amount of taxable income to the tax authorities.
How do I report Stablecoin Taxes on My Tax Return?
When reporting stablecoin taxes on your tax return, it's crucial to distinguish between capital gains and income. As previously mentioned, certain stablecoin transactions like receiving payments, mining, airdrops, and earning interest are classified as ordinary income and, therefore, subject to ordinary tax rates. On the other hand, selling stablecoins and making a profit will likely lead to capital gains tax. This is subject to preferential tax rates for long-term capital gains.
To ensure that you correctly report your stablecoin taxes on your tax return, keep a record of the value at the time of receipt or cost basis, as well as the sale price of any stablecoin transactions throughout the tax year. This means keeping precise records of all your transactions and their corresponding values. When it's time to file your tax return, you’ll need to report your stablecoin transactions on the appropriate forms, such as Form 8949 and Schedule D for capital gains or Form 1040, Schedule 1, Schedule C, or the appropriate business form for income.
File your tax return accurately and on time to avoid penalties or fines. To learn more about how to file your crypto taxes, please refer to our Crypto Tax Filing Guide USA 2023.
When is the Redemption of Stablecoins Taxable?
Stablecoins are generally redeemed when the holder wants to cash out their investment or convert them into fiat currency. The tax treatment of redeeming stablecoins depends on the type of stablecoin and whether or not there has been a gain or loss.
For fiat-backed stablecoins, the redemption process involves burning the redeemed coins and transferring the fiat currency back to the taxpayer. Theoretically, the value of one stablecoin should equal the value of one unit of fiat currency. This means there will be no gain or loss upon redemption. However, in practice, if there is a large trading volume involved or if you bought the dip for USDC, you have potentially realized a gain upon redemption.
Asset-backed stablecoins work similarly. Taxpayers receive their collateral back upon redemption and there should be no gain or loss to the taxpayer in theory. However, if there’s a decline in the collateral value resulting in under-collateralization of the issued stablecoins, the network would force a sale of the collateral to buy back the issued stablecoins. Any remaining collateral is then transferred back to the taxpayer. You should note any gain or loss on the forced sale of the collateral.
Algorithmic stablecoins cannot be redeemed for fiat currency or other collateral. Instead, they can only be exchanged for other cryptocurrencies or property. The exchange should result in a taxable event. You will be taxed on the increase in value of the stablecoins between issuance and exchange.
Using Crypto Tax Software for Stablecoin Taxes: Does it Work?
Yes, like with cryptocurrencies, crypto tax software can simplify the calculation of stablecoin taxes and help you successfully report them on your tax return.
It can be hard to accurately track your taxable stablecoin transactions and calculate your tax liability. This is especially true for those who frequently trade or have numerous transactions to report. Using reliable crypto tax software can help you avoid costly mistakes and ensure your taxes are filed accurately.
Accointing by Glassnode’s app offers several features, including a portfolio tracking and tax-loss harvesting tool and fully IRS-compliant tax reports. The software streamlines the reporting of stablecoin transactions and accurately calculates your tax liability following an accounting method of your choice, such as FIFO, LIFO, and specific identification.
Stablecoins: Risks and Threats
Investing or trading with stablecoins involves risks. A report by the International Monetary Fund explained the risks to consumers and markets coming from the activity of stablecoin issuers. The risks arise from:
- The design of a stablecoin’s stability mechanism
- The reserves that underpin stablecoins’ price stability
- The stablecoin issuer’s governance and management of operational risk, conflicts of interest, and concentration.
Some stablecoins may be backed by assets deemed risky or illiquid, such as commercial paper, which could result in the reserves not being fully redeemable. The motivation for investing in such less liquid and higher-risk assets typically stems from chasing higher yields. However, these investments may also be driven by conflicts of interest between the issuer and related parties. Leading stablecoin issuers such as Tether, Circle, and Binance have not yet provided regular audit reports by independent auditors.
If the reserves meant to secure a stablecoin’s value are heavily concentrated in specific institutions or assets, this is a potential red flag. Due to regulatory uncertainty and concerns about financial integrity, many commercial banks refrain from forming relationships with stablecoin issuers. That’s why stablecoin issuers have had to deposit their reserves in only a handful of banks.
Additionally, stablecoin reserves are often undiversified, meaning they consist of relatively few reserve assets. In this case, higher redemptions of stablecoins could easily create significant liquidity pressures in the market for the underlying assets.
Some stablecoin issuers may rely on market makers, crypto asset exchanges, and commercial banks to meet redemption requests and distribute cash to token-holders. Third parties involved in custody and stablecoin redemption processes may delay redemptions and add costs.
For instance, while Tether allows direct redemptions to holders, they’re only permitted for requests over $100,000. The second-largest stablecoin, USD Coin (USDC), also restricts redemption rights to institutional investors. As a result, most retail stablecoin holders must depend on crypto exchanges to convert their stablecoins to fiat currencies.
Stablecoins are also prone to speculation, market manipulation, and arbitrage. As demonstrated by the events of Black Wednesday in 1992 involving the British Pound and the Terra USD in March 2022, it’s challenging and expensive to maintain a stable value relative to a specified asset.
Stablecoin Collapses - Tax Implications
Several big events in the crypto space have affected stablecoins in recent insights leading to crucial insights. USDC, the second-most liquid US dollar-pegged stablecoin lost its peg, dropping below 87 cents. This happened after its issuer, Circle, admitted having $3.3 billion banked with the failed SVB. DAI, another popular dollar-pegged virtual currency, traded as low as 90 cents. Coinbase and Binance paused USDC-to-dollar conversions, and traders began swapping their USDC and DAI for Tether.
On the night of May 7, 2022, Terraform Labs withdrew 150 million UST from a decentralized stablecoin exchange as part of a planned effort to transfer these funds to another pool. Subsequently, a trader exchanged 85 million UST for USDC. This was followed by another trader who swapped 100 million UST for USDC in increments of 25 million over the next hour. As a result, Terraform Labs withdrew another 100 million UST from the decentralized stablecoin exchange to "rebalance" the ratio of UST to other stablecoins.
However, these large trades along with several smaller ones had already disrupted UST's peg, causing investor panic and triggering a sell-off. Many holders with their UST deposited in Anchor began to withdraw their funds. To address the situation, the Luna Foundation Guard (LFG) sold billions worth of Bitcoin from its reserves to swap for UST on May 9th. However, by May 10th, LFG's reserves were depleted, and UST had lost its peg permanently.
According to the stablecoin's algorithm, UST holders could always "burn" one UST to "mint" one dollar worth of LUNA, regardless of the price of LUNA. As a result, holders burned their UST in large quantities, causing hyperinflation of LUNA, with supply entering the trillions and prices plummeting to fractions of a cent. When LUNA's market cap fell below UST's, it became clear that not everyone could burn UST for equal value. The remaining holders sold at progressively lower prices until UST's value was barely above a penny, and the algorithmic stablecoin collapsed.
On March 11, 2023, USDC issuer Circle announced in a Twitter post that $3.3 billion in cash deposits remained at Silicon Valley Bank (SIVB), a bank shut down by financial regulators. Investors soon after redeemed more than $1 billion worth of USDC tokens, which caused the stablecoin to temporarily lose its dollar peg on some exchanges.
This resulted in the largest stablecoin swap pool on decentralized finance platform Curve experiencing a heavy imbalance. Traders began to withdraw stablecoins from centralized exchanges and swap tether (USDT) for USDC on decentralized exchanges, leading to stablecoin outflows from crypto exchanges.
In response to the panic, Binance and Coinbase temporarily suspended USDC conversions. Customers holding USDC on these exchanges were unable to withdraw or convert it to other cryptocurrencies, anxiously waiting for more information from Circle or for the stablecoin to regain its peg.
In a company blog post from March 11, 2023, Circle reassured investors that USDC liquidity operations would resume as normal when banks opened on Monday morning in the United States. The company also stated that USDC would remain redeemable 1 to 1 with the U.S. Dollar. Additionally, Circle initiated transfers of its exposure of $3.3 billion in cash deposits that remained at Silicon Valley Bank to other banking partners, and reassured investors that it would stand behind USDC and cover any shortfall using corporate resources, involving external capital if necessary.
Stablecoin Regulatory Issues
At present, there is no all-encompassing regulatory structure in place for stablecoins, although there have been suggestions for alterations to the regulation surrounding them in all major economies.
In the United States there is uncertainty regarding which federal agencies have the authority to oversee these products. As per the Chairman of the Securities and Exchange Commission, Gary Gensler, stablecoins pose a unique risk to the financial system and the wider economy. In addition the Commodity Futures and Trading Commission and the Securities and Exchange Commission (SEC) have initiated enforcement actions against stablecoin issuers. Specifically the SEC has enforced actions against Terraform and its Chief Executive Officer, the issuer of TerraLuna, and issued a Wells notice against Paxos for minting Binance USD.
Moreover, before national banks and federal savings associations can engage in certain cryptocurrency, distributed ledger, and stablecoin activities, they must receive written approval from the Office of the Comptroller of the Currency. They must also demonstrate that they have adequate processes and procedures to manage risks and comply with the law.
While the federal government continues to develop possible approaches to stablecoin regulation, on June 8, 2022, the New York Department of Financial Services issued its Guidance on the Issuance of U.S. Dollar-Backed Stablecoins which outlines the requirements for issuance of USD-backed stablecoins and focuses on redeemability, reserves and attestation.
The Market in Crypto Asset Regulation (MiCA) is the proposed regulatory framework that aims to establish a consistent set of rules for assets in the crypto ecosystem in the EU. It aims to address gaps in existing financial services legislation.
MiCA includes restrictions on stablecoins of two types:
1. Electronic Money Tokens: maintain a stable value by referencing a single official currency; and
2. Asset-Referenced Tokens: maintain a stable value by referencing multiple fiat currencies, commodities, cryptocurrency assets, or a combination of these.
Publicly offering or listing Electronic Money Tokens and Asset-Referenced Tokens in the EU requires authorization.
Authorized credit institutions or Electronic Money Institutions may list e-money tokens but must notify their supervisory authority and publish a white paper that includes detailed information. Issuers of e-money tokens must comply with capital requirements and rules on safeguarding received funds.
Issuers of Electronic Money Tokens must also maintain a reserve of assets. MiCA stipulates the right of investors to redeem their tokens at any time. Thus, the reserve requirements will ensure issuers won’t run into any liquidity risks when faced with a large number of simultaneous redemption requests.
MiCA also effectively limits the daily average number of transactions and trading volume associated with the uses of Electronic Money Tokens and Asset-Referenced Tokens as means of exchange. The limit is 1 million and EUR 200 million, respectively.
The United Kingdom
In April 2022, the UK confirmed its intentions to take the necessary legislative steps to regulate stablecoins used as a means of payment. In the United Kingdom, cryptocurrency assets satisfy the “electronic money” criteria under the UK Electronic Money Regulations 2011. However, proposals now aim to incorporate Asset Reference Tokens and Algorithmic Stablecoins in this regulation.
The information contained in this guide, including any supplemental materials, is for general information purposes and does not constitute financial, investment, legal or tax advice. The present content is not intended as a thorough, in-depth analysis, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. Please consult your tax advisor.