Mapping Income Tax Challenges of Decentralised Finance

Abstract

This article examines the tax aspects of Decentralised Finance (DeFi) and the challenges posed by DeFi in relation to tax regulation. The edifice of the world’s financial system has, traditionally, been built around the role of financial intermediaries, particularly banks, that link lenders and borrowers for a fee. DeFi operations eliminate the need for central intermediaries by using direct blockchain-based transactions to replace them. Such replacement, however, introduces complexities into tax law interpretation and compliance. The author’s analysis highlights potential shifts in the tax burden from corporations to individuals, which could, potentially, deepen economic disparities and complicate the equitable application of tax laws. The author discusses five main areas of challenge to the current system of income tax: the redistribution of financial service income to DeFi participants; the identification of economic activities as business operations; the taxation of capital gains on investments; the characterisation of investment returns; and the tax treatment of expenses. Additionally, the article addresses administrative challenges, such as the need for innovative data collection methods, and international cooperation. The discussion extends to alternative entity-level taxation and other tax mechanisms, and advocates a tax policy study to design and ensure fair tax collection and ways to support a stable economic environment that embraces both innovation and fiscal responsibility. The research emphasises how urgent it is for policymakers and tax authorities to adapt regulatory practices to integrate DeFi effectively into global financial and tax systems.