Decentralized finance, often known as DeFi, is a type of blockchain-based finance that allows consumers to access financial services without having to interact with centralized services like banks, brokerages, or exchanges.
There is enormous potential for DeFi. Our current financial systems are constrained by national boundaries, a small number of firms, and antiquated technology. In the end, this causes billions of people to lack both financial freedom and access to financial services.
With worldwide, decentralized networks that remove power from intermediaries and place it in the hands of the people, DeFi challenges centralized financial institutions.
In this post, we’ll go over everything you need to know about DeFi, how cryptocurrency investors are using it to profit, and how DeFi may affect your taxes.
What is DeFi
DeFi is more than one idea. It’s a catch-all phrase for a wide range of financial apps created with blockchain technology or that make use of cryptocurrencies.
The objective of the game? Break apart centralized banking systems and profit from it.
In a Telegram chat in 2018, the phrase “DeFi” was first used. The new automated financial services that a group of business owners and technologists planned to create on the Ethereum blockchain were in need of a name. The idea was straightforward: to make decentralized finance available to anyone with an internet connection. It was inspired by Bitcoin’s idea of a decentralized currency and motivated by smart contracts’ possibilities.
In just three years, the DeFi market will have millions of investors and approximately $90 billion in collateral.
What can you do with DeFi
Now that you are aware of how and why DeFi was developed, let’s examine its capabilities. DeFi, as we stated before, is a massive collection of several protocols rather than a single application or process. DeFi protocols are self-contained programs (smart contracts) designed to carry out particular tasks.
Many of these were developed in order to address issues that existed in the conventional financial sector. For instance, if you apply for a loan from a traditional bank, you would often need to submit various documents, proof of identification, and evidence of your income and address. However, with DeFi, all you have to do is deposit an asset into a certain protocol, which takes care of everything else. The terms, circumstances, and rules are set down in the protocol. The protocol will terminate the contract if you are unable to pay the agreed-upon amounts back.
How is DeFi taxed
You must be aware of the tax repercussions of your DeFi investments because tax authorities all over the world are coming down on cryptocurrency speculators.
We haven’t even begun to touch the surface of the many options and capabilities DeFi provides to investors, and DeFi is always evolving. This indicates that tax authorities haven’t yet provided precise guidance on DeFi taxes.
All tax offices have specific guidelines on how to tax cryptocurrencies, and they always fall under one of two categories: capital gains tax or income tax. This depends on whether your cryptocurrency investment is perceived as regular income or as the sale of an asset.