Gross Proceeds Reporting by Brokers That Regularly Provide Services Effectuating Digital Asset Sales

Federal RegisterDec 30, 2024

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 10021]

RIN 1545-BR39

Gross Proceeds Reporting by Brokers That Regularly Provide Services Effectuating Digital Asset Sales

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Final regulations.

SUMMARY:

This document contains final regulations regarding information reporting by brokers that regularly provide services effectuating certain digital asset sales and exchanges. The final regulations require these brokers to file information returns and furnish payee statements reporting gross proceeds on dispositions of digital assets effected for customers in certain sale or exchange transactions.

DATES:

Effective date:

These regulations are effective on February 28, 2025.

Applicability dates:

For dates of applicability,

see

§ 1.6045-1(q).

FOR FURTHER INFORMATION CONTACT:

Roseann Cutrone or Jessica Chase of the Office of the Associate Chief Counsel (Procedure and Administration) at (202) 317-5436 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Authority

This document contains amendments to the Income Tax Regulations (26 CFR part 1) by adding final regulations under section 6045 of the Internal Revenue Code (Code) to require certain decentralized finance industry participants to file and furnish information returns as brokers. Section 6045(a) provides an express delegation of authority to the Secretary of the Treasury or her delegate (Secretary) to require every person doing business as a broker to make returns, in accordance with such regulations as the Secretary may prescribe, showing the name and address of each customer, with such details regarding gross proceeds and such other information as the Secretary may by forms or regulations require. Section 80603 of the Infrastructure Investment and Jobs Act, Public Law 117-58, 135 Stat. 429, 1339 (2021) (Infrastructure Act) amended section 6045 clarify the definition of broker as it relates to persons responsible for regularly providing services effectuating transfers of digital assets, to expand the categories of assets for which basis reporting is required to include all digital assets, and to provide a definition for the term digital assets. Finally, the Infrastructure Act provided that these amendments apply to returns required to be filed, and statements required to be furnished, after December 31, 2023, and provided a rule of construction stating that these statutory amendments shall not be construed to create any inference for any period prior to the effective date of the amendments with respect to whether any person is a broker under section 6045(c)(1) or whether any digital asset is property which is a specified security under section 6045(g)(3)(B).

The final regulations are also issued under the express delegation of authority under section 7805(a) of the Code. Section 7805(a) authorizes the Secretary to “prescribe all needful rules and regulations for the enforcement of [the Code], including all rules and regulations as may be necessary by reason of any alteration of law in relation to internal revenue.” The Infrastructure Act amended section 6045, and the Secretary has determined that these final regulations are needful for the enforcement of the Code because tax compliance would be increased if brokers were required to file information returns, and furnish payee statements, under section 6045.

See

Proposed Rules, Gross Proceeds and Basis Reporting by Brokers and Determination of Amount Realized and Basis for Digital Asset Transactions, 88 FR 59576 (August 29, 2023) (describing need for regulation and its anticipated impact on tax administration).

Background

On August 29, 2023, the Treasury Department and the IRS published in the

Federal Register

(88 FR 59576) proposed regulations (REG-122793-19) (proposed regulations) relating to information reporting under section 6045 by brokers. These proposed regulations included rules that would apply to brokers that generally act as agents and dealers in transactions with their customers involving digital assets, which are defined generally as any digital representation of value that is not cash and is recorded on a cryptographically secured distributed ledger (that is, a database that records transactions across multiple computers) or any similar technology. The proposed regulations also included rules that would apply to brokers that act as digital asset middlemen, a new category of broker proposed to address the use of digital assets to make certain payments and to reflect the clarified definition of broker under the Infrastructure Act. This proposed new category of broker would include certain participants that operate within the segment of the digital assets industry that is commonly referred to as decentralized finance (DeFi).

The DeFi industry offers services that allow for transactions that use automatically executing software commonly referred to as smart contracts based on distributed ledger technology without any participant in the DeFi industry (DeFi participant) taking custody of the private keys used for accessing the digital asset customer's digital assets on a distributed ledger. Additionally, the proposed regulations included specific rules under section 1001 of the Code for determining the amount realized in a sale, exchange, or other disposition of digital assets and under section 1012 of the Code for calculating the basis of digital assets.

This preamble's use of the DeFi term is not intended to create any inference as to whether or not this segment of the digital assets industry operates without any centralized participants.

The proposed regulations stated that written or electronic comments provided in response to the proposed regulations must be received by October 30, 2023. The due date for comments was extended until November 13, 2023. In response to the proposed regulations, the Treasury Department and the IRS received over 44,000 written comments.

All posted comments were considered and are available at

https://www.regulations.gov

or upon request. A public hearing was held on November 13, 2023. In addition, the Treasury Department and the IRS continued to accept late comments through noon eastern time on April 5, 2024.

Although

https://www.regulations.gov

indicated that over 125,000 comments were received, the Treasury and the IRS did not actually receive over 125,000 comments. Instead, 125,000 reflects the number of “submissions” that each comment self-reported as being included in the comment, whether or not the comment actually included such separate submissions.

On July 9, 2024, the Treasury Department and the IRS published in the

Federal Register

(89 FR 56480) final regulations (REG-122793-19) (TD 10000) regarding information reporting by certain brokers and the determination of amount realized and basis for certain digital asset sales and exchanges. TD 10000 generally applies to digital asset brokers that act as agents for a party in the transaction, such as operators of custodial digital asset trading platforms, certain digital asset hosted wallet providers, and certain processors of digital asset payments (PDAPs), as well as persons that interact with their customers as counterparties to transactions, such as owners of digital asset kiosks, brokers who accept digital

assets as payment for commissions and certain other property, brokers that transact as dealers in digital assets, and certain issuers of digital assets who regularly offer to redeem those digital assets. Additionally, TD 10000 finalized specific rules under section 1001 for determining the amount realized in a sale, exchange, or other disposition of digital assets and under section 1012 for calculating the basis of digital assets.

TD 10000 did not finalize the definition of digital asset middleman from the proposed regulations as applied to DeFi participants (referred to in the preamble to TD 10000 as non-custodial industry participants) because the Treasury Department and the IRS determined that additional consideration of the issues and comments received with respect to these participants was warranted. Instead, TD 10000 reserved on the proposed definition of digital asset middleman that would have treated these participants as brokers. The preamble to TD 10000 also indicated that the Treasury Department and the IRS intend to expeditiously issue separate final regulations with respect to these participants.

The

Summary of Comments and Explanation of Revisions

of these final regulations summarizes the digital asset middleman provisions in the proposed regulations that were reserved in TD 10000, which provisions are explained in greater detail in the preamble to the proposed regulations. After considering the comments to these provisions, the reserved portion of the proposed regulations relating to the definition of a digital asset middleman is adopted as amended by this Treasury decision in response to such comments as described in the

Summary of Comments and Explanation of Revisions.

These final regulations concern Federal tax laws under the Internal Revenue Code only. No inference is intended with respect to any other legal regime, including the Federal securities laws and the Commodity Exchange Act, or the Bank Secrecy Act and its implementing regulations, which are outside the scope of these regulations.

Summary of Comments and Explanation of Revisions

I. Comparison of the Decentralized Digital Asset Ecosystem With the Securities Industry

A few comments received in response to the proposed regulations asserted that the definition of broker in the final regulations should not extend beyond the scope of the definition of broker in the regulations that apply to securities industry participants in carrying out securities transactions. The Treasury Department and the IRS disagree with these comments and address them in Part II of this

Summary of Comments and Explanation of Revisions.

Before turning to that discussion, however, the Treasury Department and the IRS believe that a comparison of the functions carried out by brokers and other participants in the securities industry with the functions carried out by DeFi participants is useful in analyzing how the broker definition should apply to DeFi participants.

A. The Securities Industry

In the securities industry, the sale of a security typically involves three fundamental functions, each of which is necessary for the trade to take place. First, a customer will give a trade order to sell its securities to a securities broker, specifying the details of the order, such as the quantity and identity of the securities to be sold. Second, the securities broker will route the order details to a trading center, such as a national securities exchange or an alternative trading center, for example in the case of U.S. equities the New York Stock Exchange (NYSE) or the Nasdaq Stock Market, to execute the order. Third, once the exchange or other trading center finds a counterparty to the customer's order, the matched trade will be sent to a clearing organization that will record and settle the transaction by moving the traded securities and funds between the accounts of the two brokers representing the matched customers. While other financial institutions may be involved in the sale transaction, and the functions involved may involve additional steps, these three functions are core functions.

See

DTCC,

Accelerating the U.S. Securities Cycle to T+1,

Figure 2: Illustrative T+1 settlement trade flow, at page 8 (December 1, 2021), available at

https://www.dtcc.com/-/media/Files/PDFs/T2/Accelerating-the-US-Securities-Settlement-Cycle-to-T1-December-1-2021.pdf;

Financial Industry Regulatory Authority (FINRA),

The LifeCycle of a Trade

(November 21, 2017), available at

https://www.finra.org/investors/insights/online-trade-lifecycle

(describing the steps as the placement of an order by a customer and the receipt of the order by the broker, the sending of the order by a broker to an exchange or other trading center and the execution of the order on that exchange or other trading center, and the clearing and settling of the trade); Securities & Exchange Commission,

Trade Execution: What Every Investor Should Know

(January 15, 2013), available at

https://www.sec.gov/about/reports-publications/investorpubstradexec.

The securities broker that receives the customer's order may offer additional services. For example, while retail customers many years ago held physical stock and bond certificates themselves or with third-party custodians, today a securities broker or affiliate of that broker typically will hold a retail customer's securities as a custodian, although there are still limited circumstances under which an individual may hold physical securities certificates. For institutional customers, it is common for a financial institution other than the securities broker that receives the customer's trade order to hold the customer's securities. In some cases, for example in the case of an insurance company or pension plan, the customer's securities may be held by a bank that offers specialized custodial services. In other cases, for example in the case of a hedge fund, the customer's securities may be held by its primary securities broker, referred to as a prime broker, but the customer may give the order to a different broker, referred to as an executing broker, that offers lower fees or other terms preferred by the customer. If the securities broker taking the customer's order does not hold the customer's securities, the executing broker and the financial institution holding the customer's securities will communicate with each other to ensure that the trade is executed smoothly by the exchange or other trading center.

The market that executes the transaction may be a national securities exchange, as described above. Alternatively, the trade may be executed on an alternative trading center or by a single-dealer platform or wholesale broker. The function of all these trading centers is to match a sale order with a buy order.

Another possibility is that the securities broker may not go to an external trading center to execute the trade. Instead, if the securities broker is also a dealer in those securities, it may fill the order by acting as the counterparty to the customer's trade. Alternatively, the securities broker may match the sell order with a buy order from another customer.

See

FINRA,

Where Do Stocks Trade?

(September 28, 2023), available at

https://www.finra.org/investors/insights/where-do-stocks-trade.

The last step in the transaction is for the sale to be cleared and settled. Clearing and settlement of a sale of securities involves verifying that the terms of the buy and sell orders match and carrying out the movement of securities from the account of the seller's securities broker to the account of the buyer's securities broker (which credits those securities to the buyer) and the movement of cash in the reverse direction. This function is carried out by a specialized financial institution that may be referred to as a clearing organization.

Historically, communications between securities brokers and their customers took place in person or by telephone. Customers now may communicate a trade order to a securities broker through a mobile device application (mobile device app) or a website accessible via a computer or mobile device. The mobile device app or website provides a user interface with visual elements that enable customers to see the services offered and buttons and fill-in screens to enable customers to communicate trading instructions to the broker through the mobile device app or website. For example, a customer may access a mobile device app or website offered by a securities broker to select among a number of possible transactions, make its selection via buttons and fill-in screens, and authorize the purchase or sale of securities by clicking a button. Doing so generates a trade order in the form of software code which is transmitted to the broker's systems and used to initiate the remaining steps in the transaction. Similarly, each of the other steps in the sale of a security typically now take place electronically, through specialized software.

B. The Decentralized Digital Asset Ecosystem

DeFi service providers use distributed ledger technologies to offer investment and other financial services, similar to those provided in the securities industry by securities brokers and exchanges, that enable customers to carry out trades of digital assets using applications,

sometimes referred to as DeFi applications or dApps, without relying on a traditional centralized financial intermediary. The services provided generally involve multiple DeFi participants performing various functions throughout the process in order to complete a customer's transaction, including: the intake of a customer's trade order details and communication of that order to the validation network for execution of the trade using the automatically executing contracts of the DeFi protocol and for recordation and settlement of the trade via a consensus mechanism. Because these steps do not require the involvement of a centralized financial intermediary (although some participants may in fact be structured as such), they rely on software programs. Additional services and/or service providers may also be involved in the transaction. For example, another type of DeFi application, commonly referred to as a DeFi aggregator, may communicate the customer's trade to the DeFi protocol with the most favorable trade execution terms.

In the context of the DeFi ecosystem, these final regulations use the term execute to refer to the activation of the automatically executing contracts of DeFi applications and not to the simultaneous activities of validators that initiate this activation.

Several comments received in response to the proposed regulations referenced or described a model, referred to by some in the DeFi industry as the DeFi technology stack model or the DeFi stack reference model, which describes the components and functions involved in the communication, execution, and settlement of a typical DeFi transaction. This DeFi technology stack model is also described in several scholarly papers.

The DeFi technology stack model classifies the technologies involved in the communication, execution, and settlement of a typical DeFi transaction into different technology layers, with each layer representing the performance of a different function in carrying out the overall transaction. In its simplest form, the DeFi technology stack model describes three primary technology layers—the interface layer, the application layer, and the settlement layer—even though these layers can be further subdivided into sub-layers.

See

BIS Paper at 4 (describing the application layer as having three sublayers). Other scholars describe the DeFi technology stack model as having more than three primary technology layers without subdivision within each layer.

See e.g.,

FRB Review at 155 (describing five primary layers). Regardless of the number of layers described by any given model, the functionality provided by each layer is generally needed to complete the communication, execution, and settlement of a digital asset transaction involving DeFi participants.

See

BIS Paper at 4. For simplicity's sake, this preamble describes the DeFi technology stack model with three primary layers because that model is sufficient for the purpose of analyzing the issues raised by the comments received in response to the proposed regulations.

See e.g.,

R. Auer, B. Haslhofer, S. Kitzler, P. Saggese, and F. Victor,

The Technology of Decentralized Finance (DeFi),

Bank for International Settlements (January 2023) (BIS Paper), at 3, available at:

https://www.bis.org/publ/work1066.htm,

and F. Schär,

Decentralized Finance: On Blockchain—and Smart Contract-Based Financial Markets,

Federal Reserve Bank of St. Louis Review, at 153, 156 (2d Qtr. 2021) (FRB Review), available at:

https://research.stlouisfed.org/publications/review/2021/02/05/decentralized-finance-on-blockchain-and-smart-contract-based-financial-markets.

In general terms, the three-layer DeFi technology stack model places the interface layer at the top of the DeFi technology stack model because this is the layer with which most users of digital assets interact. The interface layer is the layer that enables digital asset users to communicate with DeFi participants operating on the other layers for ultimate execution and settlement of the transaction. The interface layer does so by providing software (sometimes referred to as front-end services) that provides the digital asset user with tools—including screens, buttons, forms, and other visual elements incorporated in websites, mobile device apps, and browser extensions—that users can use to trade digital assets in their unhosted wallets

using DeFi protocols or DeFi aggregators operating on the application layer. The application layer is the layer that executes the user's trade order as part of the validation process. It is comprised of DeFi protocols that consist of automatically executing software programs or smart contracts that, when called upon, perform a predetermined series of actions, for example exchanging digital asset A for digital asset B, when certain conditions are met. Finally, the settlement layer is generally responsible for recording financial transactions on the distributed ledger, including transactions conducted by users that trade digital assets using DeFi protocols. Each of these layers are described in more detail in Parts I.B.1., 2., and 3. of this

Summary of Comments and Explanation of Revisions.

References in this preamble to an owner holding digital assets generally or holding digital assets in a wallet are meant to refer to holding or controlling the keys to the digital assets and, thus, the ability to transfer those digital assets.

See

§ 1.6045-1(a)(25)(iv).

While not included in the three-layer model described in the BIS Paper, an important component of a DeFi transaction is the use of an unhosted wallet by digital asset users. A wallet is a means of storing, electronically or otherwise, a user's private keys to digital assets (more technically, the private keys to distributed ledger digital asset addresses as defined in § 1.6045-1(a)(20)) held by or for the user. Private keys are required to conduct transactions with the digital assets associated with those keys and are sometimes analogized to a password to a bank or investment account. In contrast to a hosted wallet, in which a custodial service electronically stores the private keys to digital assets held on behalf of digital asset users, an unhosted wallet is a non-custodial means of storing a user's private keys to digital assets held by or for the user.

See

§ 1.6045-1(a)(25)(i) and (iii). A broadly

analogous fact pattern (disregarding the technological differences) in the securities industry would be the use of a home safe by an investor to store the investor's securities certificates, so that only the investor controls what happens with those certificates. Unhosted wallets also typically include software that enables digital asset users to use their private keys, generally by signing or authorizing a transaction. Unhosted wallets may also provide wallet users with other services, such as tools that enable users to interact with the DeFi marketplace.

1. The Interface Layer

While DeFi protocols execute exchanges of digital assets, interacting directly with a DeFi protocol requires the ability to write software code that will communicate with other participants in the DeFi ecosystem. Although some digital asset users possess these technical skills, most retail digital asset users do not. Instead, most retail digital asset users use the services provided by other participants in the DeFi ecosystem that offer a more user-friendly way to specify the details of the transaction they wish to carry out and to communicate that order so that it can be carried out. These services are generally referred to as front-end services because they are provided at the front end of a transaction and are classified as the interface layer because they are the services that most users face.

Providers of front-end services typically offer a suite of services that enable their customers to view the market conditions relating to a customer's proposed trade, to input their proposed trade, and then to initiate the additional steps necessary to trade their digital assets (trading front-end services). Providers of these trading front-end services are referred to here as trading front-end service providers. This suite of services may be offered as part of the enhanced services offered by an unhosted wallet or alternatively by a website or mobile app to which customers connect their unhosted wallets. In either case, this service is provided through software that assists customers in initiating digital asset transactions, such as an exchange of digital asset A for digital asset B using a DeFi protocol. For example, when digital asset user C seeks to trade digital assets in C's unhosted wallet using a DeFi protocol, C may use a mobile device app or a website accessible via computer or mobile device that is designed for that purpose. Embedded in that mobile device app or website is software that provides C with visual elements that enable C to see the services offered, such as screens to view the distributed ledger market and potential trade transactions and buttons for C to press to communicate C's desired transaction order.

When customers use trading front-end services, they will typically be provided with an array of available digital asset trading pairs applicable to the digital assets they hold in their unhosted wallets. For example, a customer that wishes to exchange a digital asset will be shown a menu of the trading pairs available for exchange of the customer's digital asset for different digital assets as well as the current exchange rate for each potential trade. Some trading front-end services also offer customers the ability to choose the DeFi trading application that will execute their transaction. After a customer reviews the available trading pairs and decides on a potential transaction, the customer will input the necessary trade order information. Thereafter, the trading front-end service will typically ask the customer to confirm the specific trade order details. If the trade order details are confirmed by the customer, the trading front-end service will convert that trade order information into software code in the form of a data object, referred to here as coded trade order instructions. The coded trade order instructions include all of the details of the transaction, including how many digital assets to remove from the customer's unhosted wallet, the fees (if any) payable to the trading front-end service provider, and whether these fees will be withheld from the amount of digital assets disposed or the digital assets received in the trade. The coded trade order instructions must specify the particular DeFi trading protocol that will execute the customer's trade. The coded trade order instructions also specify the type of digital assets the customer will receive at the completion of the transaction and may specify the digital asset address into which the received digital assets should be transferred. In advance of certain transactions requested by the customer, the provider of trading front-end services will also obtain the customer's permission for the particular DeFi protocol to move digital assets out of the customer's wallet in one or more transactions. Without this service, many customers' trades cannot be executed.

After the coded trade order instructions are complete, the next step is for the customer to authorize or sign the transaction, for example by clicking a button in the customer's wallet. Once the customer authorizes the transaction in their wallet, the unhosted wallet then forwards the signed transaction to a communication node for broadcast to the distributed ledger network, where it will stay as a pending transaction until a validator chooses to include it in a block, and the block is added to the distributed ledger. As part of the validator's processing of a DeFi protocol transaction, the coded trade order instructions provided through the trading front-end services call the applicable DeFi protocol's automatically executing smart contracts, which execute the transaction by performing the operations it was coded to perform without human intervention. In less technical terms, once the customer authorizes the transaction, the coded trade order instructions determine the subsequent steps in the transaction as it is processed. In short, trading front-end services permit a customer to select, confirm, and communicate the details of a trade transaction that it wishes to carry out using a DeFi protocol so that the transaction can be executed and settled by other DeFi participants. Notwithstanding differences in the technology used and the details of the mechanisms by which a customer's order is carried out, these services are similar to those provided to a customer by a traditional securities broker that does not hold or custody a customer's assets.

In some cases, a trading front-end service provider might take control of the customer's digital assets by routing the customer's digital assets to an address controlled by the trading front-end service provider, for example, where the trading front-end services include DeFi aggregator services.

Unhosted wallet providers do not necessarily offer the trading front-end services described in the previous paragraphs. Unhosted wallet providers may offer only more limited, basic wallet services or they may offer both basic wallet services and trading front-end services. As discussed in Part III.A.2. of this

Summary of Comments and Explanation of Revisions,

a core function of an unhosted wallet is to store private keys to distributed ledger digital asset addresses, so that wallet users can securely hold their digital assets at those addresses. In addition, as part of the basic wallet services, unhosted wallet providers typically include software that enables their customers to use those private keys to sign or authorize a transaction, similar to inputting a password or passcode to authorize other types of online transactions. Many providers of unhosted wallets also provide basic wallet services that enable their customers to transfer digital assets from

one wallet to another wallet. A customer that wishes to use trading front-end services but whose unhosted wallet provider does not offer the desired services or does not offer them at a competitive price, can use the trading front-end services provided by a third-party website or a mobile device app by connecting their unhosted wallet to that third-party website. To carry out any transaction that will be recorded on the distributed ledger, the unhosted wallet will broadcast the signed transaction to the distributed ledger network, often through the use of specialized communication nodes. The basic wallet services described in this paragraph can be distinguished from the enhanced wallet services in which the trading front-end services used to interact with a DeFi protocol (described in the previous paragraphs in this part) or a DeFi aggregator that communicates the customer's trade to the DeFi protocol with the most favorable trade execution terms are provided by the unhosted wallet.

2. The Application Layer

The application layer is in the middle of the three-layer DeFi technology stack model. One of the core functions of the application layer is to provide DeFi protocols that users can interact with to trade digital assets. DeFi protocols provide a function that is analogous to the function provided by a stock exchange or other trading center for matching buy and sell orders in the securities industry, although there are technological differences as to how that function is carried out.

A DeFi protocol is comprised of computer software that utilizes distributed ledger technology to provide digital asset exchange services through automatically executing software that performs a predetermined series of actions when certain conditions are met. BIS Paper at 2. One type of DeFi protocol is an automated market maker. BIS Paper at 4. Some DeFi protocols create an exchange marketplace by pooling digital assets provided by multiple digital asset users to create market liquidity.

Id.

As discussed in I.B. of this

Summary of Comments and Explanation of Revisions,

another type of DeFi application relevant to the purchase and sale of digital assets is a DeFi aggregator. DeFi aggregators interact with, and use the services of, other DeFi protocols. BIS Paper at 4. A DeFi aggregator communicates a user's trade order to a DeFi protocol that may offer the most favorable trade execution terms.

Although DeFi applications can facilitate many types of activities, such as non-custodial staking and re-staking, this preamble focuses only on DeFi protocols and DeFi aggregators that enable digital asset users to exchange digital assets for different digital assets, referred to respectively as DeFi trading protocols and DeFi trading aggregators and collectively as DeFi trading applications.

Many of the comments describe DeFi trading applications as having immutable software that cannot be changed. However, many of these DeFi trading applications can simply be replaced by other applications that have new or different features, thus allowing for software upgrades in practice. In other cases, a DeFi trading application may have an “administration key” or similar tool that allows developers, founders, or other persons to modify the software, such as by changing or updating certain variables within the software. The details of the changes that can be made to the software, and who can make them, however, are different with each DeFi trading application.

3. The Settlement Layer

The settlement layer is at the bottom of the three-layer DeFi technology stack model. The settlement layer is generally responsible for completing financial transactions and discharging the obligations of all involved parties. BIS Paper at 4. Settlement involves recording financial transactions on the distributed ledger. This function is comparable to the clearing and settling of securities transactions, some of which are now being settled through distributed ledger technology. Settlement of a digital asset transaction is achieved by validators including the transaction in a block and adding that block to the blockchain through a consensus mechanism that resolves potential conflicts using consensus standards developed by the distributed ledger network.

Id.

In addition to validators, there are other DeFi participants, such as block builders, that may participate in this process. Once recorded, transactions are generally immutable, meaning they cannot be reversed. The recording of a transaction on the settlement layer generally effects a “state change” in a distributed ledger.

II. Statutory Authority To Treat DeFi Participants as Brokers

A. Background

Before the amendments made to the Infrastructure Act, the definition of broker in section 6045(c)(1) included a dealer, a barter exchange, and a person who (for consideration) regularly acts as a middleman with respect to property or services.

See

section 6045(c)(1)(A), (B), and (C). The Infrastructure Act, in section 6045(c)(1)(D), added a new clause to the definition of broker: any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.

Section 1.6045-1(a)(1)

defines brokers that are required to report under section 6045. Under this section, “any person . . . that, in the ordinary course of a trade or business during the calendar year, stands ready to effect sales to be made by others” is a broker obligated to file information returns under section 6045. Section 1.6045-1(a)(10) of the pre-TD 10000 regulations defined effect for this purpose to mean either to act as a principal with respect to a sale (for example, a dealer in securities who buys a security from one customer and then sells that security to another customer) or to act as an agent with respect to a sale if the nature of the agency is such that the agent ordinarily would know the gross proceeds of the sale. Because the regulatory definition of the term broker includes a reference to effecting sales, the definition of the term effect affects the types of persons who are treated as brokers. In addition, § 1.6045-1(a)(4) further defines a barter exchange that is a broker under section 6045(c)(1)(B) as any person with members or clients that contract either with each other or with such person to trade or barter property or services either directly or through such person.

Unless otherwise qualified, regulation section references refer to the final regulations in effect before the effective date of these final regulations. The final regulations in effect before the effective date of TD 10000 will collectively be referred to as the pre-TD 10000 regulations.

In § 1.6045-1(a)(10)(i)(D), TD 10000 added to the definition of effect: to act as a digital asset middleman for a party in a sale of digital assets. Section 1.6045-1(a)(21)(i) defined a digital asset middleman for this purpose as any person who, with respect to a sale of digital assets, provides a facilitative service. Section 1.6045-1(a)(21)(iii)(B)(

) through (

) defined a facilitative service by referencing five specific services in which the broker acts either as an agent or a counterparty in a digital asset sale.

Proposed § 1.6045-1(a)(21)(iii)(A) would have also included in the facilitative services definition any service that directly or indirectly effectuates a sale of digital assets, such as providing a party in the sale with access to an automatically executing contract or protocol, providing access to digital asset trading platforms, providing an automated market maker

system, providing order matching services, providing market making functions, providing services to discover the most competitive buy and sell prices, or providing escrow or escrow-like services to ensure both parties to an exchange act in accordance with their obligations. To be covered by this proposed rule, under proposed § 1.6045-1(a)(21)(i), the person providing facilitative services would have to ordinarily know or be in a position to know the identity of the party making the sale and the nature of the transaction. Proposed § 1.6045-1(a)(21)(iii)(A) would have excepted from the definition of facilitative services certain validation services if conducted by a person engaged in the business of providing distributed ledger validation services and certain sales of hardware or licenses of software by persons engaged in the business of selling hardware or licensing software, for which the sole function is to permit persons to control private keys which are used for accessing digital assets on a distributed ledger. TD 10000 reserved on both the facilitative service definition under proposed § 1.6045-1(a)(21)(iii)(A) and the definition of the ordinarily would know or position to know standard (together referred to herein as the position to know standard) under proposed § 1.6045-1(a)(21)(ii). The proposed text for these provisions is discussed more fully in Parts III.A.2., III.A.3., and III.A.4. of this

Summary of Comments and Explanation of Revisions.

B. Comments Received

1. The Statutory Language

The Treasury Department and the IRS received numerous comments directed at the facilitative services definition under the proposed new digital asset middleman rules. As a threshold matter, several comments argued that this definition is inconsistent with the plain meaning of the broker definition under section 6045(c)(1)(D). Other comments asserted that the broker definition under section 6045(c)(1)(D) is limited to persons acting as agents in digital asset transactions. One comment cited Merriam-Webster Dictionary's definition of broker, as “someone who acts as an intermediary: such as . . . an agent who negotiates contracts of purchase and sale . . . [or] an agent who arranges marriages,”

as support for this assertion. Other comments reasoned that the term effectuate was meant to be synonymous with the term “effect” in § 1.6045-1(a)(10) of the pre-TD 10000 regulations, which, the comment stated, for over 35 years has required the broker to act as an agent (or principal) in the transaction.

See

TD 7873, 48 FR 10302 (March 11, 1983). Another comment also focused on the definition of “customers” in the pre-TD 10000 regulations to similarly argue that section 6045(c)(1)(D) should not expand the scope of the broker definition beyond persons acting as agents or principals in a transaction. Specifically, the term customer is defined in § 1.6045-1(a)(2) to mean the person that makes the sale if the broker acts as an agent for such person in the sale, as a principal in the sale, or as a participant in the sale responsible for paying to such person or crediting to such person's account the gross proceeds on the sale. Because the definition of customer under the pre-TD 10000 regulations requires that the broker-customer relationship be an agency, principal, or payor relationship, this comment argued that section 6045(c)(1)(D) should similarly be limited to persons acting as agents or principals in the sale.

Merriam-Webster Dictionary, “broker,” accessed October 25, 2023,

https://www.merriam-webster.com/dictionary/broker.

As discussed in Parts II.B.1.a. and II.B.1.b. of this

Summary of Comments and Explanation of Revisions,

the Treasury Department and the IRS do not agree that the statutory language defining broker under section 6045(c)(1)(D) is limited only to persons that act as the customer's agent (or as a principal/dealer) in a digital asset transaction.

a. The Definition of Broker Prior to the Infrastructure Act

For over 35 years, the Code has set forth a broad definition of broker under section 6045(c)(1). Under this definition, the term broker is not limited to conventional securities brokers. Rather, the statutory language defines the term broker to include several other types of market participants. First, section 6045(c)(1)(A) treats a dealer as a broker. Dealers typically hold inventory and act as principals in sale transactions.

George R. Kemon

Commissioner,

16 T.C. 1026 (1951).

Second, under section 6045(c)(1)(B), the term broker includes a barter exchange, which is defined in section 6045(c)(3) to mean any organization of members providing property or services who jointly contract to trade or barter such property or services. Long-standing regulations define a barter exchange to mean any person with members or clients that contract either with each other or with such person to trade or barter property or services either directly or through such person.

See

§ 1.6045-1(a)(4). The regulations require these barter exchanges to report an exchange of property or services if the barter exchange arranges a direct exchange of property or services among its members or clients.

See

§ 1.6045-1(e)(2). That is, a barter exchange is treated as a broker if it merely provides the service of bringing together the parties to the exchange, without acting as either an agent or a principal to the exchange.

Third, under section 6045(c)(1)(C), the statutory broker definition includes certain middlemen with respect to property or services. Because the statutory language must be given meaning, the term middleman must include persons who would not otherwise be considered brokers under the definition without section 6045(c)(1)(C). Pursuant to this authority, the section 6045 regulations treat certain payors and agents as brokers, including professional custodians as well as dividend reinvestment agents that do not take custody of customer securities.

See

§ 1.6045-1(b)(1)(ii) and (v) (

Example 1

). Additionally, the flush language in section 6045(c) expressly exempts a person that manages a farm on behalf of another person from the definition of broker with respect to their farm management activities.

See

H.R. Rep. No. 100-795, at 360 (1988) (the bill exempts farm managers from the requirement of filing a Form 1099-B with respect to their farm management activities because this information must already be filed, in a more useful format, by these farm managers on a Schedule F, thus, making the Form 1099-B duplicative). This farm-manager exemption shows that Congress broadly construed the term middleman beyond conventional securities brokers. In addition, § 1.6045-1(b)(2)(ii) and (vii) (

Example 2

) provide specific exclusions for stock exchanges and clearing organizations, which, absent those exclusions, would be middlemen treated as brokers. Indeed, virtually all other persons that § 1.6045-1(b)(2) (

Example 2

) illustrates as non-brokers, including certain stock transfer agents for a corporation, certain escrow agents or nominees, and certain floor brokers on a commodities exchange, are examples of persons that could be considered middlemen.

Thus, prior to the Infrastructure Act, the term broker under section 6045(c)(1) included specified types of principals, custodial agents, non-custodial agents, payors, and service providers, pursuant to the statute and long-standing implementing regulations.

See e.g.,

§ 1.6045-1(c)(3)(iv) and (c)(4)(iii), (iv), and (v) (

Examples 3, 4,

and

) (multiple

broker examples involving one broker that holds the customer's assets and another broker that does not hold the customer's assets). The term broker was not defined by reference to any particular type of property or services. Accordingly, statutory authority existed before the enactment of the Infrastructure Act to treat centralized digital asset exchanges that act as traditional brokers or dealers as brokers for purposes of section 6045(c)(1).

In addition, section 6045(c)(1) also provided statutory authority to treat as a broker any other person that satisfied the definition of broker, dealer, or a middleman with respect to property or services if the middleman regularly acted as such for consideration.

See

Part II.B.2. of this

Summary of Comments and Explanation of Revisions,

for a discussion of the scope of this authority with respect to DeFi participants.

b. The Definition of Broker Under Section 6045(c)(1)(D) as Enacted by the Infrastructure Act

Section 6045(c)(1)(D) treats as a broker any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person. This statutory language explicitly addresses certain types of activities not previously addressed expressly by section 6045(c)(1) that are relevant to determining broker status. Section 6045(c)(1)(D) refers to persons who provide specified types of digital asset services, when regularly provided for consideration on behalf of another person. The relevant services are those that effectuate transfers of digital assets. The statutory language treats the person providing those services as a broker.

Statutory language must be construed to avoid rendering it as surplusage.

See TRW, Inc.

Andrews,

534 U.S. 19, 31 (2001) (noting the “cardinal principle” of statutory interpretation requires that “if it can be prevented, no clause, sentence, or word shall be superfluous, void, or insignificant.”). Accordingly, the Treasury Department and the IRS understand the statutory language to define the term broker in a manner that does not merely restate what was the law prior to the Infrastructure Act.

One comment asserted that the text in section 6045(c)(1)(D) merely expands the broker definition with respect to the new types of assets (digital assets) that must be reported and clarifies that the persons reporting these new types of digital asset transactions must be conducting otherwise similar activities to brokers included in the existing definition of broker. The Treasury Department and the IRS do not agree that section 6045(c)(1)(D) applies only to digital asset brokers that fall within the broker definition under section 6045(c)(1) prior to the Infrastructure Act amendments. As described in Part II.B.1.a. of this

Summary of Comments and Explanation of Revisions,

section 6045(c)(1) already provided authority to address at least some digital asset brokers prior to the Infrastructure Act amendments. Section 6045(c)(1)(D) was added to the Code because Congress recognized that, in certain respects, the digital asset industry works differently from the securities industry and that explicit statutory language providing that certain additional digital asset service providers should be treated as brokers was essential to providing clarity on how information reporting rules apply to transactions involving digital assets. Nothing in the text of section 6045(c)(1)(D) limits the scope of digital asset brokers to those that fall within the broker definition under section 6045(c)(1) prior to the Infrastructure Act. Additionally, section 6045(c)(1)(D) does not limit the scope of digital asset brokers to persons who act as agents, because by its terms the statutory language refers to service providers. A person providing services to a customer may or may not be acting as an agent for the customer. Many service providers are not agents for their customers. Section 6045(c)(1)(D) refers to persons providing services and, therefore, is not limited to persons providing services only as agents. Moreover, because persons acting as agents are already included in the broker definition under section 6045(c)(1)(C), limiting section 6045(c)(1)(D) to persons providing services as agents for digital asset transactions would render its text entirely superfluous.

Section 6045(c)(1)(D) also is not limited to persons who effectuate transfers of digital assets. Section 6045(c)(1)(D) applies to any person who provides “any service effectuating transfers,” not “any person who effectuates transfers.” That is, the statutory language in section 6045(c)(1)(D) applies to persons who provide services to others, which services effectuate digital asset transfers. Given this textual distinction, the Treasury Department and the IRS have determined that section 6045(c)(1)(D) properly applies to persons that supply customers with services that are used by those customers to carry out digital asset transactions. As described in Part I.B.1. of this

Summary of Comments and Explanation of Revisions,

that is exactly the function provided by trading front-end service providers. For the reasons described in that part, most digital asset users could not easily carry out a DeFi sale or exchange of digital assets without the services of a trading front-end service provider. Although trading front-end service providers may not act as agents for their customers in these transactions, the services provided by these trading front-end service providers with respect to digital assets enable their customers to trade their digital assets through other DeFi participants, just as the services provided by securities brokers enable their customers to trade their securities through other securities market participants. That is, both trading front-end service providers and securities brokers make it possible for a customer to review a range of options for possible transactions, to make a selection and confirm that selection, and to communicate the details of the transaction that the customer wishes to carry out so that the transaction can be executed and settled by other market participants. Similarly, in both cases, the means by which those services are provided may include a website or mobile device app that provides a series of visual elements, such as forms, buttons that initiate actions, and dynamic page updates, that enable customers to view the market conditions relating to their proposed trades and to interact with that market by inputting their trade orders.

Several comments argued that merely providing customers with software that the customer can use to engage in digital asset transactions does not constitute a “service effectuating transfers.” The Treasury Department and the IRS do not agree that the definition of broker should turn on the technological implementation of the services provided because the statute makes no reference to a particular form of technology. Instead, the definition should turn on what those services do. For example, the fact that, currently, a securities broker or dealer takes customer orders or routes these orders electronically does not change the nature of the services that the securities broker or dealer provides. The provision of a suite of software that enables a customer to interact with a distributed ledger network and effectuate transactions using DeFi trading applications is an example of providing a service that effectuates transfers.

Numerous comments argued that the term effectuate in section 6045(c)(1)(D) prevents the application of the broker definition to DeFi participants because these participants do not control the

private keys to the customer's digital assets being traded. As support for this argument, one comment cited a dictionary's definition of effectuate as “to cause or bring about (something)” and a Supreme Court interpretation of the meaning of “effect” as requiring a “reasonably close causal relationship between a change in the physical environment and the effect.”

See

Effectuate,

Merriam-Webster Online,

https://www.merriam-webster.com/dictionary/effectuate;

Metro. Edison Co.

People Against Nuclear Energy,

460 U.S. 766, 774 (1984). This comment also compared transactions in which DeFi participants do not control the private keys to the customer's digital assets with those carried out by traditional securities brokers in which the brokers hold custody of the customer's securities and then asserted that the definition of effectuate cannot apply to the services provided by DeFi participants. Other comments argued that the word effectuate was meant to apply only to the one person who carries out the transaction. These comments concluded that expansion of the reporting regime under section 6045 to persons that do not possess traditional characteristics of a broker in carrying out transactions exceeds the scope of the statute.

The Treasury Department and the IRS do not agree that the actions of only one person, whether within the traditional securities industry or within the DeFi industry, causes a transaction to be carried out (or effectuated), which is why the pre-TD 10000 regulations contain a multiple broker rule. The Treasury Department and the IRS do agree, however, that a comparison of the persons involved in the steps necessary to carry out a securities transaction with the services involved in the steps necessary to carry out a DeFi transaction is helpful to understanding what it means to effect or effectuate a transaction. For purposes of this analysis as well as throughout these final regulations, the term person has the meaning provided by section 7701(a)(1) of the Code, which provides that the term generally includes an individual, a legal entity, and an unincorporated group or organization through which any business, financial operation or venture is carried on, such as a partnership. The term person includes a business entity that is treated as an association or a partnership for Federal tax purposes under § 301.7701-3(b). Accordingly, a group of persons providing services that together carry out a customer's digital asset transaction may be treated as a broker whether or not the group operates through a legal entity if the group is treated as a partnership or other person for U.S. Federal income tax purposes.

As discussed in Part I.A. of this

Summary of Comments and Explanation of Revisions,

in the securities industry, the steps of a transaction typically begin when an investor communicates a trade order to a securities broker, who may or may not have custody of the investor's securities, and authorizes the securities broker to carry out the trade. The securities broker generally will assess how to obtain the best execution for the customer. That assessment could lead the broker to fill the order from its own account or match the trade with an offsetting trade order from another customer. The broker could also decide to route the investor's order to a trading center, such as a national securities exchange, an alternative trading system, or a dealer. The exchange or other trading center generally will attempt to find a counterparty to the investor's order. If the order is executed, transaction information typically will be sent to a clearing organization that will move the funds and securities between the appropriate accounts at the clearing organization to settle the transaction. The regulations under section 6045 treat only one of these securities industry participants as the broker with reporting obligations.

See

§ 1.6045-1(b)(2)(ii) and (vii) (

Example 2

) (not treating certain stock exchanges and clearing organization as brokers). Notwithstanding this rule, each of these participants technically meets the definition of a person who effects (or “act[s] as . . . an agent for a party [albeit not the customer] in the sale” if it ordinarily would know from its services the gross proceeds from the sale).

See

§ 1.6045-1(a)(10)(i)(A). Accordingly, it is the actions of all these securities industry participants—along with those of the customer—that collectively cause the transaction to be carried out.

Similarly, as discussed in Parts I.B. and I.B.1. through I.B.3. of this

Summary of Comments and Explanation of Revisions,

the DeFi technology stack model shows that, in addition to the customer, there are multiple DeFi participants involved in causing a digital asset transaction to be carried out. In the DeFi industry, when a customer inputs a trade order on a mobile device app or a website accessible via computer or mobile device, a trading front-end service provider receives that trade order and has the customer confirm the trade order details. Once the trade order details are confirmed by the customer on the customer's computer or mobile device, the trading front-end services translate those details into coded trade order instructions which are sent to the customer's unhosted wallet to obtain the customer's signature or authorization. Thereafter, the wallet transmits the coded trade order instructions to the distributed ledger network for the eventual interaction with the applicable DeFi trading application for matching and for settlement pursuant to the services of DeFi participants operating at the settlement layer. Importantly, like the traditional securities transaction, the actions of the customer and all these DeFi participants collectively cause the transaction to be carried out. Accordingly, like in the securities industry, in which the customer, the securities broker, the securities exchange, and the clearing organization are all typically needed to carry out a securities transaction, in a DeFi transaction, the customer, the trading front-end service provider, the DeFi application, and the validator are all typically needed to carry out the DeFi transaction.

Regarding the comment that the definition of effectuate cannot apply to DeFi participants that do not control the private keys to the customer's digital assets, as discussed in Part II.B.5. of this

Summary of Comments and Explanation of Revisions,

the Treasury Department and the IRS do not agree with this comment because the current broker rules as applied to the securities industry treat persons without custody of a customer's assets as a broker under section 6045.

See e.g.,

§ 1.6045-1(c)(3)(iv) and (c)(4)(iii), (iv), and (v) (

Examples 3, 4,

and

) (examples treating persons that do not hold the customer's assets as brokers).

2. Title of the Broker Definition in the Infrastructure Act

Several comments argued that the existing scope of activities that give rise to treating a person as a broker should not be expanded to cover DeFi participants because section 80603(a) of the Infrastructure Act titled the new broker definition as a “clarification of [the] definition of broker.” One comment stated that the definition of broker under section 6045(c)(1)(D) is limited to agents and principals. Another comment stated that a broker under section 6045(c)(1)(D) must be a middleman. Another comment stated that a middleman under section 6045(c)(1)(D) must be an intermediary. The Treasury Department and the IRS do not agree that limiting the meaning of section 6045(c)(1)(D) to persons

acting as the customer's agent or a principal in the transaction is required by the definition of broker under section 6045(c)(1)(A) through (C) because, except for section 6045(c)(1)(A), which is specifically limited to dealers, the definition of broker includes no such limitation. As discussed in Part II.B.1.a. of this

Summary of Comments and Explanation of Revisions,

under section 6045(c)(1)(B) and the regulations thereunder, the term broker includes a barter exchange that is not acting as a customer's agent or as a dealer or principal. Similarly, under section 6045(c)(1)(C), the term broker includes any other person who (for a consideration) regularly acts as a middleman with respect to property or services.

Although the term middleman is not defined in the statute, the term is used in other tax information reporting rules to refer generally to persons acting in a variety of capacities relevant to the particular function, for example, making payment.

See e.g.,

§ 1.6049-4(a)(2)(ii) (the term “payor” includes a middleman as defined in § 1.6049-4(f)(4)); § 1.6049-4(f)(4)(i) (middleman means any person who makes payment of interest for, or collects interest on behalf of, another person, or who otherwise acts in a capacity as intermediary between a payor and a payee, and also includes a trustee). Outside tax law, however, the term is used more broadly to include persons that make referrals to others so that these others can negotiate a sale between themselves in addition to those that act as agents for others.

See e.g., Dickson Marine Inc.

Panalpina,

179 F.3d 331 (5th Cir. 1999). In

Dickson Marine Inc.,

the court found that an intermediary making a referral was a middleman and not the agent of another person where that other person did not assert sufficient control over the intermediary to establish an agency relationship.

See also

167 Cong. Rec. S6096 (daily ed. August 9, 2021) (Senator Warner's statement in the colloquy that persons solely engaged in validating transitions and persons solely engaged in selling hardware or software with the sole function of permitting someone to control private keys used to access digital assets will not be treated as brokers under the proposed compromise amendment).

Although this compromise amendment was not adopted due to issues unrelated to the broker definition, the Treasury Department and the IRS have long held the view that the broker definition under section 6045(c)(1) should not apply to ancillary parties who cannot get access to information that is useful to the IRS. Indeed, notwithstanding the authority provided by section 6045(c)(1)(C) to treat middlemen as brokers, the section 6045 regulations impose broker reporting obligations only on those market participants in the securities industry that have the requisite information about the securities sales of their customers even though other market participants that do not have this information also act as middlemen in carrying out these sales.

See e.g.,

§ 1.6045-1(b)(2)(i) (stock transfer agent that ordinarily would not know the gross proceeds from sales not treated as broker); 1.6045-1(b)(2)(v) (floor broker that maintains no records with respect to the terms of sales not treated as broker).

Several comments cited to private sector publications describing unenacted prior drafts of the Infrastructure Act legislation and in particular drafts of the broker definition to argue that the definition in section 6045(c)(1)(D) cannot be interpreted to apply to DeFi platforms. According to a source cited by one comment, one prior draft would have provided that a broker includes “any person who (for consideration) regularly provides any service responsible for effectuating transfers of digital assets, including any decentralized exchange or peer-to-peer marketplace.”

According to another source cited by a different comment, another prior draft would have provided that a broker includes “any person who (for consideration) regularly provides any service or application (even if noncustodial) to facilitate transfers of digital assets, including any decentralized exchange or peer-to-peer marketplace.”

The Treasury Department and the IRS do not agree that these reported drafts of the broker definition support the more limited definition proposed by the comments. The text of the bills referred to in these comments does not reflect consideration by any member of Congress because these draft bills were not introduced. As such, they are not legislative history for the enacted amendments to section 6045.

Ella Beres,

Crypto Tax Enforcement Update: The New Broker Definition in the Information Reporting Requirement Provision of the Infrastructure Bill Aims to Exclude Node Operators, Miners, and Validators,

Davis Wright Tremaine LLP (August 3, 2021); available at:

https://www.dwt.com/insights/2021/08/crypto-tax-enforcement-update.

Jason Brett,

New Language For Crypto Tax Reporting Excludes Decentralized Exchanges, Miners Still Vulnerable,

Forbes (August 2, 2021); available at:

https://www.forbes.com/sites/jasonbrett/2021/08/02/new-language-for-crypto-tax-reporting-excludes-decentralized-exchanges-miners-still-vulnerable/?sh=41b5027b5f56.

One comment referenced several proposals to amend the current definition of broker that were introduced after the Infrastructure Act was enacted. These post-enactment proposals would limit the broker definition to persons who effect sales at the direction of their customers rather than persons who provide services effectuating transfers.

See e.g.,

Lummis-Gillibrand Responsible Financial Innovation Act, S. 2281, 118th Cong. 802 (2023) (defining the term “broker” to mean “any person who (for consideration) stands ready in the ordinary course of business to effect sales of crypto assets at the direction of their customers”); Keep Innovation in America Act, H.R. 1414, 118th Cong. 2 (2023) (defining “broker” to include “any person who (for consideration) stands ready in the ordinary course of a trade or business to effect sales of digital assets at the direction of their customers”). The comment argued that these proposals indicate an intent to clarify the meaning of the broker definition under section 6045(c)(1)(D) so that the provision does not apply to DeFi participants. The Treasury Department and the IRS do not agree that the language within proposals to amend a statute offered after that statute is enacted are persuasive authority for how to interpret the meaning of the enacted statute. If anything, if the purpose of the proposed legislation is to change the language of the statute to prevent the application of the broker definition to DeFi participants, that would support the interpretation that the statute as enacted applies to such participants.

4. Comparison of the Broker Definition With Standards Applied by Other Governmental Bodies

Several comments argued that the definition of broker as applied to digital assets should conform to standards developed by governmental bodies outside the purview of title 26. The Treasury Department and the IRS do not agree that rules or regulations outside the purview of title 26 should determine the scope of these final regulations.

Several comments argued that the definition of broker as applied to digital assets should be confined to persons acting as agents so that it would be consistent with the standard recommended by the Financial Action Task Force (FATF), an inter-governmental body that includes the United States and 39 other member nations and aims to prevent global money laundering and terrorist financing. In 2018, FATF modified its recommendations to member nations to address virtual assets and virtual asset service providers (VASPs).

In 2021, FATF issued updated guidance intended to help national authorities and private sector entities to develop and understand anti-money laundering/counter-terrorism financing rules as applied to virtual asset activities and VASPs. This guidance specifically addresses DeFi arrangements.

The Treasury Department and the IRS do not agree that the standard set forth in the 2021 FATF Guidance is limited to persons acting as agents. The 2021 FATF Guidance specifically states that creators, owners and operators, and some other persons who maintain control or sufficient influence in the DeFi arrangements, even if those arrangements seem decentralized, may fall under the FATF definition of a VASP when they provide or actively facilitate VASP services. Moreover, FATF's Targeted Update on Implementation of the FATF Standards on VAs and VASPs issued in June 2024 reports that nearly half of surveyed jurisdictions either require certain DeFi arrangements to be licensed or registered as VASPs. Over 40 percent of remaining surveyed jurisdictions reported taking steps to identify and address risks in the DeFi ecosystem.

FATF (2018),

Report to the G20 Leaders' Summit,

available at

https://www.fatf-gafi.org/content/dam/fatf-gafi/reports/Report-G20-Leaders-Summit-Nov-2018.pdf.

FATF (2021),

Updated Guidance for a Risk-Based Approach, Virtual Assets and Virtual Asset Service Providers,

¶ 67-69, pp. 27-28, FATF, Paris. (2021 FATF Guidance), available at:

https://www.fatf-gafi.org/publications/fatfrecommendations/documents/guidance-rba-virtual-assets-2021.html.

See

FATF (2024),

Targeted Update on Implementation of the FATF Standards on Virtual Assets and Virtual Asset Service Providers,

¶ 53, p. 28. FATF, Paris, France, available at

https://www.fatf-gafi.org/content/dam/fatf-gafi/recommendations/2024-Targeted-Update-VA-VASP.pdf.coredownload.inline.pdf.

Several comments suggested that the broker definition under section 6045(c)(1)(D) should be limited to custodial digital asset brokers so that it would be consistent with the broker reporting rules of other jurisdictions. As support, one comment cited the definition of “Reporting Crypto-Asset Service Provider” (RCASP) under the Crypto-Asset Reporting Framework (CARF),

a framework for the automatic exchange of information between countries on crypto-assets developed by the Organisation for Economic Co-operation and Development (OECD), to which the United States is a party. Specifically, this comment argued that the proposed definition of broker would be inconsistent with the definition of RCASP, which provides that an RCASP includes someone that acts as a counterparty or intermediary in exchange transactions or that otherwise makes available a trading platform.

Another comment argued that the definition of crypto asset services under the European Union's Markets in Crypto-Assets Regulation (MICA)

also includes only centralized exchanges and custodial brokers.

International Standards for Automatic Exchange of Information in Tax Matters: Crypto-Asset Reporting Framework and 2023 update to the Common Reporting Standard,

OECD Publishing, Paris, June 8, 2023, available at:

https://www.oecd.org/en/publications/international-standards-for-automatic-exchange-of-information-in-tax-matters_896d79d1-en.html

(Crypto-Asset Reporting Framework).

See Rules,

Section IV.B., Crypto-Asset Reporting Framework.

Markets in Crypto-Assets Regulation (MICA) Regulation (EU) 2023/1114 of the European Parliament and the Council of 31 May 2023 on markets in crypto-assets,

Official Journal of the European Union, Volume 66, June 9, 2023, available at:

https://eur-lex.europa.eu/eli/reg/2023/1114/oj

(MICA).

The Treasury Department and the IRS do not agree that the CARF definition of RCASP is inapplicable to DeFi participants. Indeed, a frequently asked question (FAQ) relating to this issue was recently published by the OECD Committee on Fiscal Affair's Working Party 10, which is the OECD group that developed the CARF. The question addressed in the FAQ is whether the definition of RCASP excludes non-custodial services that effectuate exchange transactions.

The term RCASP is defined as “any individual or Entity that, as a business, provides a service effectuating Exchange Transactions for or on behalf of customers, including [. . . ] by making available a trading platform.”

The FAQ answer explains that, for purposes of that definition, a trading platform may be made available by an individual or Entity with or without offering custodial services. Accordingly, the CARF definition of RCASP does not exclude DeFi participants.

OECD,

Crypto-Asset Reporting Framework: Frequently Asked Questions,

September 2024, available at

https://www.oecd.org/content/dam/oecd/en/topics/policy-issues/tax-transparency-and-international-co-operation/faqs-crypto-asset-reporting-framework.pdf.

See Rules,

Section IV.B, Crypto-Asset Reporting Framework.

Finally, the Treasury Department and the IRS do not agree that the MICA definition of crypto-asset services is limited only to centralized exchanges and custodial brokers. Title 1, Article 3 of MICA defines crypto-asset services to include the operation of a trading platform for crypto-assets and the custody and administration of crypto-assets on behalf of clients. Recital 22 of MICA makes it clear that crypto-asset services that are in part “performed in a decentralised manner” fall within its scope and excludes crypto-asset services only when they are “provided in a fully decentralised manner without any intermediary.” To the extent that assertedly decentralized DeFi crypto-asset service providers in fact have a degree of centralized control, MICA treats those service providers as within its scope. Moreover, financial laws or regulations of a non-U.S. government or union of governments do not determine the scope of U.S. tax rules.

5. Miscellaneous Comments

One comment suggested that the broker definition under section 6045(c)(1)(D) is limited to custodial brokers because any application to non-custodial brokers would be an unprecedented expansion of the section 6045 reporting obligations. As support for this position, this comment stated that the application of the transfer statement requirements under section 6045A(a) to certain transfers of digital assets to brokers reflects Congress's focus on custodial brokers because those rules apply only to transfers to custodial brokers. Additionally, this comment argued that the new reporting obligation under section 6045A(d), which requires reporting on certain transfers of digital assets from accounts maintained by a broker, also reflects Congress's focus on custodial brokers. The Treasury Department and the IRS do not agree that the broker definition under section 6045(c)(1)(D) is limited to only custodial

digital asset brokers. Section 6045A(a) cross references section 6045(c)(1) for the definition of broker, and there is no custodial broker limitation in the definition of broker in section 6045(c)(1). As discussed in the securities industry background in Part I.A. of this

Summary of Comments and Explanation of Revisions,

a securities broker may or may not hold customer assets in custody. The pre-TD 10000 regulations applied to securities brokers whether or not they provide custodial services. Additionally, dealers that are brokers under section 6045(c)(1)(A) can transact with customers without providing custodial services to those customers. Members of barter exchanges that are brokers under section 6045(c)(1)(B) can similarly exchange property or services with other members without the barter exchange holding custody of the traded property or services.

See

§ 1.6045-1(e)(2)(i). Finally, the multiple broker rules under long-standing regulations illustrate fact patterns that demonstrate that not all persons treated as brokers under section 6045 are custodial brokers.

See e.g.,

§ 1.6045-1(c)(3)(iv) (cash on delivery) and (c)(4)(iii) and (iv) (

Examples 3

and

One comment suggested that the final regulations should treat as the broker only the DeFi participant that performs the actions without which the transaction could not be carried out. As the DeFi technology stack model shows, however, this proposed “but for” standard would most likely result in all the DeFi participants being treated as performing essential actions without which the transaction could not be carried out. The DeFi technology stack model shows that, in addition to the customer, there are multiple DeFi participants involved in causing a digital asset transaction to be carried out. Each of these DeFi participants provide services that are necessary to effectuate a transaction. The section 6045 regulations treat multiple parties in the securities industry that are involved in effecting a securities transaction as brokers and include a multiple broker rule to avoid duplicative reporting. As is discussed in Part III.A.1. of this

Summary of Comments and Explanation of Revisions,

however, these final regulations treat only one of these DeFi participants as the broker based on a determination of which DeFi participant is in the best position to provide the necessary reporting on the digital asset transactions of customers.

Several comments argued that retaining the broker definition in § 1.6045-1(a)(1) of the pre-TD 10000 regulations for digital asset broker reporting oversteps the statutory authority given to the Secretary because that definition fails to include a requirement that the broker's activities be undertaken “regularly” and “for consideration” as required under section 6045(c)(1)(D). Another comment recommended that this “for consideration” requirement be added to the “trade or business” requirement in the broker definition under the regulations. The Treasury Department and the IRS do not agree that the broker definition fails to include these requirements. A broker is defined in § 1.6045-1(a)(1) as “any person . . . that, in the ordinary course of a trade or business during the calendar year, stands ready to effect sales to be made by others.” Under

Groetzinger

Commissioner,

480 U.S. 23 (1987), persons “engaged in a trade or business . . . must be involved in the activity with continuity and regularity . . . for income or profit.” Accordingly, the requirement that the person effect sales in the “ordinary course of a trade or business” is sufficient to ensure that the person treated as a broker under section 6045(c)(1)(D) “regularly” effects those sales “for consideration.”

One comment requested further guidance on what the “for consideration” requirement means in the context of the DeFi industry. Another comment argued that the “for consideration” requirement in the statute requires that the person providing the effectuating services earn consideration from each specific transaction effectuated to be included in the broker definition. The Treasury Department and the IRS do not agree that the text of the statute mandates such a narrow interpretation of this requirement or that it is necessary for these final regulations to address its meaning in the context of the DeFi industry. The same “for consideration” requirement has existed in the broker definition under section 6045(c)(1)(C) for over forty years, yet there is no exception for brokers providing services on an overall flat-fee basis or as a percentage of total invested assets. Moreover, such an exception would likely incentivize DeFi participants or other brokers to modify their fee models to avoid reporting, a result that would thwart the goals of information reporting.

III. Definitions of a Digital Asset Middleman and an Effectuating Service

Section 1.6045-1(a)(21)(i) defines a digital asset middleman as any person who, with respect to a sale of digital assets, provides a facilitative service. Section 1.6045-1(a)(21)(iii)(B)(

) through (

) defines a facilitative service by referencing five specific services in which the broker acts either as an agent or a counterparty in a digital asset sale. As discussed in the

Background,

TD 10000 reserved on the portion of the facilitative services definition included in proposed § 1.6045-1(a)(21)(iii)(A) that would have defined a facilitative service as any service that directly or indirectly effectuates a sale of digital assets, such as providing a party in the sale with access to an automatically executing contract or protocol, providing access to digital asset trading platforms, providing an automated market maker system, providing order matching services, providing market making functions, providing services to discover the most competitive buy and sell prices, or providing escrow or escrow-like services to ensure both parties to an exchange act in accordance with their obligations.

Several comments argued that the proposed definition of facilitative services was too broad because it referred to services that both directly and indirectly effectuate sales of digital assets. Another comment argued that a standard that captures services that indirectly effectuate transactions would have no discernible limits. Several comments stated that this broad definition would apply the broker definition to internet browsers, smartphone manufacturers, internet service providers, and many other persons not even considered part of the DeFi industry because these participants arguably “indirectly” effectuate transactions. One comment said that the definition's inclusion of services that “indirectly” effectuate transactions would treat as brokers persons who are not in the chain of proceeds settlement, such as fund administrators, which provide ancillary administrative services relating to a sale. Many of these comments recommended narrowing the definition of facilitative service to only include services that directly effectuate a sale.

The Treasury Department and the IRS agree that the proposed facilitative services definition's reference to services that indirectly effectuate sales of digital assets is too broad. The Treasury Department and the IRS did not intend to include in the definition of broker persons not within the DeFi industry, such as internet service providers, internet browsers, or computer or smartphone manufacturers. Accordingly, to address this concern, as discussed in Parts III.A. through III.C. of this

Summary of Comments and Explanation of Revisions,

the final

regulations narrow the scope of DeFi participants that meet the definition of a digital asset middleman. Additionally, to make it clear that the reach of the digital asset middleman definition in this regard is not any broader than the broker definition under section 6045(c)(1)(D), the final regulations change the term facilitative services used in the proposed definition of digital asset middleman to the term effectuating services.

One comment stated that the definition of facilitative services would capture all participants described in the DeFi technology stack model resulting in duplicative reporting. Another comment stated that the facilitative services definition results in disparate treatment for DeFi participants in a digital asset transaction than is applied under current law to securities industry participants providing analogous services in a securities transaction. For example, this comment argued that the NYSE and Nasdaq are not brokers for section 6045 purposes, but analogous businesses in the DeFi industry would be brokers under the proposed facilitative services definition. Although, as discussed in Part II.B.1.b. of this

Summary of Comments and Explanation of Revisions,

the definition of broker under section 6045(c)(1)(D) is broad enough to include multiple DeFi participants involved in a DeFi transaction, the Treasury Department and the IRS have determined that such a broad definition could result in duplicative reporting. Accordingly, the Treasury Department and the IRS have determined that in these final regulations the only DeFi participants that should be treated as brokers are trading front-end service providers. This determination was made for several reasons, which are discussed in more detail in the remainder of this Part III. of this

Summary of Comments and Explanation of Revisions.

First, such providers are the DeFi participants that have the closest relationship to customers and therefore are in the best position to obtain customer identification information. Second, numerous commenters expressed concerns regarding, in the view of the comments, the difficulty in identifying operators of DeFi trading applications and the potential difficulty such operators would have in changing the potentially immutable code of those DeFi trading applications. Those concerns are not as salient to trading front-end service providers because those providers typically are legal entities or individuals and the software used to provide trading front-end services is not immutable. Accordingly, the persons responsible for carrying out broker diligence and reporting will be easy for taxpayers and the IRS to identify, and those providers have the capability to modify their operations to comply with these regulations. Appropriately, these DeFi participants are also the participants that provide services that are most analogous to the functions performed by brokers in the securities industry.

A. Interface Layer Activities

1. In General

In addition to other listed services, the proposed regulations would have included in the definition of facilitative services certain services that are described in the DeFi technology stack model as interface layer services and which are referred to in this preamble as trading front-end services. Specifically, proposed § 1.6045-1(a)(21)(iii)(A) would have included in the definition of facilitative services any service that provides a party in the sale with access to an automatically executing contract or protocol or digital asset trading platform. To illustrate the meaning of providing a party with such access, proposed § 1.6045-1(b)(17) (

Example 17

) describes a website that matches buyers and sellers of digital assets and thereafter directs such buyers and sellers to use automatically executing contracts to settle their matched transactions and concludes that the website is an example of providing these access services.

One comment suggested that instead of referring to the services that provide “access to an automatically executing contract or protocol or digital asset trading platform,” the final regulations should refer to these services as “front-end services” because the front-end term captures not only the visual elements provided by a website that offers these services but also the software that powers the interactive features of the website or mobile app, such as forms, buttons that initiate actions, and dynamic page updates without full page refreshes. The Treasury Department and the IRS agree with this recommendation and have adopted the front-end services terminology referred to herein as trading front-end services.

This preamble also uses the trading front-end services term in describing the comments received even when those comments refer to these services using different terms, such as user interface services or application programming interface.

One comment stated that DeFi systems, including those created by software developers, operators of DeFi protocols, and trading front-end service providers, are purely software infrastructure used for communication and coordination. This comment argued that these services are akin to those of a phone service provider, and therefore none of these DeFi participants participate in the buying or selling of digital assets. Another comment asserted that the definition of facilitative services should not apply to trading front-end services used by customers to interact with DeFi trading applications because these services are merely informational services, much like those provided by Google, Yahoo! Finance, or Wikipedia to internet users seeking information. This comment argued that, in all these cases, the service provider is merely generating and displaying information in response to user inputs, and, as such, should not be treated as carrying out what the user does with the provided information. Another comment suggested that trading front-end services should not be treated as facilitative services because these services are merely tools that are used by customers to access the DeFi ecosystem. Another comment similarly argued that trading front-end service providers merely provide tools through which customers can participate on their own in a DeFi transaction. This comment likened coded trade order instructions to a torque wrench that a person purchases to repair their own car as opposed to engaging a licensed mechanic who already owns a torque wrench to repair the person's car. One comment argued that the final regulations should treat DeFi trading applications as brokers, not trading front-end service providers. In contrast to these comments, a few comments acknowledged that trading front-end service providers should be the DeFi participant treated as brokers that are required to report under section 6045. One comment requested that the final regulations clarify that trading front-end service providers are brokers. This comment also noted that the software used by trading front-end service providers to perform these services can be modified and customized to comply with regulatory requirements and are already being modified by some market participants to comply with anti-money laundering (AML) and Know Your Customer (KYC) obligations under the Bank Secrecy Act (BSA) (31 U.S.C. 5311

et seq.

The Treasury Department and the IRS agree that the suite of services offered by a trading front-end service provider, including the generation of customized coded trade order instructions, are

provided through software that is used for communication and coordination of functions on the distributed ledger network. The Treasury Department and the IRS do not agree, however, that persons providing trading front-end services that enable their customers to interact with DeFi trading applications are akin to those of a phone service provider or are merely providing informational services like that of a search engine or that such services are analogous to buying off-the-shelf tools to repair one's own car because trading front-end services enable customers to engage in DeFi transactions. As discussed in Part I.B.1. of this

Summary of Comments and Explanation of Revisions,

trading front-end service providers offer a suite of services that enable their customers to view an array of choices relating to their proposed trades, to input their proposed trades, and then to initiate the additional steps necessary to trade their digital assets by interacting with other DeFi participants operating within the distributed ledger network. The suite of trading front-end services also includes, in some cases, interacting with customers in advance of a trade order to obtain their permission for a DeFi trading protocol to move digital assets out of the customers' wallets and converting these customer permissions into software code that can later interact with the DeFi trading protocol when a transaction is executed by the DeFi trading protocol. Once the customer authorizes the transaction, the coded trade order instructions prepared by the trading front-end services determine the subsequent steps in the transaction as it is processed, including calling the applicable DeFi protocol's automatically executing contracts for automatic execution and settlement if the transaction is included in a block and added to the blockchain by a validator. Consequently, not only do the suite of services offered by the trading front-end service provider supply the customer with information, but these services are also essential and integral to enabling the customer's order to be communicated, understood, and executed by the other DeFi participants operating within the distributed ledger network. Accordingly, the suite of services provided by a trading front-end service provider are not analogous to a torque wrench used to repair one's own car because, once customers authorize or sign the transaction in their wallets, the functions conducted thereafter within the distributed ledger network are all initiated by the services provided by the trading front-end service provider (including the coded trade order instructions) whereas buyers of torque wrenches need to use their own skill to repair their cars. In the former case, the services provided to the customer effectuate the transaction via the coded trade order instructions whereas in the latter case, the buyer of the torque wrench, not the torque wrench itself, repairs the car.

Additionally, it should be noted that trading front-end services are analogous to the services provided by securities brokers in the securities industry. When a securities broker receives an investor's order to sell securities, it will generally have some mechanism to verify the order details. The securities broker will then route the order to a securities exchange or other trading center for execution or fill or match the order internally. If a transaction is ultimately executed, the transaction information typically will be sent to a clearing organization that will record and settle the transaction by moving the traded securities and funds between the appropriate accounts. That is, once the customer has provided the trade order details to the securities broker and authorized the transaction, the remaining steps in a transaction that is executed by a securities exchange or other trading center take place pursuant to the securities broker's communications with other market participants. The securities broker functions as the recipient of the customer's order and the intermediary that typically communicates the customer's trade order to other market participants for eventual execution of that order.

Like the services provided by securities brokers in the securities industry, a trading front-end service provider receives a customer's trade order, verifies the order details, and obtains confirmation from the customer. Although the trading front-end service provider may not obtain the customer's final authorization for the transactions or transmit the coded trade order instructions to the distributed ledger network, the services provided by the trading front-end service provider enable the customer's trade order to be communicated to the other DeFi participants, including the specific DeFi trading protocol called by the coded instructions and the other DeFi participants operating on the settlement layer, to execute the transaction. Indeed, the coded trade order instructions provided by the trading front-end service provider are analogous to the coded trade order instructions that a securities broker sends to a securities exchange or other trading center in a traditional securities transaction and are essential to carrying out the overall transaction. Accordingly, because these trading front-end services provide essential services that enable their customers to carry out DeFi transactions, the Treasury Department and the IRS have determined that it is also appropriate to treat these services as effectuating services.

Further, the Treasury Department and the IRS understand that trading front-end services are typically offered by a legal entity or individual, which means there is a person within the meaning of section 7701(a)(1) that would be obligated to comply with broker reporting. Additionally, because persons providing trading front-end services generally host websites, these persons provide services that interact directly with customers undertaking DeFi transactions. Indeed, there generally is an agreement between trading front-end service providers and their customers, under which, as part of customary onboarding procedures, customers are treated as having agreed to general terms and conditions. These agreements may be part of the compliance program used by trading front-end service providers to assess the customer's suitability with respect to economic sanctions programs administered and enforced by Treasury Department's Office of Foreign Assets Control (OFAC).

As such, a person providing trading front-end services is the DeFi participant that is closest to the customer. In contrast, as discussed in Part III.B. of this

Summary of Comments and Explanation of Revisions,

some comments argued that DeFi trading applications are not operated by persons within the meaning of section 7701(a) and do not interact directly with the customer undertaking DeFi transactions. Additionally, unlike the potentially immutable code used by DeFi trading applications, the suite of services provided by trading front-end service providers typically utilize software that is mutable. Accordingly, the Treasury Department and the IRS have determined that it is appropriate to treat trading front-end service providers as brokers under section 6045(c)(1)(D) for the following reasons. First, trading front-end service providers are the DeFi participants that have the closest relationship to the customers and therefore are in the best position to obtain customer identification information. Second, trading front-end

service providers are legal entities or individuals that can be identified by taxpayers and the IRS. Third, trading front-end service providers typically do not utilize immutable code in providing these services and therefore can make changes to their operations to comply with these regulations. Therefore, with respect to any digital asset sales

effected by these brokers that are subject to reporting, these brokers must file Forms 1099-DA,

Digital Asset Proceeds From Broker Transactions,

to report the information required by that form as appropriate and must retain the information for seven years as required to be retained by § 1.6045-1(d)(11)(i), such as the transaction ID of the reported transaction and the digital asset address from which the digital asset was transferred in connection with the sale. In addition, the required information must also be made available for inspection upon request by the IRS. For a discussion of the reasons why the Secretary exercised discretion in not treating other DeFi participants, such as persons that operate DeFi trading applications and persons that perform functions on the settlement layer, as brokers under section 6045(c)(1)(D),

see

Parts III.B. and III.C. of this

Summary of Comments and Explanation of Revisions.

See

OFAC,

Frequently Asked Questions: Questions on Virtual Currency: 560,

available at:

https://home.treasury.gov/policy-issues/financial-sanctions/faqs/560

(discussing OFAC compliance obligations for transactions using digital currency).

Like centralized brokers, however, these trading front-end service providers treated as brokers are not required to report on the transactions identified in Notice 2024-57, 2024-29 I.R.B. 67 (July 15, 2024), for which brokers are not required to make a return under section 6045(a) until further guidance is issued.

Several comments argued that the facilitative services definition should not apply to trading front-end service providers (including certain unhosted wallet providers as discussed in Part III.A.2. of this

Summary of Comments and Explanation of Revisions

) because the customer must authorize the transaction in the customer's wallet after the wallet receives the coded trade order instructions from the trading front-end service provider and because it is the customer's wallet, not the trading front-end service provider, that sends the coded trade order instructions to the distributed ledger. One comment asserted that trading front-end service providers do not monitor whether a customer deploys the coded trade order instructions received from the trading front-end service provider, just as an encyclopedia does not monitor whether a reader uses information obtained from its pages. Another comment argued that, to be consistent with standards applied by other offices of the Treasury Department, these final regulations must adopt the standard used by the Financial Crimes Enforcement Network (FinCEN)

in its guidance relating to virtual currencies.

See

Fin-2019-G001,

Application of FinCEN's Regulations to Certain Business Models Involving Convertible Virtual Currencies,

May 9, 2019 (2019 FinCEN Guidance). Specifically, in the view of this comment, FinCEN's 2019 Guidance looked to whether a user had “total independent control over the value [of digital assets]” in determining whether digital asset businesses providing services to that user are money services businesses subject to AML obligations under the BSA and FinCEN's implementing regulations.

See

31 CFR chapter X.

The Treasury Department and the IRS considered these comments but do not agree that trading front-end service providers should be excluded from the broker definition for the following reasons. First, although it may be the wallet, and not the trading front-end service provider, that sends the coded trade order instructions to the distributed ledger network, it is the coded trade order instructions generated by the suite of services offered by the trading front-end service provider that ultimately call for the interaction with the DeFi trading protocol's automatically executing contracts and, once the transaction is selected for validation and included in a block, cause the validator to settle the transaction. These trading front-end services provide an essential communication function notwithstanding that the coded trade order instructions may not be broadcast to the distributed ledger network by the trading front-end service provider.

In addition, although the preamble to TD 10000 looked to the application of the BSA's AML obligations as support for the conclusion that operators of custodial digital asset trading platforms, digital asset hosted wallet providers, and digital asset kiosks have information about their customers, the Treasury Department and the IRS are not required to follow the BSA or the 2019 FinCEN Guidance in determining whether trading front-end service providers should be brokers under section 6045(c)(1)(D). The AML obligations in FinCEN's regulations issued under the BSA apply generally to financial institutions, whereas information reporting under section 6045 applies to persons included in the definition of broker under section 6045(c)(1). Because section 6045 did not condition the definition of broker on such person being a financial institution under the BSA, the extent to which AML obligations apply to trading front-end service providers does not limit the Secretary's ability to treat such persons as brokers under section 6045(c)(1)(D).

Cf.

section 6050I(c)(1)(B) (explicit reference to BSA).

These final regulations are issued under title 26, and this preamble therefore does not address the proper interpretation of FinCEN's total independent control standard in the 2019 FinCEN Guidance. In any event, the Treasury Department and the IRS do not agree that a total independent control standard is the appropriate standard for determining whether a DeFi participant, such as a trading front-end service provider, provides a service that effectuates a transfer of digital assets as required by section 6045(c)(1)(D), or that a user of trading front-end services has sole control over its assets when it uses a trading front-end service. Trading front-end service providers offer a suite of services that include the translation of the customer's trade order input into coded trade order instructions that ultimately call for the interaction of the customer's digital assets with the DeFi trading application and, once the transaction is selected for validation and included in a block, cause the validator to settle the transaction. For example, these coded trade order instructions specify the number and type of digital assets to be removed from the customer's wallet and the type of digital assets to be deposited into the customer's wallet in exchange. Additionally, the trading front-end services also may include obtaining the customer's permission for the DeFi protocol to remove digital assets out of the customer's wallet and translating that permission into a separate set of instructions that will be broadcast to the distributed ledger for use by the DeFi protocol in future transactions authorized by the customer. Moreover, in some cases, a trading front-end service provider might take control of the customer's digital assets by routing the customer's digital assets to an address controlled by the trading front-end service provider. Accordingly, despite not holding the digital asset customer's private keys, once the customer authorizes or signs the transaction, the services provided by the trading front-end service provider exercise a degree of control over the customer's digital assets involved in transactions.

Numerous comments argued that trading front-end service providers should not be treated as brokers because they are unable to backup withhold from the digital assets disposed by the customer in the transaction or the

digital assets received in the transaction because trading front-end service providers do not have custody of the private keys used for accessing a customer's digital assets. Another comment recommended that, if trading front-end service providers are treated as brokers, they should be exempt from any obligation to backup withhold in DeFi transactions. The final regulations do not adopt these comments. Backup withholding is an essential enforcement tool to ensure that complete and accurate information returns can be filed by brokers with respect to payments made to their customers. Accurate taxpayer identification numbers (TINs) provided by the customers of brokers and other information provided by brokers are critical to matching such information with income reported on a customer's Federal income tax return. Customers that fail to provide their TINs to a broker as requested may be liable for penalties under section 6723 of the Code. A complete exception from backup withholding for DeFi sales of digital assets would increase the likelihood that customers will not provide correct TINs to their brokers. Trading front-end service providers exercise a degree of control over their customer's digital assets once the transaction has been authorized or signed in the customer's unhosted wallet to withhold their fees from the customer's digital assets and can similarly satisfy their obligation to backup withhold from either the digital assets disposed by the customer in the transaction or the digital assets received in the transaction should the customer fail to provide its name, address, and TIN. The Treasury Department and the IRS are aware, however, that not all arrangements between trading front-end service providers and their customers currently provide for backup withholding. The Treasury Department and the IRS intend to publish a notice of proposed rulemaking under § 31.3406(h)-2(b) with proposed regulations that would provide trading front-end service providers with greater flexibility to satisfy their backup withholding obligations with respect to these transactions.

One comment argued that the delivery of application-programming interfaces is merely the provision of hardware or software that enables customers to access digital assets, and the legislative history is clear that such activities ought not cause a person to be a broker. The Treasury Department and the IRS agree that persons that provide application-programming interface services, which is another name for trading front-end services, write the software code that translates the details of the customer's trade order into coded trade order instructions. The Treasury Department and the IRS do not agree that the definition of broker should turn on the technological nature of the services provided. Instead, the definition should turn on what those services do. Because trading front-end service providers provide services that their customers need in order to engage in DeFi transactions and that are designed specifically for that purpose, that is, by offering a menu of transactions for a customer to choose from and translating the details of the customer's trade order into coded trade order instructions that are used to communicate with other DeFi participants in order to engage in DeFi transactions, it is appropriate to treat these services as effectuating transfers of digital assets under section 6045(c)(1)(D).

Several comments argued that because some digital asset users can themselves write the software code that is included in the coded trade order instructions, trading front-end service providers that provide this software coding service should not be treated as brokers. The final regulations do not adopt this comment because trading front-end service providers offer a suite of services to customers that enable them to engage in DeFi transactions. Moreover, that some sophisticated digital assets users are able to interact with DeFi trading protocols without the services provided by trading front-end service providers should not affect the obligation of trading front-end service providers to report on the transactions of customers that do utilize their services. Additionally, as discussed in Part III.B. of this

Summary of Comments and Explanation of Revisions,

the IRS intends to evaluate the information reported by trading front-end service providers and the extent to which changes in the industry enable retail digital asset users to use DeFi trading applications without using trading front-end services.

In sum, for all these reasons, the Treasury Department and the IRS have concluded that trading front-end services that enable customers to interact with DeFi trading applications should be treated as effectuating services for purposes of the digital asset middleman rule. Accordingly, final § 1.6045-1(a)(21) defines a digital asset middleman as any person who is responsible for providing an effectuating service with respect to a sale of digital assets. Final § 1.6045-1(a)(21)(i) defines an effectuating service as any trading front-end service where the person providing that service ordinarily would know or be in a position to know the nature of the transaction (as defined in final § 1.6045-1(a)(21)(iii)(B) and discussed in Part III.A.3. of this

Summary of Comments and Explanation of Revisions

) or any other service set forth in § 1.6045-1(a)(21)(iii)(B)(

) through (

) (previously referred to as a facilitative service in TD 10000). The final regulations use the term “trading front-end service” rather than “front-end service” to make it clear that only the front-end services that enable customers to interact with DeFi trading applications are included in the effectuating services definition. Specifically, final § 1.6045-1(a)(21)(iii)(A)(

) limits the definition of a trading front-end service to a service that, with respect to a sale of digital assets, receives a person's order to sell and processes that order for execution by providing user interface services, including graphic and voice user interface services, that are designed to: (i) enable such person to input order details with respect to transactions to be carried out or settled on a distributed ledger or similar technology; and (ii) transmit those order details so that the transaction can be carried out or settled on a distributed ledger or similar technology, including by transmitting the order details to the person's wallet in such form that, if authorized or signed by the person, causes the order details to be transmitted to a distributed ledger network for interaction with a digital asset trading protocol. The Treasury Department and the IRS are aware that technology evolves rapidly. Accordingly, this definition is intended to apply broadly to any front-end service that enables customers to input their order details for interaction with a digital asset trading protocol regardless of the order of the steps necessary to carry out that transaction on the distributed ledger network. It is also intended that this definition will apply to any front-end service that enables customers to interact with aggregation protocols as well as digital asset trading protocols.

Additionally, final § 1.6045-1(a)(21)(iii)(A)(

) provides additional rules for determining whether services are trading front-end services. First, services are defined as trading front-end services without regard to whether the digital assets received upon execution of the transaction at a digital asset address in the wallet controlled by the person using the trading front-end services to dispose of digital assets (first person) or at a digital asset address in a wallet controlled by a second person,

including the provider of the front-end services itself. Thus, for example, if a first person uses services that otherwise meet the definition of trading front-end services to exchange digital asset A for digital asset B and the order details include an instruction to deliver digital asset B to a digital asset address in a wallet controlled or owned by a second person, for example, as a payment, the services provided by the front-end service provider will be treated as trading front-end services.

Final § 1.6045-1(a)(21)(iii)(A)(

) also provides that the transmission of order details to a distributed ledger network for interaction with a digital asset trading protocol includes the direct or indirect transmission to a distributed ledger network of order details that call upon or otherwise invoke the functions of automatically executing contracts that comprise a digital asset trading protocol. Accordingly, the addition of intermediate steps before the digital asset customer's transaction can be broadcast to a distributed ledger network or before the transaction can otherwise cause the interaction with a digital asset trading protocol, whether for business purposes or in an attempt to avoid meeting the trading front-end services definition, will not prevent the services provided by the trading front-end service provider from being treated as trading front-end services. Thus, for example, the transmittal of a customer's order details for interaction with a DeFi aggregator application before interaction with a specific DeFi trading protocol that offers the most favorable transaction terms is an indirect transmission to a distributed ledger network for interaction with a digital asset trading protocol described in final § 1.6045-1(a)(21)(iii)(A)(

)(

). This rule would not, however, treat basic speech-to-text interface services that merely translate customer's voice commanded trade orders to written text orders as trading front-end services because basic text-to-speech interface services do not invoke the functions of the DeFi protocol as required by final § 1.6045-1(a)(21)(iii)(A)(

)(

). Instead, the translated speech-to-text trade order would be sent to a trading front-end service provider that would, in turn, convert that written trade order into coded trade order instructions.

In addition, final § 1.6045-1(a)(21)(iii)(C) provides exceptions for certain wallet services and validation services, which exceptions are discussed in Parts III.A.2. and III.C. of this

Summary of Comments and Explanation of Revisions.

Additionally, final § 1.6045-1(a)(21)(iii)(D) defines a digital asset trading protocol as a distributed ledger application consisting of computer software, including automatically executing contracts, that exchange one digital asset for another digital asset pursuant to instructions from a user.

One comment requested guidance regarding whether persons that offer front-end services for users to provide liquidity to liquidity pools or users to stake their assets through staking pools that issue receipts or tokens in exchange for the users' digital assets would be treated as brokers under the broker definition. Although the definition of trading front-end services under these final regulations could apply to front-end services that enable users to contribute their digital assets to liquidity pools and to staking pools in exchange for receipts or tokens, brokers are not required to make returns on these transactions under section 6045 until a determination has been made that these transactions are subject to such reporting.

See

Sections 3.03 and 3.04 of Notice 2024-57, 2024-29 I.R.B. 67 (July 15, 2024). The Treasury Department and the IRS anticipate that any termination to the no-reporting relief in Notice 2024-57 for such transactions will take into account that the termination may cause persons not currently required to report to start doing so and therefore such persons would need some time to build or buy systems to comply with reporting. Finally, in response to the comment requesting clarification as to whether providing staking as a service could cause the provider to be treated as a broker, to the extent that such services do not give rise to the sale of a digital asset, the provision of those services would not cause the provider to be treated as a broker.

2. Unhosted Wallet Services

Proposed § 1.6045-1(a)(21)(iii)(A) included two sentences in the proposed definition of facilitative services that addressed the extent to which unhosted wallet services were included in the definition. The first sentence would have specifically excluded from the definition of facilitative services the selling of hardware or the licensing of software for which the sole function is to permit persons to control private keys which are used for accessing digital assets on a distributed ledger if such functions are conducted by a person solely engaged in the business of selling such hardware or licensing such software. The second sentence illustrated the limits of this proposed exclusion by stating that software that provides users with direct access to trading platforms from the wallet platform is not an example of software with the sole function of providing users with the ability to control private keys to send and receive digital assets. Proposed § 1.6045-1(b)(23) (

Example 23

) illustrated the wallet exclusion rule by describing a wallet that neither provides “access” nor “connection services” to a digital asset trading platform, and proposed § 1.6045-1(b)(22) (

Example 22

) illustrated the limits of the wallet exclusion rule by describing a wallet that provides “access” to a digital asset trading platform.

One comment argued that the wallet exclusion rule's application only to wallets the “sole function” of which is to permit persons to control private keys was too narrow because the purpose of wallet software is to allow users to interact with other blockchain addresses (including smart contracts). The Treasury Department and the IRS do not agree that this exclusion is too narrow. The rationale behind the wallet exclusion was to exclude ancillary parties who cannot obtain information about sales of digital assets. Senator Warner's statements made during the colloquy make it clear that he intended this wallet exclusion to be limited to providers of those wallets for which the only function is to permit persons to control private keys which are used for accessing digital assets on a distributed ledger. 167 Cong. Rec. S6095-6 (daily ed. August 9, 2021). Senator Warner's expressed intent to provide only a limited exclusion for wallet providers is made even more clear when he said later in the colloquy, “[o]f course, if these [wallet providers] . . . provide additional services for consideration that would qualify as brokerage, the rules would apply to them as any other broker.” 167 Cong. Rec. S6096 (daily ed. August 9, 2021).

Many comments argued for a complete exclusion from the facilitative services definition for wallet services because, the comments stated, wallet providers and wallet developers typically do not have the information necessary to know the nature of transactions processed nor are they generally able to obtain that information. One comment stated that once the private key is exported, the wallet provider may not even be aware that a transaction happened if the transaction originates with a third-party trading front-end service provider, even though the digital assets disposed of in the transaction are removed from the user's wallet and the digital assets received in the transaction are received in the user's wallet. Another comment stated that unhosted wallet providers

may be able to see the digital assets leaving a wallet, but they cannot know the underlying details of the transaction. One comment stated that unhosted wallet providers do not typically know the functionality of a given protocol that a wallet user interacts with using the user's wallet.

As discussed in Part I.B. of this

Summary of Comments and Explanation of Revisions,

providers of unhosted wallets often provide customers with an assortment of services. Because the rationale behind the wallet exclusion is to exclude ancillary parties who cannot obtain information about sales of digital assets, it is important to examine each of these services to determine if they enable the person providing the wallet services to obtain information about customers' sales of digital assets contained in the wallet. Services provided by the wallet for key storage and transaction authorization are performed in every transaction undertaken with digital assets in the customer's wallet. These services, however, do not provide any information to the person providing the wallet services regarding the underlying nature of the transaction. Services enabling customers to transfer native and non-native digital assets on the distributed ledger similarly do not provide any information to the person providing the wallet services regarding the underlying nature of the transaction. Additionally, the connection that enables a customer to go to a third-party trading front-end service provider for trading front-end services also does not provide the person providing the wallet services with information with respect to the transaction because the coded trade order instructions in that case are created by the third-party trading front-end service provider. Thus, despite the transaction being sent to the customer's wallet for authorization or signature before it is then transmitted by the wallet to the distributed ledger for interaction with the DeFi trading application, the person providing the wallet services does not have visibility into the coded trade order instructions if the instructions are created by a third-party trading front-end service provider. Accordingly, the Treasury Department and the IRS have determined that it is appropriate to treat all these basic wallet services as excluded from the definition of effectuating services under the final regulation.

In contrast, when the person providing the wallet services also provides trading front-end services for a transaction, this wallet provider creates the coded trade order instructions that includes the specifics of the customer's trade order. In that circumstance, the person providing these enhanced wallet services has the information about the underlying sale. Additionally, these persons also interact directly with their customers and, as such, can obtain the customer's identity. Accordingly, it is appropriate in these cases to treat these enhanced wallet trading front-end services as effectuating services under the final regulation and a person providing these enhanced wallet services as a digital asset middleman.

Several comments requested guidance regarding the extent to which a developer of wallet software that provides a service that is considered to be a “service effectuating” transfers should be treated as a provider of that service. The extent to which a software developer would be treated as the provider of the software's services is a question of fact that depends on how the software sale or licensing transaction is structured and the activities provided by the software developer thereafter. For example, if a developer licenses or sells the developed software to a third party, who thereafter uses the software without any continuing involvement by the software developer to provide wallet services to customers, the software developer would not be the provider of the wallet services. In contrast, if the software developer licenses the wallet services directly to customers, the developer would be the provider of the wallet services. The Treasury Department and the IRS disagree with the comment in so far as it can be read to suggest that the final regulations should incorporate additional guidance regarding each potential factual scenario.

One comment stated that persons providing unhosted wallet services do not know the identities of their customers taking part in the transaction. Another comment stated that these persons may have difficulty determining who is the beneficial owner of the digital assets held within the wallet, such as when more than one customer knows the private key or when one person opens an account on behalf of another person. The Treasury Department and the IRS do not agree that persons providing wallet services are not able to obtain the identities of their customers. On the contrary, a person providing wallet services is the DeFi participant in the best position to obtain that information because there generally is an agreement between the person providing wallet services and the customer under which, as part of customary onboarding procedures, such customers are treated as having agreed to general terms and conditions. Those terms and conditions can address the need to obtain customer identification information. Although, as suggested by the comments, it may be difficult for the person providing wallet services to be certain that the person controlling the private keys in the wallet is the beneficial owner of the digital assets held within the wallet, this concern is no different from any other business that transacts with customers electronically.

Many comments stated that, taken together, the wallet exclusion in the proposed regulations would result in treating all providers of wallet software as brokers. Several comments argued that this wallet exclusion was too narrow because all wallet software provides users with “access” to digital asset trading platforms, thus, no wallet provider will qualify for the exclusion. Several comments stated that the wallet exception's reference to software that provides wallet users with “direct access to trading platforms from the wallet platform” made it difficult to understand how the overall wallet exclusion was intended to apply because “trading platform” and “wallet platform” were not defined in the proposed regulations. One comment argued that the wallet connection services referred to in proposed § 1.6045-1(b)(23) (

Example 23

) should not be considered a facilitative service because this software merely permits a wallet user to authorize transactions involving digital assets in the user's wallet with respect to a transaction initiated outside of the wallet. Some comments argued that this broad application of the facilitative services definition to persons providing wallet services was inconsistent with the stated intent of the proposed regulations and the legislative history of the amendment to section 6045.

Several comments argued that the wallet services described in the wallet exclusion rule should not be limited to persons “solely” engaged in the business of selling such hardware or licensing such software. These comments argued that even if a person is engaged in other activities that constitute acting as a broker with respect to one transaction, those activities should not affect whether the person is a broker with respect to the wallet services described in the wallet exclusion provided with respect to a second transaction. That is, when a person who is a wallet provider engages in broker activities with respect to the first transaction, this does not affect whether that wallet provider can obtain the information necessary to report the second transaction. Several comments

argued that a precise interpretation of the wallet exclusion rule as written would result in treating wallet providers that conduct any other activities (even non-business hobbies) as providing facilitative services and as brokers for all activities. Another comment argued that although a well-advised wallet provider could put exempt activities into different legal entities to achieve a more rational result, it would be more appropriate to modify the rule to remove this restriction. Another comment suggested that this requirement would create a “cliff effect” for wallet providers, whereby a wallet provider that offers one service that falls within the broker definition will be treated as a broker for all transactions undertaken by customers using that provider's wallet services.

The Treasury Department and the IRS agree that the exclusion for wallet services should not be limited to persons that are “solely” engaged in the business of selling such hardware or licensing such software. Additionally, the requirement should not cause wallet providers to be brokers for all transactions undertaken by customers using that provider's wallet services if the provider offers one service that falls within the broker definition. For that reason, final § 1.6045-1(a)(21)(iii)(C)(

) provides that if a person licenses software or sells hardware that provides unhosted wallet services that include both trading front-end services with respect to some sales of digital assets and other services that are not trading front-end services (or other effectuating services under final § 1.6045-1(a)(21)(iii)(B)) with respect to other sales of digital assets, then that person will be treated as providing effectuating services only with respect to the sales of digital assets that are carried out using the trading front-end services provided by the unhosted wallet. Accordingly, persons providing unhosted wallet services must make information returns with respect to customer sales that are undertaken using the wallet's trading front-end services, but those persons are not required to make information returns with respect to customer sales that are undertaken using a third-party front-end service provider's trading front-end services. A wallet provider that does not provide trading front-end services but provides other effectuating services described in final § 1.6045-1(a)(21)(iii)(B), however, would nonetheless be required to report on customer sales effected using those other services. Thus, for example, if a person providing unhosted wallet services also operates a digital asset kiosk, that person would be required to report on sales of digital assets undertaken by customers using that kiosk even if the digital assets sold were stored in an unhosted wallet provided by that person. Additionally, § 1.6045-1(b)(2)(x) (

Example 2

) has been modified to conform to this final rule.

3. Position To Know

Under proposed § 1.6045-1(a)(21)(i), a person performing facilitative services with respect to a sale would meet the definition of a digital asset middleman only if the nature of the services arrangement is such that the person ordinarily would know or be in a position to know the identity of the party that makes the sale and the nature of the transaction potentially giving rise to gross proceeds from the sale.

a. Position To Know the Identity of the Customer

Proposed § 1.6045-1(a)(21)(ii)(A) would have treated a person as ordinarily knowing or in a position to know the identity of the party that makes the sale if that person maintains sufficient control or influence over the provided facilitative services so as to have the ability to set or change the terms under which its services are provided to request that the party making the sale provide that party's name, address, and TIN, in advance of the sale. The proposed rule also would have treated this sufficient control or influence standard as being met if the person providing the facilitative services has the ability to change the fees charged for those services.

Several comments recommended that the final regulations retain only the ordinarily would know standard as applied to knowing the identity of the customer. Other comments stated that the position to know standard has no reasonable limitation because virtually any provider could theoretically request customer information or modify the terms of its arrangement or fee structure. Several comments criticized the new standard because it does not use an objective test but rather an “ability” standard which is not based on the DeFi participant's business model but instead is based on hypothetical circumstances. One comment asserted that persons that provide wallet services and application-programming interface services do not meet the position to know standard with respect to a customer's identity because, the comment stated, these providers have no information on the customer. In contrast, several comments stated that providers of user interface services have sufficient control or influence to add the services necessary to comply with the position to know standard and the proposed broker reporting requirements. Indeed, one comment stated that these interfaces can be modified and customized to comply with regulatory requirements and are already being modified by some market participants to permit AML/KYC compliance.

As discussed in Part III.A.1. of this

Summary of Comments and Explanation of Revisions,

persons that provide trading front-end services work directly with customers to translate their trade order details into coded trade order instructions for later use. These services are provided pursuant to general terms and conditions that the customers agree to as part of customary onboarding procedures. Accordingly, trading front-end services can update these general terms and conditions as necessary to learn the identity of their customers. Given that trading front-end service providers have access to their customers and, therefore, can query them about their identity, the Treasury Department and the IRS have determined that it is not necessary in the final regulations to include the position to know standard as applied to the identity of the party that makes the sale. It should be noted that there is currently no knowledge standard for any other brokers regarding the identity of the customer because these rules only treat persons that have access to customers as brokers.

b. Position To Know the Nature of the Transaction

Proposed § 1.6045-1(a)(21)(ii)(B) would have treated a person as ordinarily knowing or in a position to know the nature of the transaction potentially giving rise to gross proceeds from a sale if that person maintains sufficient control or influence over the facilitative services provided to have the ability to determine whether and the extent to which the transfer of digital assets involved in a transaction gives rise to gross proceeds, including by reference to the consideration that the person receives or pursuant to the operations of, or modifications to, an automatically executing contract or protocol to which the person provides access. The proposed rule also would have treated this sufficient control or influence standard as being met if the person providing the facilitative services has the ability to change the fees charged for those services.

One comment asserted that persons that provide application-programming interface services do not meet the position to know standard with respect to the nature of the transaction because these providers have no information on

whether the underlying transaction actually took place. Another comment agreed with the proposed position to know standard's reference to sufficient control or influence because it is consistent with the FATF standard, which provides that creators, owners, and operators or some other persons who “maintain control or sufficient influence” in the DeFi arrangements may fall under the FATF definition of a VASP where they are providing or actively facilitating VASP services. 2021 FATF Guidance at ¶ 67, p. 27. Several comments stated that trading front-end service providers do not have visibility into the nature of the transaction because they do not monitor whether a customer deploys, through the customer's wallet, the coded trade order instructions that they provided. One comment questioned whether a person meets this standard if the person needs to implement technological changes to be in a position to know the nature of the transaction. Several comments requested that the final regulations eliminate the position to know standard and instead only apply the ordinarily would know standard because the position to know standard would force trading front-end service providers to modify their services to comply with the final regulations. One comment explained that although some trading front-end service providers might receive contingent trade-based fees, others receive non-contingent payments for their services. For example, this comment stated that some trading front-end services provided by blockchain explorers provide services that require considerable sophistication for customers to use and, as a result, receive their compensation from sources other than these customers, such as advertising revenue, donations, or sales of blockchain data. Trading front-end service providers might alternatively receive non-contingent periodic payments under a services agreement with a DeFi governance organization, such as a foundation or decentralized autonomous organization (DAO). This comment stated that, in the case of a services agreement with a DeFi governance organization, a trading front-end service provider might collect data on protocol use (such as, the number of transactions and average transaction size) in setting its periodic fees. The comment argued that the reviewed data on the protocol is anonymized by the blockchain technology and not specific enough to the transactions undertaken pursuant to the front-end's services to provide definitive information about whether these transactions were authorized or signed by the customer and then settled on the distributed ledger. Finally, regarding the proposed rule's reference to a person's ability to change its fees in determining whether a person has sufficient control or influence over its services, one comment requested that final regulations provide more guidance regarding what is meant by fees charged.

The Treasury Department and the IRS do not agree that trading front-end service providers do not have the ability to know if a transaction for which they provided coded trade order instructions was ultimately executed and settled on the distributed ledger. As stated by the referenced comment, trading front-end service providers may receive contingent, trade-based fees as consideration for their services. To ensure that these fees are paid, trading front-end service providers include in the coded trade order instructions a direction for the requisite fee (whether withheld from the traded-away digital assets or the traded-for digital assets) to be sent to a wallet address owned by the trading front-end service provider. Because this fee will not be paid unless the customer authorizes the transaction in the customer's wallet and the transaction is settled on the distributed ledger, the receipt of these fees provides the trading front-end service provider with the information necessary to know that the transaction took place. Trading front-end service providers that receive non-contingent fees for their services also have the ability to determine whether a transaction created through their trading front-end services was carried out. For example, these providers could include in the coded trade order instructions a direction to notify the trading front-end service provider when the transaction is settled on the distributed ledger similar to the way the sender of an email can receive a read receipt. Indeed, these providers inherently have more information about the transaction than other persons searching the blockchain, so they are in a better position to obtain relevant information from the blockchain. Although these final regulations may require trading front-end service providers receiving non-contingent consideration to make changes in the coded instructions solely for the purpose of complying with these broker reporting rules, this is not different from any other broker that makes changes in their operations to comply with these broker reporting rules. Accordingly, regardless of the structure of the trading front-end service provider's compensation, trading front-end service providers maintain control or sufficient influence over the suite of services that they offer (including the coded trade order instructions) to have the ability to determine whether and the extent to which the transfer of digital assets involved in a transaction gives rise to gross proceeds.

Although trading front-end service providers should always be treated as maintaining control or sufficient influence over the suite of services that they offer (including the coded trade order instructions) to meet the position to know standard, the final regulations nevertheless have retained a modified version of the proposed position to know standard to ensure that other front-end service providers that might inadvertently be treated as providing trading front-end services under final § 1.6045-1(a)(21)(iii)(A) will not be treated as providing an effectuating service under this definition. Accordingly, pursuant to final § 1.6045-1(a)(21)(ii), a person providing a trading front-end service ordinarily would know or be in a position to know the nature of the transaction potentially giving rise to gross proceeds from a sale of digital assets if that person maintains control or sufficient influence over the trading front-end services to have the ability to determine whether and the extent to which the transfer of digital assets involved in a transaction gives rise to gross proceeds. The sufficient control or influence language used in the proposed regulations is modified to control or sufficient influence to draw from the language used in the 2021 FATF guidance.

See

2021 FATF Guidance at ¶ 67, p. 27.

Final § 1.6045-1(a)(21)(ii) also adds three examples of when a person would meet this control or sufficient influence standard. These examples are not intended to be the exclusive examples that would meet this standard. First, the section provides that a person providing trading front-end services will be considered to maintain control or sufficient influence over such services if that person has the ability to amend, update, or otherwise substantively affect the terms under which the services are provided or the manner in which the order is processed. Second, similar to the proposed regulations' reference to a person's ability to change their fees in determining whether a person has sufficient control or influence over its services, final § 1.6045-1(a)(21)(ii) provides that a person that has the ability to collect the fees charged for the trading front-end services from the transaction flow (that is, from the digital assets disposed or the digital assets received in the trade order) would be

treated as a person that maintains control or sufficient influence over the trading front-end services provided. This result would apply whether or not the person providing trading front-end services actually collects fees in this manner for its services. Third, final § 1.6045-1(a)(21)(ii) provides that a person providing trading front-end services will be considered to maintain control or sufficient influence over such services if that person has the ability, in connection with processing the order, to add to the order a sequence of instructions to query the distributed ledger to determine if the processed order is, in fact, executed or to use another method of confirmation based on information known to that person as a result of providing the trading front-end services. In contrast, a front-end service provider that provides services that enable a website to be accessed on a computer or mobile device but does not translate the customer's trade order into coded trade order instructions that can be sent to the customer's wallet for authorization would not be considered maintaining sufficient control or influence over the services provided to know the nature of the transaction. Finally, to ensure that trading front-end service providers do not take steps to artificially avoid meeting the position to know standard, final § 1.6045-1(a)(21)(ii) provides that, except as provided by the Secretary, a contractual or other restriction not required by law that limits the ability of the person providing trading front-end services to amend, update, or otherwise substantively affect the terms under which the services are provided or the manner in which the order is processed will be disregarded for purposes of determining if a person meets the position to know standard. Thus, trading front-end service providers cannot contract with their customers or with operators of digital asset trading protocols to limit their coding ability to avoid falling within the effectuating services definition.

4. Other Policy Considerations

Several comments raised policy considerations in opposing the application of the digital asset middleman rules to DeFi participants. Some of these comments focused specifically on front-end service providers while others focused on DeFi trading applications or more generally on any DeFi participant that ultimately could be made subject to these rules. Several comments noted that because DeFi participants do not have custody of the digital asset user's private keys, they are not currently subject to any comprehensive regulatory oversight, such as rules requiring the implementation of cyber-security programs, business continuity or disaster recovery programs, or comprehensive insurance policies. One comment suggested that not being required to turn over personally identifiable information (PII), including their names, addresses, and TINs, is a key reason why digital asset users engage with DeFi tools and that adding this requirement would deter these users from interacting with DeFi trading applications. One comment argued that developers of DeFi systems should not be treated as brokers because they face much steeper difficulties in setting up information collection and reporting regimes because they have historically focused on technology development rather than financial services.

The Treasury Department and the IRS do not agree that DeFi participants should be excluded from the information reporting rules under section 6045 because of a lack of financial services experience or because of a purported lack of comprehensive regulatory oversight. Persons with technology expertise that operate trades or businesses relating to financial services should comply with the same rules as any other person operating financial services businesses. Regarding the regulatory oversight comments, these final regulations concern Federal tax laws under the Internal Revenue Code only. The purported absence of regulatory oversight under any other legal regime that is outside the scope of these regulations does not govern the implementation of a provision under title 26. Therefore, the Treasury Department and the IRS are not bound to use those regimes as models in determining whether DeFi participants should be required to comply with an entirely separate set of information reporting rules under section 6045.

Several comments argued that the application of the final regulations to DeFi participants would jeopardize the security of millions of Americans' personal data because DeFi participants are too small and undercapitalized to be able to store PII safely. The Treasury Department and the IRS did not adopt this comment for the final regulations because traditional brokers, including smaller brokers, have operated for many years and have implemented their own security policies and protocols.

One comment stated that many DeFi participants are run by anonymous providers, which further increases the risk to customer PII. Another comment warned that if front-end service providers are treated as brokers under the final regulations, well-meaning front-end service providers and their customers are likely to fall victim to security breaches. This comment predicted the proliferation of “spoof” front-end service provid

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