As the holiday season wrapped up and we approached New Year’s, the IRS took action during the final days of the Biden administration that many in the crypto community had been dreading. They finalized what’s known as the Broker Rule. This new regulation mandates that all crypto exchanges, whether they handle traditional-to-crypto or crypto-to-crypto transactions and regardless of whether they are custodial or non-custodial, must ensure their users comply with Know-Your-Customer (KYC) protocols.
Under this rule, simply having control over funds is no longer necessary for the IRS to classify a service as a broker. This impacts developers working on “DeFi front-end services,” requiring them to report user trading through the 1099 tax form. The regulation covers developers who create any online interface elements that facilitate trading of digital assets through unhosted wallets.
The IRS’s stance is that these developers exert a certain degree of “control” over these services. This perspective aligns with the Financial Action Task Force (FATF)’s guidelines, which classify developers of these user interfaces as Virtual Asset Service Providers. Such a designation means they must adhere to anti-money laundering and counter-financing of terrorism regulations.
Much like what FATF outlines, the IRS’s definition of control includes the ability to modify the terms under which services are delivered, as well as the ability to collect fees from transactions—even if they aren’t actively doing so. If developers can confirm transactions on a distributed ledger or provide trading front-end services, that also counts as exerting control.
Given this sweeping reach, the industry responded quickly. Immediately after the rule was published, the Blockchain Association launched a lawsuit against the IRS and the Treasury Department. They implore the courts to invalidate the rule, arguing it breaches the Constitution and existing federal laws.
Parallel to the lawsuit, Senator Ted Cruz introduced a resolution with backing from several fellow senators, including Cynthia Lummis, aiming to oppose the IRS’s rule through Congress. Cruz criticized the regulation for undermining DeFi’s core purpose: facilitating free trade in digital assets. Representative Corey joined Cruz in this effort, labeling the rule as blatant overreach.
In a recent Senate vote, the resolution received strong backing with a 70-27 outcome and is now set to be voted on in the House.
The broker rule is seen as part of the Biden administration’s aim to exert more control over non-custodial services. The Department of Justice has similarly argued in cases against Samourai Developers and Tornado Cash developers that controlling funds isn’t necessary for liability under money service business classifications. They assert that developing these interfaces demonstrates sufficient control to warrant regulation.
While overturning the broker rule would be a win for the industry, the outcomes of these prosecutions could set similar precedents for reporting duties of non-custodial providers.
To reinforce that these providers shouldn’t be classified as money service businesses, Representative Tom Emmer has introduced the Blockchain Regulatory Certainty Act in Congress, aiming to offer strong protections for developers.
This piece is contributed by L0la L33tz. The views expressed are exclusively those of the author and do not necessarily align with BTC Inc or Bitcoin Magazine’s positions.
