The use case for Stablecoins and Altcoins to reduce friction and taxes when using DApps.
Anyone familiar with cryptocurrency or cryptoassets knows that decentralized apps known as dapps are the hip new trend, but how many people are actually using them? The perceived simplicity of many dapps combined with the large amount of friction involved in using them means that only early adopters have bothered to dip their toes into many of these communities. This article will explore how stablecoins and altcoins can help reduce these issues by lowering unnecessary taxes and avoiding the volatility of cryptocurrency prices when you just want to use an app.
Simply put a stablecoin is a cryptocurrency whose value is meant to be stable and not fluctuate wildly as many other cryptocurrencies do. This is a simplified explanation, but is defined enough for the purpose of this article. There are various types of stablecoins including ones pegged to the value of the US Dollar and others that are backed by collateral such as other cryptocurrencies or precious metals. Stablecoins are usually seen as a tool for traders but they can also fill a role in the evolving dapp ecosystem that will make using dapps easier to use, especially for people who live in countries where crypto is not taxed as currency.
The price of a cryptocurrency such as BTC or ETH when you decide to sell or spend it is likely to have changed relative to the price you purchased it at. Stablecoins change this dynamic by being pegged to a value that is unlikely to change over time. This allows you to trade from cryptocurrencies or fiat currency into a stablecoin and back, without having to cash out through an exchange into fiat.
No! The traditional narrative surrounding stablecoins is that they are for traders and nothing else, but this is very far from the truth. Stablecoins also have a very strong use case for regular users of dapps, but taking advantage of this use case today is easier said than done, especially in the USA, due to one simple fact of life – TAXES.
The biggest hurdle for dapp users today when considering the use of stablecoins is actually the fact that most cryptocurrency enthusiasts and dapp users have at least a small supply of Ethereum(ETH) that they are holding at any one time. Since many dapps are currently resting on the Ethereum blockchain, ETH is used to fuel most transactions that occur on dapps today. This is an issue when you consider that the tax laws in many countries default to what is known as a FIFO(First in First out) method where the first cryptocurrency you purchase within a given year is also the first coins that are considered sold when you make a transaction. Since stablecoins are usually traded back into ETH before being used within a dapp, they usually cause more friction and fail at preventing the user from incurring capital gain taxes.
The issue rears its ugly head when the price of ETH has increased between the time you first began to hold any amount of ETH and the time at which you make your transactions within the dapp. Since the FIFO method considers that you have sold your initial holding first, it causes a tax burden on the user each and every time they decide to make a transaction regardless of whether they were holding ETH or holding a stablecoin.
Some savvy users attempt to avoid this burden by always purchasing the amount of ETH they are going to spend with fiat immediately prior to the purchase, allowing them to claim a LIFO(Last in First out) method on their taxes by claiming they are selling the ETH that they had just purchased moments before to make the transaction. At least in the USA, it is unknown if this will be considered legal by the IRS. For this reason, It is not suggested that anyone currently use this workaround. If you do use this method ensure you use a separate wallet for these type of transactions so you are able to prove that you always act in the same manner when making your purchases. If it were proven that this method was in fact accepted by the IRS, then it would probably be the easiest way to avoid large capital gains.
The name of the game for a dapp user is finding a way to make transactions in their dapps without using a currency that has increased in price throughout the year. There are really only a few solutions currently that avoid this issue and all of them have their own issues.
Let’s explore the first and least feasible option which is to never hold any ETH. If you purchase ETH only at the time you plan to use it by purchasing it using fiat, you will always be spending the ETH that you just acquired to make the purchase, thus incurring zero capital gains. In other words if you use your dollars to purchase crypto and then immediately spend that crypto for your trade or purchase, you will avoid capital gains as long as you do not hold any additional amount of that particular cryptocurrency before you make the purchase. This is obviously hard to do when ETH is the native currency for most dapps and is also a currency many users hold in their speculation portfolio.
The second solution is much more realistic but relies on the developers of dapps to start accepting stablecoins as payment methods when purchasing Non Fungible Tokens (cryptocollectibles). If you are interacting with a dapp that accepts a stablecoin then as a user you are able to purchase stablecoins using ETH, fiat, or another crypto and then use that bag of stablecoins only to purchase NFT’s or perform transactions within dapps. Since the price of the stablecoin should not change over time you will not need to worry as much about capital gains taxes. Obviously, this still does not avoid capital gains caused by gas fees from creating transactions. dapp developers can allow transactions to run off-chain or at least limit the amount and cost of transactions on the blockchain to help alleviate this issue.
A third alternative, although even harder to pull off, is to hold a bag of stablecoins and then trade those stablecoins for a different altcoin that you have not held throughout the year and use that to make the purchase. As long as the stablecoins price does not fluctuate and the dapps you use allow you to make purchases using altcoins you don't hold on a regular basis ,you should not have a large capital gains tax, if any, for your purchases. This method relies on dapp developer providing a myriad of purchase options which is something that is becoming more prevalent with market leaders such as Axie Infinity.
One way to avoid this issue altogether is to not spend your cryptocurrencies from within dapps and instead to buy things using fiat. A small number of dapps, including Axie Infinity, allow users to purchase items such as land using fiat, which completely avoids this problem. Although it seems counter intuitive, having strong fiat on-ramps for users is necessary for adoption and for reducing the headache involved with getting into this space.
The solution that I think most of the community is currently exercising is avoiding dapps altogether. There were very few people who filed cryptocurrency tax returns last year in the USA and that trend is likely to continue into this year as the complications involved in using your cryptocurrency as actual currency have not gotten any easier. The reality of the situation is that most users are waiting on the sidelines until a clearer path is paved for them to follow.
DApp developers have a lot of power when it comes to avoiding this issue for their users. All of the following methods would help:
Yes. I previously wrote an article exploring how to use Bitcoin.Tax to complete your crypto taxes, yet as a regular user of dapps filing my return was still a huge hassle. The suggestion by many to go see a tax professional will only get you so far when these issues are barely explored past a surface level within the community. Many people don’t see these issues because they feel no dapps have adoption or feel that the issues lie with adoption itself and not with how we are designing these products. I do not see this issue as being as prevalent on other chains that may not have fees so I see a future where dapps from all blockchains see adoption, but I do not see that happening until we can find a way for users to interact with dapps without worrying about the tax implications.
Everything I presented here is my personal experience and opinion about taxes in the USA and is in no way tax advice. If you have any suggestions or comments please feel free to leave them below.
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