Table of Links Abstract and 1. Introduction Abstract and 1. Introduction Bitcoin and the Blockchain 2.1 The Origins 2.2 Bitcoin in a nutshell 2.3 Basic Concepts Crypto Exchanges Source of Value of crypto assets and Bootstrapping Initial Coin Offerings Airdrops Ethereum 7.1 Proof-of-Stake based consensus in Ethereum 7.2 Smart Contracts 7.3 Tokens 7.4 Non-Fungible Tokens Decentralized Finance and 8.1 MakerDAO 8.2 Uniswap 8.3 Taxable events in DeFi ecosystem 8.4 Maximal Extractable Value (MEV) on Ethereum Decentralized Autonomous Organizations - DAOs 9.1 Legal Entity Status of DAOs 9.2 Taxation issues of DAOs International Cooperation and Exchange of Information 10.1 FATF Standards on VAs and VASPs 10.2 Crypto-Asset Reporting Framework 10.3 Need for Global Public Digital Infrastructure 10.4 The Challenge of Anonymity Enhancing Crypto Assets Conclusion and References Bitcoin and the Blockchain 2.1 The Origins 2.2 Bitcoin in a nutshell 2.3 Basic Concepts Bitcoin and the Blockchain 2.1 The Origins 2.1 The Origins 2.2 Bitcoin in a nutshell 2.2 Bitcoin in a nutshell 2.3 Basic Concepts 2.3 Basic Concepts Crypto Exchanges Crypto Exchanges Crypto Exchanges Source of Value of crypto assets and Bootstrapping Source of Value of crypto assets and Bootstrapping Source of Value of crypto assets and Bootstrapping Initial Coin Offerings Initial Coin Offerings Initial Coin Offerings Airdrops Airdrops Airdrops Ethereum 7.1 Proof-of-Stake based consensus in Ethereum 7.2 Smart Contracts 7.3 Tokens 7.4 Non-Fungible Tokens Ethereum Ethereum 7.1 Proof-of-Stake based consensus in Ethereum 7.1 Proof-of-Stake based consensus in Ethereum 7.2 Smart Contracts 7.2 Smart Contracts 7.3 Tokens 7.3 Tokens 7.4 Non-Fungible Tokens 7.4 Non-Fungible Tokens Decentralized Finance and 8.1 MakerDAO 8.2 Uniswap 8.3 Taxable events in DeFi ecosystem 8.4 Maximal Extractable Value (MEV) on Ethereum Decentralized Finance and 8.1 MakerDAO Decentralized Finance and 8.1 MakerDAO 8.2 Uniswap 8.2 Uniswap 8.3 Taxable events in DeFi ecosystem 8.3 Taxable events in DeFi ecosystem 8.4 Maximal Extractable Value (MEV) on Ethereum 8.4 Maximal Extractable Value (MEV) on Ethereum Decentralized Autonomous Organizations - DAOs 9.1 Legal Entity Status of DAOs 9.2 Taxation issues of DAOs Decentralized Autonomous Organizations - DAOs Decentralized Autonomous Organizations - DAOs 9.1 Legal Entity Status of DAOs 9.1 Legal Entity Status of DAOs 9.2 Taxation issues of DAOs 9.2 Taxation issues of DAOs International Cooperation and Exchange of Information 10.1 FATF Standards on VAs and VASPs 10.2 Crypto-Asset Reporting Framework 10.3 Need for Global Public Digital Infrastructure 10.4 The Challenge of Anonymity Enhancing Crypto Assets International Cooperation and Exchange of Information International Cooperation and Exchange of Information 10.1 FATF Standards on VAs and VASPs 10.1 FATF Standards on VAs and VASPs 10.2 Crypto-Asset Reporting Framework 10.2 Crypto-Asset Reporting Framework 10.3 Need for Global Public Digital Infrastructure 10.3 Need for Global Public Digital Infrastructure 10.4 The Challenge of Anonymity Enhancing Crypto Assets 10.4 The Challenge of Anonymity Enhancing Crypto Assets Conclusion and References Conclusion and References Conclusion and References 3. Crypto Exchanges The Bitcoin Blockchain allows users to transact 24x7 using wallet software which facilitate signing and broadcasting transactions to be included in blocks that get added to the Bitcoin Blockchain. However, Bitcoin owners also have two other fundamental requirements of being able to convert fiat currency into crypto assets and vice versa, as well as exchanging one crypto asset into another. The crypto exchanges provide these facilities and many more to the owners of crypto assets. In this ecosystem the exchanges can be divided into two categories, centralized and decentralized exchanges. The major differences between them are: The wallets provided by crypto asset exchanges are known as custodial wallets as the keys contained the wallet are in the custody of the crypto exchanges. The users access their accounts and authorize transactions using a PIN or a password which the exchange executes locally or on the blockchain, on behalf of the user, charging a fee. Some of the other facilities provided by the exchanges are: i) Liquidity: Due to the participation of market makers, the crypto exchanges can provide liquidity to the markets. It enables facilitation of trades as enough number of buyers/sellers are present at any given point through facilities like margin trading. ii) Derivatives: Products like Futures and Options based on the underlying crypto assets are offered by exchanges. iii) Passive Income: By providing services like liquidity to exchanges, staking crypto assets in proof-of-stake consensus mechanism, loans, and yield farming[64], many crypto exchanges allow users to earn passive income on their crypto assets. Many centralized and decentralized exchanges offer such services and in the latter case they form a part of Decentralized Finance (DeFi) which is an emerging area in crypto asset ecosystem and warrants an in-depth discussion as a part of a separate paper. Besides centralized and decentralized exchanges there are also some peer-to-peer trading platforms like LocalBitcoins and Paxful which list various individual suppliers of crypto assets who provide quotes and acceptable volumes of trade. The suppliers specify methods like credit card payments, bank transfers, gift cards etc. for paying for crypto assets like Tether, Bitcoin or Ethereum. These platforms provide escrow service which minimizes the counter party risk and the seller transfers the crypto assets to the buyer once the receipt of the payment by the seller is confirmed. As the sellers on such platforms are persons who might be neither registered as crypto asset traders nor regulated, they can be potentially used by taxpayers to evade their due taxes on their crypto asset transactions. However, to comply to AML/CFT laws and regulations such services have verification levels depending on the types of transactions being undertaken by the user. For example, LocalBitcoins has 4 verification tiers in which the most basic level captures information regarding Full Name, Country of Residence, Email address and Phone number65 of the user. This can enable tax administrations and other law enforcement agencies to gather information regarding such transactions in their jurisdiction. Many centralized crypto exchanges execute trades based on order matching and get their liquidity from market makers and margin trading facility. As the transaction costs of recording the transactions on the blockchain are high, the centralized exchanges execute transactions by passing accounting entries in their own accounts of crypto assets or accounts of other users maintained with them. This off-chain nature of transactions enables faster processing times and greater scalability compared to on-chain transactions, which must be validated and confirmed by the blockchain network. For example, if Alice buys 0.1 BTC from a centralized exchange, the exchange might debit its own BTC account by 0.1 and credit 0.1 BTC to Alice’s account in the form of an accounting entry. The exchange may also match the sell order of Bob against the buy order of Alice and debit Bob’s BTC account by 0.1 BTC and credit 0.1 BTC to Alice’s account. The exchange would also credit the fiat currency value of 0.1 BTC to Bob’s fiat currency funds and debit the equivalent amount from Alice’s fiat currency funds kept with the exchange. Usually, the transactions undertaken on a centralized exchange cannot be traced on the blockchain except when the funds are transferred in the form of crypto assets from one exchange to another by the user, or to/from any other non-custodial wallet addresses outside the exchange. Similarly, some exchanges may utilize on-chain settlement mechanisms for certain types of trades or transactions to provide greater transparency and security. However, most trading activities on centralized exchanges are conducted off-chain to optimize performance and scalability, albeit at the expense of decentralization and trustless nature inherent to blockchain technology. The management of user keys also differs between centralized exchanges and decentralized exchanges. In centralized exchanges, users typically do not have direct control over their private keys, which are used to sign transactions and authorize the transfer of funds. Instead, users rely on the exchange to manage their keys on their behalf, with the exchange holding custody of the keys associated with user accounts. This centralized custody model introduces counterparty risk, as users must trust the exchange to safeguard their assets and manage their keys securely. However, some exchanges offer additional security features such as two-factor authentication and cold storage to mitigate this risk. The exchange charges a service fee for this transaction and is liable to pay VAT/Service Tax/GST on it. It is also the case that the service fee can be paid in the form of another crypto asset (which is native to the exchange or freely tradable) at a discount. This makes the transaction equivalent of buying a service in exchange of crypto assets and may be taxed accordingly. Author: (1) Arindam Misra. Author: Author: (1) Arindam Misra. This paper is available on arxiv under CC BY 4.0 DEED license. This paper is available on arxiv under CC BY 4.0 DEED license. available on arxiv available on arxiv A form of platform arbitrage where users staking or lending their Crypto Assets move their assets between platforms that give the highest yield/return. https://localbitcoins.com/guides/verification-guide A form of platform arbitrage where users staking or lending their Crypto Assets move their assets between platforms that give the highest yield/return. A form of platform arbitrage where users staking or lending their Crypto Assets move their assets between platforms that give the highest yield/return. https://localbitcoins.com/guides/verification-guide https://localbitcoins.com/guides/verification-guide https://localbitcoins.com/guides/verification-guide
