man holding phone with FTX logo; downfall of FTT token shown on graph

Will the next wave of FTX victims be unwitting tax cheats?

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The recent fallout of FTX not only took the Web3 industry but the whole world by surprise. This catastrophic event affected approximately 1.2 million people worldwide and might have set the industry back by several years in terms of adoption. After what happened, many consumers might have lost confidence in blockchain and cryptocurrencies, and it’s hard to blame them. 

While it is clear for Web3 natives that FTX failure is a consequence of mismanagement or potential fraud that can exist in any industry, a less expert audience might have difficulties determining the difference between code flaws and lousy administration.

Sadly, even after what happened to Celsius and Three Arrows Capital, FTX’s meltdown is one other event that hurt consumers and businesses that trusted a centralized organization to manage their assets. On a positive note, decentralized finance (DeFi) has been working well, confirming that code is typically safer than people’s judgments.

A lot has been said regarding managing risks across exchanges and self-custody, and much more will be said on how FTX didn’t handle customer money correctly, but nothing has been said about preserving your trading data.

There have been other important topics to handle, and everyone tends to address any reporting closer to the end of the tax year. The problem is, some of this crucial information might not be available anymore if a centralized exchange goes out of business and offline as a result. 

On-chain immutability and security

The beauty of blockchain technology is that all the records of any transactions are stored, forever, on an immutable and secure public ledger. All changes are recorded in an auditable way with an indisputable timestamp, ensuring that no single person or organization can tamper with the data. 

This makes it easy for anyone to follow their transactions and oversee their holdings, even across multiple wallets, and it allows users to automate their tax filing process so that they do not need to manually input each transaction into a spreadsheet or other accounting software. In addition, each transaction can be “labeled,” whether it is a swap between assets or a sale of an airdrop, and adapt it to the different tax treatments and regulations worldwide and ensure that profit or loss is treated in the correct way.

While on-chain privacy is still a priority for many protocols — with ZK technology being improved as we speak — the transparency and the composability that blockchain provides are still far superior to a centralized exchange. The combination of these features has been a game changer for the industry and, over time, it will affect and improve many of the traditional trading venues and stock exchanges.

In a utopian world, everyone holds their assets on-chain and the only custody risks are on the users themselves. The reality is that we are far from the general public being able to manage their own keys and it is understandable that many still prefer to hold their cryptocurrencies on centralized exchanges given the practical complexity of self-custody and DeFi. 

Protecting your trading data

In one way or another, the journey for any person in Web3 starts from a centralized exchange, but they have been often criticized for the opaqueness of their operations. 

While we are all aware of the risks of holding assets on centralized exchanges, our trading data are in danger as much as the tokens themselves, but sometimes we realize it only when it is too late. It is never a bad idea to keep a backup of your trading history. 

Sadly, even in a situation where the exchange shuts down, the majority of the tax authorities still want records, and users might not be able to claim losses or pay the correct amount of tax if they can’t prove their trading history. Ultimately, as taxpayers, the responsibility lies on your shoulders to ensure you remain compliant with all applicable laws and regulations when it comes to filing your taxes. 

As such, it is essential staying up-to-date with changes in local tax rules, and keeping accurate records of all transactions is one of the most important things you can do when navigating the crypto tax landscape as the legislation is still evolving.  

This, in turn, will help ensure that you receive the maximum deductions and credits available, allowing you to maximize your profits (or carry-forward losses). Additionally, some countries are starting to offer specific incentives for cryptocurrency investors who can prove the legitimacy of their trading activities. Whatever the situation may be, knowing the applicable laws and staying compliant is key to avoiding any unwanted legal or tax issues.  

Many more regulations and precise guidelines will come up after this disastrous event, especially given that Sam Bankman-Fried, the now ex-CEO of FTX, tricked many legislators into collaborating on guidelines that would have been beneficial to him.

Until then, with proper planning and accurate recordkeeping, you can benefit from a much smoother taxation experience when declaring and filing tax returns related to your crypto investments.  

As in any new industry, there are a lot of practices that we learn only when it is too late. The cascade of events can be comparable to a “2008 moment” for the Web3 industry but with bad actors being washed away, the future is looking brighter.

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