One rising phenomenon behind cryptocurrency related projects is a crypto swap. A crypto swap occurs when one cryptocurrency is deprecated in exchange for a replacement. Unlike a cryptocurrency-to-cryptocurrency trade (e.g. bitcoin for ether) which is clearly a taxable event per IRS A15, a cryptocurrency swap (e.g. single collateral SAI for multi-collateral DAI) is a unique type of transaction without clear IRS guidance. In this post, we will discuss what token swaps are and the relevant tax implications.
What Are Token Swaps?
Token swap is a process by which one concurrency is exchanged for another at a predetermined rate. Swaps occur because the underlying blockchain that supports the coin is being changed; holders have to take some actions to get access to the new token. When you go through a token swap, the old tokens are discarded and you get new tokens in place for the old ones. Note that coin swaps are tangibly different compared to crypto-to-crypto trades because the coin being traded is discarded in favor of a replacement.
Some exchanges automatically handle token swaps for users so it is completely invisible to the user. More often than not, however, users have to take some action to send in their old tokens to receive the replacement token/coin. This is the case if you hold tokens on your own wallet.
In 2018, taxpayers who owned the token VEN, had to go through a token swap. The predetermined conversion rate was 1:100. So, after the swap, each single unit of VEN was replaced with 100 units of VET.
Let’s assume Eduardo has 100 VEN. He sends his VEN balance in for a swap. VEN is discarded, and he receives 10,000 (100 x 100) VET in return. If Eduardo fails to properly perform the swap, he will lose access to the legacy token, whose blockchain may have stopped operating
Token Swap Taxation
Although there is no direct tax code governing token swaps, it is reasonable to think that guidance related to stock splits apply to token swaps. According to the IRS, a stock split occurs when a company creates additional shares, thus reducing the price per share.
If you own stock that has split and now own additional shares, you must adjust your basis per share or per the lots of the stock you own. If the old shares of stock and the new shares are uniform and identical, then:
- Allocate the basis of the old shares to the old and new shares
- Determine the per share basis by dividing the adjusted basis of the old stock by the number of shares of old and new stock
Thus, stock splits are not taxable events. However, they do affect cost basis for a shareholder. Applying this logic to token swaps, new coins resulting from token swaps do not create a taxable event. However, it is crucial that you allocate the basis among the new coins and start tracking them properly. Figuring out the cost basis and distributing them among the new coins can be tricky after you go through a coin swap.
Continuing with the example above, let’s assume the cost basis of Eduardo’s 100 VEN is $5,000. This means that the cost basis per unit of VEN is $50 ($5,000 / 100). After the swap, the total basis of Eduardo’s 10,000 VET remains the same. However, the cost basis per unit of VET goes down to $0.50 ($5,000/ 10,000).
In summary, token swaps do not lead to a taxable event. However, keeping a good record of the basis of new coins is crucial in calculating capital gains/losses when you dispose of them in the future.
Other Examples of Token Swaps
There are several token swaps that have occured in the cryptocurrency space. Here is a non-exhaustive list of some examples:
- EOS (ERC-20 token) → EOS (coin)
- KIN (ERC-20 token) → KIN (coin)
- BNB (ERC-20 token) → BNB (coin)
- Single Collateral DAI (SAI) → Multi Collateral DAI (DAI)
- Maker Vaults earning interest
- DAI → CSAI (Compound)
- RPX → PHX
- SJCX → STORJ
- PAC 1,000:1 conversion
- Shadow Cash → Particl