The tax implications of different crypto investment strategies can be categorized into – crypto trading, HODLing, dollar-cost averaging and crypto passive income sources, like staking, yield farming, lending, etc. While the first three will generally trigger capital gain taxes, crypto passive income activities will attract income taxes.
In this guide, we will dive into all four and explain their tax implications, along with all their nuances and intricacies.
The Basics of Crypto Taxes
Crypto taxes can get really complicated once you get into its nitty-gritty, i.e., claiming losses, DeFi taxes, airdrops and hard forks, etc. Plus, some countries, like India, Japan, Slovenia, and a few others, have unique crypto tax laws that don’t fit well with the common crypto taxation framework.
Fortunately, we have in-depth crypto tax guides for virtually every country that you can check out to dive deeper. But for the purpose of this article, here is a gist of how crypto taxes work in most countries:
In most countries, including the US, Canada, Australia, Spain, and more, crypto is considered a property (or some version of it) for tax purposes.
Therefore, every time you sell, swap, spend, or dispose of your crypto, you become liable for capital gain taxes, assuming you make a profit (selling price > cost basis). Similarly, if you receive crypto as a form of payment or income for selling your products or services, you become liable for ordinary income taxes.
What are the Different Strategies to Invest in Crypto?
There are many different crypto investing strategies, but we can roughly classify them into the following four categories: crypto trading, HODLing, dollar-cost averaging and crypto passive income sources, i.e., staking, yield farming, lending, etc.
Crypto Trading: Crypto trading involves actively buying and selling crypto with the goal of generating profits from short-term price fluctuations. Traders utilize various strategies, such as technical analysis and reading charts and market trends, to make informed trading decisions.
Check out our guide on different trading strategies, where we discuss the pros and cons for each strategy in depth.
HODLing: HODLing, meaning “hold on to dear life”, refers to a long-term investment strategy where, as the name suggests, investors hold onto their crypto to capitalize on the potential long-term growth, ignoring the short-term price fluctuations. As you can imagine, this strategy requires a lot of patience and conviction in the potential of selected cryptocurrencies.
According to a Glasssnode report, more people have held on to their Bitcoin for longer than a year than ever before.
Dollar-Cost Averaging (DCA): DCA involves investing a fixed amount of money at regular intervals, regardless of the crypto’s price. With this strategy, investors purchase more crypto when prices are low and less when prices are high. It’s a nice healthy balance between trading and HODLing, mitigating the impact of short-term market volatility and the need to accurately time the market.
Crypto Passive Income: Investors can participate in activities like staking, where they lock up their crypto to become a validator and receive rewards, yield farming, where they provide liquidity to DEXs to earn interest or rewards and lending platforms that allow investors to lend their crypto and earn interest on their holdings.
Taxes on Crypto Trading
As per the basics of crypto taxes, selling crypto is considered a disposal event. Therefore, capital gains taxes on realized gains. However, most countries have varying capital gain tax rates for short-term gains and long-term gains (usually the former being higher).
Since in crypto trading, you’re buying and selling crypto within minutes, hours, days, and sometimes weeks, if you’re swing trading, you will almost always pay a higher tax rate than someone holding their digital assets for more than a year.
Moreover, when you’re trading daily or weekly, the sheer volume of transactions can quickly become overwhelming, leading to potential difficulties in accurately reporting gains and losses.
Crypto traders and active investors should consider using specialized crypto tax tools like Bitcoin.Tax to simplify and ensure accurate tax reporting. These tools automatically collect transaction data from exchanges and wallets, consolidating all trading activity in one place.
Taxes on HODLing
Taxes on HODLing your crypto assets is pretty straightforward – you pay capital gains taxes if you realize a profit, or you can claim your losses to deduct other gains.
Usually, when referring to HODLing, we assume it’s holding a crypto asset for at least more than a year. Therefore, unlike crypto trading, you will be liable to a much lower, long-term capital gain tax rate when HODLing your crypto. In some countries, like Germany, there are no taxes on long-term gains at all.
Taxes on Dollar-Cost Averaging
Depending on when you sell your crypto asset when employing the dollar cost averaging strategy, you will be liable to the same long-term or short-term capital gains tax rates.
Dollar-cost averaging is not much different than crypto trading and HODLing in terms of the nature of the transactions. In other words, you’re still buying and selling (disposing of) your crypto. The only difference is the time interval.
Check out our guide on crypto dollar-cost averaging, where we explain how it works and its tax implications in depth.
Taxes on Crypto Passive Income: Staking, Lending or Yield Farming
Individually, staking, lending and yield farming can get quite complicated. However, in most countries, rewards and interests earned from these activities are generally considered taxable income, and therefore subjected to income taxes.
While most countries don’t have any clear guidelines on crypto staking taxation, they do have frameworks for taxing crypto mining rewards. Based on that, we can infer that staking rewards are subject to the same taxes as mining rewards – income tax rates, as both are consensus mechanisms to validate transactions in blockchain networks.
Yield farming and liquidity mining can get even more complex, with different tax implications for providing and withdrawing liquidity to DEXs based on different platforms. We’ve discussed the complications and loopholes in the current framework for taxing these rewards in depth here.
Lastly, we have lending rewards, and they are pretty straightforward. We have a complete guide on crypto loans and lending you can check out, but to quickly summarize – lending your crypto assets and earning interest or rewards on them is the same as depositing money in your bank account and earning interest on them. Both attract income taxes.
The primary challenge with crypto passive income taxes is reporting obligations, which can get tricky once you introduce DeFi and multiple exchanges and wallets. But as we mentioned before, Bitcoin.Tax can solve that problem.
What is the Best Crypto Investing Strategy to Maximize Tax Savings?
It’s clear that HODLing is the best crypto investing strategy to maximize tax savings. However, a better question to ask would be – should you really plan your investment strategy with the primary goal of tax savings?
While it’s tempting to focus on tax savings when planning your crypto investment strategy, you can’t let it be your sole goal.
Doing this will cause you to overlook other crucial factors, such as long-term viability, diversification and alignment with your overall financial goals. Moreover, it can lead to imbalanced risk-return ratios, limited investment opportunities and a failure to adapt to evolving tax regulations.
Rather than fixating on immediate tax benefits, take a holistic approach that considers thorough research, risk management and a long-term perspective. Remember, investing is about achieving your financial goals. So, strike a balance between optimizing taxes and profitable investment decisions when assessing the tax implications of different crypto investment strategies.
Now that you know the tax implications of different crypto investment strategies, you can go ahead and choose the one, or even more than one, that best suits your goals, how much capital you can invest and other contextual and situational factors. But keep in mind, tax-savings should never be your primary goal or concern when choosing the best crypto investing strategy.