Cardano has a lot going for it, but mind your taxes 

7 December 2023

Crypto projects come and go. Some derive temporary value from the hype created by public investors and speculators. Others might attempt to solve real-world issues, such as Third World countries’ lack of payment infrastructure.  Blockchain technology has the potential to better a country’s monetary system.  However, developers at the forefront of innovation will face challenges along the way.  A project that has undoubtedly introduced significant progress in this regard is Cardano.

The question regarding the method of taxing various transactions on this platform reveals many nuances about how the blockchain platform functions.  With crypto tax regulations changing at lightning speed, the individual trader would do well to stay on top of these developments.          

What Cardano brings to the table

The Cardano team has identified some common issues in the crypto space that may impede a project’s ability to enhance financial prosperity and welfare.     

Scalability

As Cardano founder Charles Hoskinson points out, the goal is to have a network that speeds up as more users become involved, as opposed to slowing down as users increase. Their solution to scalability problems consists of epochs, which divide up those entities that validate blocks on the blockchain. Here, nodes (essentially computers that belong to those entities running the blockchain) act as slot leaders that ensure validation.  This activity carried out by the nodes offers increased scope for scalability. 

Interoperability

The exchange between fiat currencies is best used as an example to explain the concept of interoperability.  How frustrating would it have been if there were no mechanism to exchange between euros and dollars? The same goes for exchanging Ethereum for Cardano without intermediaries. Cardano addresses the interoperability problem in the crypto context with their well-known KMZ sidechains protocol mechanism. Users can quickly move between Cardano and other cryptocurrencies that use different blockchains by allowing information transfer from one blockchain to another. 

Sustainability

Finally, there is the issue of sustainability. Suppose a network can continue improving without compromising its foundational infrastructure. To achieve this, Cardano established a treasury that collects fees and continues to pay these out to individuals who help improve the ecosystem’s network.    

The blockchain, decentralization, and Cardano

Decentralization in the crypto and blockchain context refers to the distribution of power and control across a network where no central authority calls the shots on transaction execution. Indeed, scalability, interoperability, and sustainability give a crypto project such as Cardano the edge over the inefficiencies of the traditional financial system. These three characteristics help the project achieve a higher degree of decentralization. It also facilitates the mitigation of monetary inefficiencies.  Leveraging blockchain technology offers poorer communities a better chance of accessing financial services without facing detrimental barriers to entry.    

Indeed, scalability, interoperability, and sustainability give a crypto project such as Cardano the edge over the inefficiencies of the traditional financial system.

Addressing Cardano’s Crypto Tax Challenges

Do most of your crypto holdings comprise assets built on the Cardano ecosystem? If so, there are several potential hurdles to overcome regarding crypto tax reporting.  From a crypto tax specialist’s perspective, these are the issues that require meticulous attention: 

Differentiating between a stake key and a wallet address

Cardano addresses contain two sets of information: a payment address and a staking address. You are likely familiar with a payment address used to receive, store, and send crypto assets. On the other hand, a staking address contains the staking pool activity and rewards associated with the payment address.  When handling Cardano DeFi, it is essential to consider both these addresses.  For instance, failure to account for staking rewards could drastically reduce your taxable income, resulting in an understated tax liability.  

Missing asset market values 

Asset market values misreported by crypto tax software or missing altogether necessitate intervention. Rectifying this issue may include implementing scripts to pull the market value data from a relevant price-tracking website.  The acquisition cost of an asset is derived from the asset’s market value when it is received.  Assets will only carry the correct cost basis if their market values are correct.  Otherwise, the result will likely lead to inaccurate capital gains, leaving you with an unnecessarily hefty tax bill.       

Non-fungible tokens  

Non-fungible tokens (NFTs) are tricky to account for accurately in a crypto tax context, as reporting software may not detect the NFTs that you own.  It also applies to NFTs purchased on the Cardano network. Therefore, you need a technical expert who knows where and how to pull the data to prevent any of your treasured Chilled Kongs from going off the radar. 

Accurate reporting of NFTs also links back to the importance of correct market values. If the right market value is to be obtained for NFTs purchased with obscure assets, this value needs to be pulled from a market price data source.  If not, the NFT will carry an incorrect cost basis, and the gain realized may be too high or too low.

The acquisition cost of an asset is derived from the asset’s market value when it is received.  Assets will only carry the correct cost basis if their market values are correct.  Otherwise, the result will likely lead to inaccurate capital gains, leaving you with an unnecessarily hefty tax bill.    

Takeaways

No doubt, Cardano brings a lot to the table. Yet, for its innovation and associated benefits to be sustainable in the long run, ongoing user tax compliance is vital for the industry’s development. Meeting all tax obligations will be an essential catalyst for the future legitimacy of crypto and blockchain technology.    

 

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