The cryptocurrency market has been highly volatile for the past several years. In fact, it is one of the most volatile non-derivative financial assets on the market. The value of a Bitcoin, for example, may change by more than 10% on a day due to a single tweet by Elon Musk. Stablecoins, on the other hand, have gained serious traction thanks to their stability. It is a particular type of cryptocurrency that is “pegged” to a more stable reserve asset such as fiat currencies or precious metals. Since stablecoins allow cryptocurrency markets to maintain ample liquidity without having cash on hand, they have become integral to the functioning of global crypto markets. In fact, 70% of Bitcoin trades are now conducted by Tether (USDT) which is the most popular stablecoin. The Tether supply has exploded to 78 billion in circulation and rising and about 95% of which was issued since early 2020. Tether is a cryptocurrency that is hosted on the Ethereum blockchain with tokens issued by Tether Limited, which in turn is controlled by the owners of Bitfinex.
While, according to its 2021 settlement with the New York Attorney General Letitia James, “Tether represents to users that any holder of tethers can redeem them from Tether the company at the rate of one tether for one U.S. dollar”, Tether Limited as of 2017 stated that owners of tethers have no contractual right, other legal claims, or guarantee that tethers will or can be redeemed or exchanged for dollars. On 30 April 2019, Tether Limited’s lawyer claimed that each tether was backed by $0.74 in cash and cash equivalents. In May 2021, Tether published a report showing that only 2.9% of Tether was backed by cash, with over 65% backed by commercial paper including loans to affiliated companies, notably Bitfinex.
How Stablecoins Work
Unlike Bitcoin and Ethereum that are often held as long-term investments, stablecoins are designed for use on a daily basis to foster wide acceptance of virtual currencies. Due to their steady value, stablecoins are likely not to increase in value over time. There are several different types of stablecoins tied to the asset by which they are backed. Fiat-backed stablecoins are probably the most popular type as their intrinsic value is tied to a fiat currency. The examples include Tether (USDT) or USD Coin (USDC). Asset-backed stablecoins usually require the users to put up a physical asset such as gold, silver or other cryptocurrency as collateral before they receive the stablecoins. Since these stablecoins tend to be centralized, many investors find these not appealing. There is also one type of stablecoins that are not backed by any asset at all which is why they are sometimes named as non-collateral stablecoins. A computer algorithm will control price fluctuations by either increasing or decreasing the supply of coins. These stablecoins are often distributed by startup blockchain networks as incentives to market a newly-created coin.
How Stablecoins Are Taxed
Although there have been no administrative guidelines from the Canada Revenue Agency (CRA) regarding stablecoins, they are typically viewed as an asset in the majority of the world. Therefore, dispositions of stablecoins may be subject to income tax or capital gains tax depending on the type of transactions that occurred.
- Issuance and Redemption of Stablecoins
Generally speaking, when a user acquires stablecoins by paying fiat currency, this exchange should not be a taxable event since it is merely a conversion of fiat currency into digital currency. By the same token, issuance of stablecoins backed by precious metals should also not be taxable. However, the acquisition amount will determine the cost of the stablecoins.
When stablecoins are redeemed, they are simply being converted back to the fiat currency or physical assets that are used to back them up. Since one stablecoin usually equals to a fixed amount of fiat currency or precious metals due to its stable nature, there should be no gain or loss from such redemption. Therefore, there is generally no tax arising as a result of any redemption. However, if there is a difference between the amount of fiat currency received on sale of stablecoins and the cost, there will be either a gain or loss. If there is a gain, the CRA may consider it as business income or capital gain. There is no bright-line test on how to characterize such earnings and each case is decided on facts. Therefore, it’s highly recommended to consult with an experienced Canadian tax lawyer to analyze the tax consequences of the transactions.
- Exchange cryptocurrency with stablecoins
If you trade cryptocurrency such as Bitcoin or Ethereum for stablecoins, the transaction is usually considered a taxable event. Again, whether the gain is considered as business income or capital gain depends on the facts of each case Thanks to the stable nature of stablecoins, sometimes you may end up paying zero tax since there is no gain or loss as a result of the conversion. Let’s use the following example to illustrate:
Suppose you have 1 BTC that you acquired for $US50,000. Since the market has been really volatile so you decide to convert your 1 BTC into USDT (a stablecoin). On the day of conversion, the fair market value of 1 BTC is $55,000, therefore you will realize capital gain or income inclusion of $5,000 (55,000 – 50000) and this conversion is a taxable event.
- Receiving stablecoin as a payment
When stablecoins are received as payment for your goods or services, you should report the payment as income and any coin-to-coin conversions are generally taxable events .However, simply transferring stablecoins between your wallets is not considered a taxable event. Certain cryptocurrency platforms also allow users to earn interest in stablecoins and you should report these interests as income as well.
Pro Tax Tips – Keep records of your transactions
The income you get from disposing of stablecoins may be considered either business income or a capital gain and you must report it correctly. The CRA has made it clear that taxpayers have a responsibility to keep records of all transactions up to 6 years from the end of the last tax year they relate to. Therefore, it is recommended that a taxpayer should develop the habit of exporting transaction history from trading platforms periodically. Failure to report any profit from dispositions of stablecoins may be considered as tax evasion which is a crime. Fortunately, the CRA’s voluntary disclosure program(VDP) is designed to be a second chance for a taxpayer to crrect his previous errors or disclose information not previously reported. However, the CRA is not required to accept all VDP applications and it is highly recommended to consult with an experienced Canadian tax lawyer to maximize your change of voluntary disclosure acceptance.
"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."