How Crypto Investors Are Using ‘Wash Trading’

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To say that the crypto market has taken a hit in 2022 would be the biggest understatement of the year. Unfortunately for crypto investors, this has resulted in huge losses and crushed confidence in the space.

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However, there is a strategy that some people use at the end of the year offsets some of these losses: Washing trade.

The Internal Revenue Service’s wash-sale rule prevents investors from claiming losses on securities acquired within 30 days of selling at a loss — preventing taxpayers from using “artificial” losses to offset their gains and reduce their capital gains tax liability.

While the wash-sale rule may apply to the crypto industry in the future, for now it doesn’t — and Loss compensation is possible for investors through this strategy.

Crypto is not considered an equity

In fact, the IRS says that virtual currency is considered property for federal tax purposes.

According to the IRS, “the general tax principles that apply to property transactions apply to transactions that use virtual currency.” Therefore, crypto shares are not subject to the rules.

“Until the regulations come in, the wash-sale rules don’t apply to crypto,” says Nick Reilly, part of the expert community with social crypto platform and market Earnity. “So, because of the recent bear market we’ve experienced in the space, there’s an opportunity for many investors to realize their losses and use them to offset current — and future — capital gains.”

Reilly explained the steps: First, sell your losing positions, which “realize” the loss for tax purposes.

“You can do whatever you want with the proceeds, like buy back the same token or invest in something else,” he said. “Document the transaction accurately, when you first bought the token and eventually sold it. Report the losses – and possible gains – using tax form 8949. Note: You can do this step using crypto tax software.”

To put things in context, as of December 19, the global crypto market cap was $807.81 billion — a far cry from the $3 trillion it reached in November 2021, according to CoinMarketCap data. Bitcoin — the largest crypto by market cap — hovered around $17,700 on December 19, a brutal 74.3% drop from its all-time high of $68,790 in November 2021.

The wash-selling strategy is a unique characteristic of crypto markets and provides a silver lining during tough markets, said portfolio manager Jackson Wood. Independence Day Solutions and a community specialist at Ernity.

“Losses realized in crypto can also be used to offset gains in other asset classes, such as real estate, stock market investing,” Wood said. “Intelligent investors should grasp this unique opportunity. When used properly, [it] It can be a useful tactic in portfolio and asset management.”

Regulation favored by some

While this is indeed a silver lining for investors, some experts believe it reflects the usual lack of clarity for the space — as many try to avoid future failures.

“Unfortunately, many crypto-related parties use wash trading as a popular way to harvest their tax losses. Until the law changes, there is no reason for this type of tax loss harvesting to occur,” said Sologenic co-founder Bob Ross. “With more regulatory clarity, perhaps wash Trading is more about the rules of stocks. But until then, unfortunately, it’s legal, so people will do it. The sooner crypto’s Wild West days end, the sooner the industry will mature and grow.

Additionally, wash trading applies to NFTs, said co-founder and CEO Ganesh Swamy Covalent“It’s not the best part of our industry,” he said.

“But if there are clear regulations and better data coverage for the industry, wash trade will not be a problem,” said Swamy. “Finally, it’s legal, so what do you expect? Tradfi [traditional finance] Equity traders would do the same if it weren’t so easy to find. So of course this happens in crypto – it’s legal, it’s easy to cover your tracks, and tax software makes wash trading more efficient because it’s more accurate.

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The views and opinions expressed herein are those of the author and those of Nasdaq, Inc.

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