crypto tax

What Happens to Your Tax When a Crypto Empire Falls?

Disclaimer This article is for general information purposes only and isn’t intended to be financial product advice. You should always obtain your own independent advice before making any financial decisions. The Chainsaw and its contributors aren’t liable for any decisions based on this content.

“I’m sorry… I fucked up” are not the words you expect to hear from a billionaire crypto-exchange CEO. Sam Bankman-Fried, aka Sam Bankman-F*cked, the former CEO of FTX and founder of quantitative trading firm Alameda Research, posted a 22-tweet thread to his Twitter followers almost a month ago following the halt of withdrawals on FTX.

Rewind to just a few days before, the crypto world was coasting along in relative tranquility, enjoying a small move upwards into November. The fallout caused by the collapse of Terra, Celsius and Voyager earlier in the year was finally clearing, or so it seemed.

Today, we’ll revisit the FTX debacle and contemplate the implication of what it means from a tax perspective to those unfortunate FTX users who fell prey to the fraud. 

Sam Bankman-Fried – the generous, scrappy-looking ‘wunderkind’ who turned out to be a fraud. Source: NYT

A fateful day

November 2nd 2022, a day now noted in the history books, arose after it emerged that Alameda Research and FTX were in a precarious position. In short, it was established that much of Alameda’s balance sheet consisted of FTX’s native exchange token FTT. Subsequent actions taken by rival Binance soon caused a cascade of events, dumping the price of the FTT token.

This led to a classic bank run on FTX as users began to frantically withdraw their funds from the exchange. After only around US$4.5 billion of funds had been withdrawn, FTX stopped processing withdrawals, leaving around US$10 billion in user assets locked on the platform.

After several days, a failed acquisition by Binance and multiple failed bailout attempts, it was looking increasingly likely that user funds on FTX may be irretrievable. Chinese crypto-mogul and founder of TRON, Justin Sun, stepped in and offered to back any user deposits for TRON native tokens. Seeing an opportunity to withdraw funds, users flocked to swap their tokens to any TRC-20 token, briefly driving the price of TRON almost 50x above market value. Some users went ahead and withdrew their Sun-backed token, but due to the price discrepancies between FTX and other markets, they faced an immediate 80-95% loss on their withdrawal.

FTX has since filed for bankruptcy, suffered an alleged hack for almost US$1 billion in user funds and is now being investigated by the Bahamian Government for criminal misconduct. There’s a never-ending stream of updates on a daily basis and we’ve yet to see the end. In the interim, a ton of bizarre revelations have emerged. 

Something most FTX users haven’t probably considered – crypto tax

Beyond the immediate and obvious fact that FTX users can’t recover their deposits, there are other important considerations they must consider. The end of the fiscal year is looming for many jurisdictions worldwide, so if there is no resolution by year-end, those affected will need to consider how they handle this situation for tax purposes.

There are many unknown scenarios that may unfold in the future. It is unclear whether depositors will ever get back some or all of their funds, so claiming the funds as a loss may be difficult for the time being.

 “We don’t know when you can claim a tax loss for the crypto you held on FTX and likely won’t get back. Some people will claim it when FTX entered bankruptcy and insolvency processes, others will wait until things progress. The ATO hasn’t published any guidance on FTX or similar nuclear crypto events this year.”

Harrison Dell, crypto tax lawyer, Cadena Legal

If an individual did decide to claim the funds as lost for this financial year but were then able to access them again in the next financial year, would they need to amend their tax submission or would it be counted as a zero-cost basis asset? 

It is important to note that an individual may decide to claim a capital loss once FTX went into bankruptcy. If funds or your crypto are recovered in the future, the capital loss may be reduced and in some cases may cause a capital gain depending on how the payment is made. Really, this is one where you need to speak with your tax advisor about your own circumstances.

At present it isn’t clear whether users will be able to recover a cent of their deposits from the FTX collapse, and even if they do, it is likely to be in the very distant future. At the time of writing, Sam Bankman-Fried hasn’t even been arrested or subpoenaed to appear before Congress. 

In the interim, for those crypto investors who were unfortunate to have their funds locked on FTX, how they choose to deal with the tax implications is ultimately determined by the advice of their tax advisor who would take into account the individual’s personal circumstances.

At present, there are simply no clear cut answers, however much that may be desired by all parties concerned. 

Revenge traders – beware of crypto tax

Shortly after the FTX calamity, a trend emerged on crypto Twitter, with FTX users who had funds locked on the FTX platform engaged in ‘revenge trading’ on the platform with their locked funds. The trend was started off the back of a long-time rumour that Alameda would take the opposing side of user trades on the FTX platform. FTX traders took high-leverage short positions in many FTX and Alameda-endorsed tokens, profiting massively as the FTX empire crumbled.

Of course, these profits remain locked on the FTX platform and remain unable to be withdrawn unless converted to a TRON native token. For now, the only reward is the post engagement when the infamous FTX trade profit and loss card is shared on Twitter.

While it may be tempting to join the trend and say “fuck SBF!”, in this situation, traders should be wary of triggering taxable events that may impact their tax outcomes for this fiscal year.

Dumping your whole portfolio on FTX into a token with liquidity out of FTX may cause problems as the prices on FTX compared to the market were very wrong. On the other hand, if the funds were never recoverable it’s really just monopoly money. Users should focus on getting value out first and tax should be a factor but not the main driver – most will have heavy losses for the 2023 income year.

For those who decided to take the Justin Sun bailout, as previously mentioned, it meant taking an immediate 80-95% loss. For some, the loss was worth taking if it meant being able to withdraw their funds. The only positive of this approach is that a capital loss has potentially been realised, which may allow investors to reduce capital gains made throughout the tax year.

What FTX users should do

For all intents and purposes, FTX is defunct. 

For users who have capital remaining on the FTX platform, the CSV reports of past trading, deposit and withdrawal activities will become invaluable in the future. Although there have been reports that the FTX site is compromised, it is up to you to decide whether it is worth running the risk to access these reports if you have not done so already. Not only are they important for retaining the records of your past trading activity, but they will also help prove losses for deposits that are unrecoverable.

 “Not having the information you need for tax preparation is a huge risk on an already big loss. Technically you must keep records of the cost base of assets to claim a tax loss, and without the records, you can’t claim it. Companies, trusts and SMSFs have even tighter records keeping requirements for claiming losses. The ATO may be lenient on this or perhaps the administrators will help you, but easiest to get it yourself”.

Harrison Dell, crypto tax lawyer, Cadena Legal

It is worth researching how your local jurisdiction treats lost, stolen or hacked crypto holdings. This may help you come to a more informed decision on how to treat your FTX balances.

Another potential avenue is to leverage a  crypto tax calculator software such as CryptoTaxCalculator which helps users affected by the FTX implosion by recording and categorising all FTX transactions.

If user deposits are truly lost forever, those affected will need to record their lost crypto for this year’s tax return. Keeping records of all activities on the FTX platform will go a long way in ensuring that the calculations for your taxes are correct moving forward.

It is unknown how far the FTX and Alameda contagion will spread. There have been many  casualties along the way and there’s surely more to come. For those with funds stored on centralised exchanges, it may be time to consider self-custody wallets for storing funds to avoid getting trapped on an insolvent exchange. 

Of course, this has its own risks, but it may just help avoid getting Sam Bankman-F*cked again in the future.

Harrison Dell
Harrison is the founder and director of Cadena Legal. He advises across all Australian taxes, commercial law and international taxes with a strong focus on crypto assets and technology businesses. Harrison’s client base includes wealthy individuals and family offices, venture studios, top technology businesses, blockchain projects, DAOs, crypto exchanges and general innovators in technology.
Patrick McGimpsey
Patrick McGimpsey is a freelance writer who is passionate about crypto and the world’s financial landscape. Currently studying economics at the University of Sydney, Patrick has previously covered the crypto industry for Canstar, and has contributed blogs and guides to CryptoTaxCalcuator. Patrick has over 7 years’ experience trading and investing in crypto and previously worked in the AML and fraud departments of Australian financial institutions.