Are Wrapped Tokens Taxed?

What are wrapped tokens?

A wrapped token is a cryptocurrency token pegged to the value of another cryptocurrency token. Why are they described as ‘wrapped’, you may ask? Essentially, the original asset is put in a metaphorical, digital wrapping which then allows the wrapped token to be used on a blockchain other than the one it originally existed on. You can think of wrapped tokens as similar to stable-coins, in that their value is pegged to an existing asset. Where stable-coins are pegged to traditional currencies like USD though, wrapped tokens are pegged to existing cryptocurrencies.

The benefit of wrapped tokens is that you can use your existing assets to interact with different blockchains. Is your portfolio heavily weighted in Bitcoin, but you also want to dive into the world of the Ethereum blockchain network? With wrapped tokens, you can ‘wrap’ your existing Bitcoin to create wBTC, which is then able to be used on Ethereum. Interoperability for the win!

How do wrapped tokens work?

For a wrapped token to exist, it needs a ‘custodian’. A custodian in this situation is an entity that holds an equivalent amount of the asset as the wrapped amount - e.g. a merchant, a multi-sig wallet, or a DAO that holds 100 BTC as well as 100wBTC. The process goes as follows: someone requests 2 BTC in return for 2 wBTC via a merchant. The merchant interacts with the custodian, who then mints 2 wBTC on the Ethereum blockchain. These 2 minted wBTC are then sent to the requester’s wallet. Note: this process might be different depending on the chain you’re requesting wrapped tokens from.

I wrapped a token, will I be taxed?

Wrapped tokens are a relatively new phenomenon, and as such, most taxation bodies haven’t yet delivered clear guidelines on how to handle them for tax purposes.

As a result of this lack of guidelines, you generally have two options:

The conservative approach:

In the conservative approach, you would treat any transactions where tokens are wrapped as crypto to crypto swaps. In most jurisdictions, this would then constitute a capital gains tax event.

The aggressive approach:

In the aggressive approach, you would argue that because of the lack of guidelines available from your tax regulatory body, wrapping a token is the equivalent of holding the same asset. You would argue that, as a result, this doesn’t constitute a disposal event, and as such, you wouldn’t incur capital gains tax.

We recommend that you work with a local tax professional to decide what approach is best for your personal circumstances.

Can I claim a capital loss on a wrapped token?

You’ve wrapped a token, but the token has depreciated in value since the time of receipt - can you claim this depreciation as a capital loss? If you go with the conservative approach outlined above, then you would be able to. This is because you would be accepting the tax liabilities of wrapping the token as a capital gains tax event, regardless of whether the value goes up or down.

What about fees for wrapping tokens?

In some cases, you may have to pay a transaction fee for wrapping a token. Once again, if you choose to proceed with the conservative approach outlined above, you may be able to add any related fees to your cost basis when calculating any capital gains and/or losses made on the wrapped token. We recommend that you work with a local tax professional to determine what would, or would not be, reportable.

So, what next?

As Summ (formerly Crypto Tax Calculator) leans towards the conservative approach (though you can re-categorize these transactions as ‘swaps’ if suitable to your personal circumstances), in-app wrapped token transactions will be auto-categorized as CGT events. Once you import the data source that includes your wrapped token events, these will be brought into the platform and attributed to any capital gains and/or losses accrued.

We recommend that you work with your local tax professional to see if this categorization applies to your individual circumstances.