The Tax Implications of Wrapping Crypto: Challenges and Alternatives
As the crypto space matures, investors continue to explore new ways to maximise the utility and efficiency of their digital assets. One common practice is wrapping crypto tokens, a process that converts a native cryptocurrency into a compatible version for use on another blockchain. However, this seemingly simple action can come with unexpected tax consequences, leaving many investors wondering: is there a better way?
Why Do Individuals Wrap Crypto Assets?
Wrapping crypto assets is primarily driven by the need for interoperability and increased functionality. A well-known example is Wrapped Bitcoin (WBTC), which allows Bitcoin to be used on the Ethereum network. Similarly, Wrapped Ethereum (WETH) enables ETH to function in decentralised applications (dApps) that require ERC-20 token compatibility.
Here’s why investors choose to wrap their assets:
Cross-Chain Utility: Many DeFi applications are built on Ethereum, and Bitcoin, as a non-Ethereum-based asset, cannot be used directly. Wrapping BTC as WBTC allows investors to participate in DeFi protocols, such as lending, borrowing, or yield farming.
Improved Liquidity: Wrapped assets can be traded on decentralised exchanges (DEXs), providing deeper liquidity and reducing slippage.
Smart Contract Compatibility: Ethereum’s smart contracts require assets to follow the ERC-20 token standard. Wrapping ETH as WETH allows it to be seamlessly integrated into DeFi applications.
However, despite the benefits, wrapping tokens often leads to an unintended taxable event.
The Tax Consequences of Wrapping Tokens
In many jurisdictions, tax authorities treat the wrapping of crypto assets as a taxable event because it involves exchanging one asset for another. This is similar to trading Bitcoin for Ethereum—if the original asset has appreciated in value since its purchase, the investor may owe capital gains tax upon conversion.
For example, if an individual originally purchased 1 ETH for $1,000 and it is now worth $3,000 when they wrap it into WETH, tax authorities may consider this a realisation of a $2,000 capital gain, even though the investor still holds effectively the same asset in a different form.
What Is the Alternative?
For investors looking to avoid immediate tax consequences while still accessing DeFi opportunities, there are apparent alternative strategies:
Using DeFi Solutions Like GVNR – Instead of wrapping BTC to use it on Ethereum-based DeFi platforms, investors can leverage solutions like GVNR, which enables smart contract functionality directly on the Bitcoin blockchain. Unlike wrapped assets that require conversion to another blockchain's token standard, GVNR could allow users to control their Bitcoin while engaging in decentralised finance activities. This means BTC holders can access on-chain liquidity, structured yield opportunities, and financial instruments without relinquishing custody or triggering taxable events.
More details can be found in GVNR Documentation.
Tokenised Representations Through Custodial Solutions – Instead of wrapping, some custodial services offer tokenised representations of assets that may not be classified as taxable trades. However, this depends on tax jurisdiction interpretations.
Using Cross-Chain Bridges (Not Recommended) – While cross-chain bridges are an option for moving assets between blockchains, they come with significant risks, including security vulnerabilities, smart contract exploits, and potential regulatory concerns. We do not recommend bridging assets, as detailed in our article on bridge risks.
Earning Yield on High-Value Assets Like BTC Without Tax Issues
Investors seeking yield on high-value assets while avoiding taxable events from wrapping have several alternative strategies:
Bitcoin and Ethereum Lending Platforms – Platforms like Ledn, BlockFi (before its collapse), or Aave (if BTC and ETH markets exist) allow investors to lend assets like Bitcoin and Ethereum to earn interest without needing to wrap them.
Staking or Liquid Staking Solutions – While traditional BTC staking isn't possible, solutions like Staking BTC on Stacks (STX) allow users to earn Bitcoin rewards. Ethereum holders can also participate in liquid staking protocols like Lido or Rocket Pool, earning staking rewards while retaining liquidity.
DeFi Yield Aggregators – Some DeFi protocols support yield generation on multiple assets, including stablecoins (USDC, DAI), Ethereum, and Layer 2 tokens without requiring conversion into wrapped versions.
Structured Financial Products – Investors looking for risk-adjusted returns can explore structured products that offer yield on high-value assets like BTC, ETH, and even real-world assets (RWAs) like tokenised treasury bills or bonds.
Final Thoughts
While wrapping tokens is a useful tool for crypto investors, it comes with unintended tax consequences that may not be immediately obvious. By exploring alternative DeFi solutions, GVNR, and secure financial instruments, investors can seek to maximise the value of their assets while minimising tax liabilities.
Disclaimer:
The information provided by GVNR is for informational purposes only and should not be considered financial, investment, or legal advice. GVNR makes no guarantees regarding accuracy or reliability.
NFA & DYOR: Nothing shared is financial advice. Always conduct your own research and consult a professional before making decisions. GVNR is not liable for any losses or outcomes resulting from actions taken based on this content.