Bitcoin Taxes

A Look at the Expanding Market for Dapps

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November 22, 2021
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    Bitcoin may be the most popular crypto asset by a wide margin, but DeFi, NFTs, and other applications are experiencing rapid growth. These applications are built on blockchains other than Bitcoin. They do more than provide a ledger of transactions. They facilitate everything from complex financial services to online game economies.

    Let's look at DeFi, NFTs, and the broader concept of Dapps, and why they have experienced such tremendous growth.

    Dapps have become one of the most exciting parts of the crypto industry, powering everything from DeFi to NFTs.

    What Are Dapps?

    Dapps, short for decentralized applications, are applications that run on the blockchain or other decentralized peer-to-peer networks. They operate using smart contracts that run as programs on the blockchain, specifying rules and enforcing them via code. They're a kind of digital vending machine that takes in inputs and spits out outputs.

    For example, CryptoKitties was one of the original Dapps. The game initially ran on the Ethereum blockchain where smart contracts took inputs from two cats, applied a genetic algorithm (similar to the biological one), and outputted a new cat with attributes from its parents. The new cat's genome is then stored in a non-fungible token (NFT).

    While CryptoKitties may be a fun application, there are a growing number of more practical applications. Maker, for example, is a decentralized credit platform that enables anyone to open a vault, lock in collateral, and generate Dai (a stablecoin) as a debt against that collateral that accrues interest. In essence, it's a lender without any approvals process.

    There is also a growing number of networks supporting Dapps. While Ethereum was the first-mover, Avalanche and Solana have become prevalent alternatives. Newer networks offer faster transactions and lower costs, creating more viable economics for app developers and users.

    Pros

    • Decentralized: Dapps have no central authority and don't require any intermediary to operate. Transactions don't require any trust, and users don't need to provide real-world identity.
    • Zero Downtime: Dapps are deployed to a peer-to-peer network, increasing availability and eliminating the likelihood of a denial-of-service attack on a single target.
    • Open Source: Dapps are open source, and anyone can contribute code, making them more secure and extensible. Meanwhile, smart contracts are immutable since they're on the blockchain.

    Cons

    • Usability: Dapps tend to be a challenge because users must set up specific tools to interact with the blockchain, such as a wallet that requires funding from an outside account.
    • Security: The open-source nature of Dapps makes some of them susceptible to attack if there are errors in the smart contract. In addition, insecure code is harder to update once deployed.
    • Network: Many Dapps on the same networks make them prone to congestion issues that can impact performance. The need for networks also makes the applications harder to scale.

    What's Driving Adoption?

    Dapps have become incredibly popular over the past few years. According to DeFi Pulse, there's over US$87 billion locked up in DeFi smart contracts, while NonFungible reckons that there has been over $9.5 billion worth of NFT sales over the past 52 weeks. Still, these figures represent just a fraction of the $2.7 trillion crypto market.

    Dapp Market
    The DeFi market has experienced rapid growth over the past year. Source: DeFi Pulse

    Modern Dapps include everything from collectibles to online games to financial services to online advertising. The possibilities are nearly endless when you consider the many different markets where conventional software could be improved through the removal of intermediaries and the involvement of anyone.

    Several factors will continue to drive the market:

    • Awareness: Consumers, businesses, and investors are becoming increasingly comfortable with crypto, increasing the likelihood of adopting and using Dapps for their everyday needs.
    • Performance: Ethereum's launch of ETH 2.0 and move toward a proof-of-stake mechanism could dramatically improve performance and lower cost—and other blockchains are making similar moves.
    • Security: Dapps have become more secure over time as developers close loopholes that hackers exploit. The open-source nature of Dapps means that they can quickly adapt to improve.
    • Investment: Many businesses are starting to recognize the importance of Dapps, and increasing investment in the space could help create more options and promote long-term growth.
    • New Use Cases: Dapps continue to enter new markets, expanding their growth potential. As a result, Dapps could become increasingly popular as developers target new verticals.

    Emergen Research believes that the market for Dapps reached nearly $11 billion in 2019 and could reach $368 billion by 2027, representing an astounding 56% compound annual growth rate. But the real growth depends on the rate of consumer and institutional adoption of these technologies.

    Dapp Tax Implications

    Crypto has become an enforcement priority for the IRS over the past couple of years. In addition to updating Form 1040 with a crypto question, the agency subpoenaed numerous exchanges and actively tracked down individuals it believes may be evading taxes. As a result, it has never been more critical to ensure you're correctly calculating and paying taxes.

    Since Dapps deal in cryptocurrencies, there is almost always tax implications for Dapp transactions. The IRS has made it clear that all virtual currencies are considered “property” and are therefore subject to capital gains taxes. If you purchase or receive a token that appreciates in value, you will owe tax on the appreciated amount.

    Some examples of tax liabilities include:

    • DeFi Dapps typically offer investors a yield in exchange for lending crypto or providing liquidity. As a result, the "interest" generated from these transactions is generally taxable.
    • NFT Dapps often facilitate the sale of art or collectibles. When these works are sold, they may be subject to the same collectibles tax as their counterparts in the physical world.
    • Play to Earn Games Dapps often pay crypto tokens throughout normal gameplay, which the IRS likely considers income subject to taxation like any other crypto tokens.

    The best way to keep track of crypto tax liabilities is using dedicated accounting software. For instance, ZenLedger connects with your wallets and exchanges, aggregates transactions across them, and ensures that you're paying the correct amount of tax. You also have an audit trail in place if the IRS comes looking for documentation.

    The Bottom Line

    Dapps are one of the most exciting subsets of the crypto industry—and their growth remains in the early innings. As blockchains mature and consumers become accustomed to cryptocurrencies, these applications could experience tremendous growth by supplanting existing financial services, collectibles, and other multi-billion dollar markets.

    If you're using Dapps, ZenLedger can help ensure that you're correctly computing and paying taxes each year. Sign up for a free trial today!

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    Simplifying DeFi, NFT, and Crypto Taxes for Investors and Tax Professionals

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