What Are Rebase Tokens & How Are They Taxed?

You've probably heard of rebase tokens, like Ampleforth or Olympus, because of their spectacular potential returns. For instance, Olympus offers a 468% APY with $266 million in total value. However, before investing in these projects, it's a good idea to take the time to understand how they operate and the potential risks.

Let's take a look at how rebase tokens work, whether they're a good investment, and what taxes you might owe.

Rebase tokens have become extremely popular due to their lofty APYs, but are they good investments?

What Are Rebase Tokens?

Rebase, or elastic, tokens are cryptocurrencies that automatically adjust supply levels to maintain a constant value. For example, Ampleforth (AMPL) is an uncollateralized synthetic commodity that rebases every 24 hours to achieve a target price of USD$1.00. Many rebase tokens have stablecoin-like properties but don't maintain a reserve.

The goal is to create a non-dilutive cryptocurrency token with an elastic supply, addressing a key shortcoming of both Bitcoin and U.S. dollars. As a result, rebase tokens could become excellent sources of collateral for decentralized finance (DeFi) protocols that currently rely on mercenary liquidity providers (resulting in very unpredictable liquidity).

Critics argue that rebase tokens are Ponzi schemes that reward early investors at the expense of later investors. Moreover, if new investment stops, the entire system could collapse since the smart contract only affects supply (not prices). Indeed, there have already been several instances of crashes in rebase token ecosystems.

How Do Rebase Tokens Work?

Rebase tokens are similar to stablecoins in that they aim to maintain a peg to a certain value, such as USD$1.00. While algorithmic stablecoins buy and sell tokens using a reserve to maintain a peg, rebase tokens adjust supply levels by automatically burning tokens in circulation or minting new tokens. However, the overall value remains the same for token holders.

For instance, suppose that you purchase 1 AMPL for USD$1.00 and the price increases to USD$2.00. The Ampleforth protocol will increase the supply of AMPLs and you'll end up with 2 AMPLs worth USD$1.00 each. If the price of AMPL falls to USD$0.50, you would end up with 0.5 AMPLs worth $0.50 as the price of 1 AMPL reverts back to USD$1.00.

Rebase token ecosystems incentivize on-chain liquidity using staking and liquidity pools. For instance, Ampleforth's Geyser program enables anyone to stake their LP tokens on Geyser and receive AMPL tokens as rewards. Early-stage projects have offered extremely high APYs to build liquidity, further stirring accusations of a Ponzi scheme.

Making Money with Rebase Tokens

Rebase tokens are similar to other cryptocurrencies in that their value increases or decreases. But unlike other tokens, the increase and decrease in value come from a changing supply rather than a changing price. As a result, crypto traders and investors should look at the tokens' market capitalization rather than their price to assess performance.

The two largest rebase token projects are Olympus and Ampleforth. Olympus has a market capitalization of $330 million, according to CoinGecko, whereas Ampleforth’s market capitalization stands at about $70 million. In total, rebase tokens have an aggregate market capitalization of about $700 million.

Some other popular rebase token projects include:

• Temple
• Wonderland
• Klima
• Snowbank
• Redacted Cartel

Aside from investing directly in rebase tokens, rebase token liquidity pools offer attractive APYs. You can stake a cryptocurrency, like Ethereum, and receive reward tokens over time. By providing liquidity to decentralized exchanges or other parties, these token ecosystems generate income for their treasury that's distributed to its stakers.

How Rebase Tokens Are Taxed

Crypto traders and investors participating in rebase token economies may experience several different taxation events, including both ordinary income and capital gains taxes.

First, you must report any capital gains when converting a stablecoin or other cryptocurrency into a rebase token. For instance, if you're up 100% in Ethereum and sell USD$1,000 worth of ETH to buy USD$1,000 worth of rebase tokens, you will owe a tax on your USD$500 ETH profit even though you never sold the ETH or cash.

Second, any income that you generate from staking is taxed as ordinary income based on its fair market value in dollars. The IRS has not clarified whether staking rewards are counted as income when received or when they're redeemed. As a result, you must choose between a "conservative" or "aggressive" approach to paying taxes.

And third, you owe capital gains tax on any appreciation in these rewards between the time you receive it and sell it for another cryptocurrency or cash. If your rewards depreciate in value from the time you received them, you still owe ordinary income tax on the original amount, but you can write off the loss against your other capital gains or some income.

Finally, it’s worth noting that your capital gains tax rate depends on your tax bracket and the holding time. If you hold a cryptocurrency for less than one year, you owe short-term capital gains taxes equivalent to your ordinary income tax bracket. As a result, increasing your holding times can significantly reduce your tax rate for capital gains.

ZenLedger is the easiest way to track your transactions across different protocols and wallets. By automatically aggregating data, the platform computes the information necessary to complete IRS Schedule 1, IRS Schedule D, IRS Form 8949, and other forms. You can also download your entire transaction history across wallets and exchanges.

The Bottom Line

Rebase tokens are a hot trend in the DeFi world, but there are some caveats to keep in mind. In particular, investing in these tokens involves a high level of risk and could generate several tax events. You should understand these risks before buying and selling rebase tokens or participating in staking programs.

If you need help keeping your crypto taxes organized, ZenLedger provides the most comprehensive platform to aggregate your transactions across wallets and exchanges, compute your capital gain or loss, and pre-fill the IRS forms you need to file. You can even integrate with TurboTax and find opportunities to save with tax-loss harvesting tools.

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