What Are Interest-Bearing Tokens?
Interest-bearing tokens like aUSDC from Aave and cUSDC from Compound are digital receipts representing your share of a lending pool. When you deposit USDC into these protocols, you get back tokens that increase in value as interest accrues. These tokens are not just static receipts—they grow, reflecting the interest earned over time. The key point: the tokens' value increases, but the IRS has not issued explicit guidance on their tax treatment.
How Interest Accumulates on These Tokens
When you deposit USDC into Aave or Compound, your deposit begins earning interest immediately. This interest is automatically added to your deposit balance. The interest rate varies with market conditions. For example, if you deposit 10,000 USDC and the interest rate is 5% annually, after one year, your deposit's value would grow to approximately 10,500 USDC. The interest is effectively embedded in the increasing value of your aUSDC or cUSDC tokens.
When Does Interest Income Accrue for Tax Purposes?
A critical question: does interest accrue taxable income immediately, or only when you withdraw? The IRS has not issued specific rules for interest-bearing tokens. Most tax professionals agree: the interest is considered income as it accrues, similar to how traditional bank interest is taxed annually. This means that even if you don’t withdraw your aUSDC or cUSDC, the IRS expects you to report the interest income annually, based on the increase in token value.
Example: Interest Accrual and Tax Timing
Suppose you deposit $10,000 USDC into Aave on January 1. You receive aUSDC tokens in return. Over the year, your balance grows to $10,500 due to interest. Even if you don’t withdraw, the IRS considers you to have $500 of ordinary income for that year. When you eventually withdraw or sell your aUSDC, you’ll also have a capital gains calculation based on the change in value from your original basis.
Tax Treatment of Interest-Bearing Tokens
Most tax professionals agree: interest earned on aUSDC or cUSDC is taxable as ordinary income in the year it accrues. This is similar to how interest income from bank accounts is taxed. The IRS has not specifically addressed these tokens, but their stance on similar instruments suggests this approach. Software that ignores interest accrual risks underreporting income. When you sell or redeem these tokens, you'll also need to calculate capital gains based on your adjusted basis.
Common Mistakes with Interest-Bearing Tokens
❌ Ignoring interest accrual until withdrawal
Why
Many users believe they only recognize income when they cash out.
Fix
Report interest as it accrues annually, based on the increase in token value.
⚠️ Cost
Potential underpayment of taxes and IRS penalties.
❌ Not adjusting cost basis for interest
Why
People forget that the basis increases with interest earned.
Fix
Track the basis to include accrued interest when calculating capital gains.
⚠️ Cost
Incorrect gain/loss calculation, risking audit issues.
How Moonscape Handles Interest-Bearing Tokens
Moonscape automatically detects deposits of aUSDC and cUSDC, tracks the accumulation of interest over time, and updates your cost basis accordingly. When you redeem or sell, Moonscape calculates your gains, including interest earned but not yet realized. It flags interest accruals and provides detailed reports, ensuring compliance with tax rules—even in the absence of explicit IRS guidance.