Crypto Staking Regulation
Learn about the regulations surrounding crypto staking to help decide whether it's a worthy investment.
Cryptocurrency staking refers to the practice of locking up digital assets for rewards. The purpose of locking up the assets can vary significantly from one network or protocol to another. Generally, staking provides investors with an opportunity to earn passive income.
The concept of staking is still relatively new, like virtual currency and blockchain technology. Due to this factor, most financial regulators worldwide have not developed regulations to guide it.
Despite a lack of uniform staking regulations worldwide, financial authorities in some countries have already developed laws to regulate staking within their territories. This article examines existing staking regulations in different parts of the world.
Staking Rules in the United States
The U.S. is generally one of the world's leaders in technological innovations. This nation is also known for making appropriate laws to guide new industries. However, as far as crypto staking is concerned, financial regulators there have not made much headway.
Similar to the approach authorities have taken with proof of work mining, no federal laws prohibit staking. Similarly, there are no established laws that permit it.
State governments in the U.S. that regulate mining focus primarily on the form of energy used for mining. Since staking doesn't require much energy consumption, regulators have not paid much attention to it.
However, the monetary value of the cryptocurrency industry is starting to attract the attention of relevant authorities, which means more regulations are forthcoming. Likely, there will soon be comprehensive laws on staking. The recent Bi-Partisan cryptocurrency bill from the U.S. Senate is an example.
The Tax Treatment of Staking Rewards in the U.S.
Where regulators in the US appear to have made some headway is in the tax treatment of crypto staking rewards. In 2014, the Internal Revenue Service issued a policy statement saying that existing general tax principles would apply to virtual currency.
This means that the exchange or sale of convertible virtual currency or its use as payment for real-world transactions will have tax implications for federal tax purposes.
The IRS stated in the FAQ for the policy that any rewards from crypto mining will result in a taxable event.
In the IRS's view, mining is a business or trade, and tokens created through mining should be taxed based on their fair market value. This makes them subject to ordinary income tax and self-employment tax.
Although the policy statement is only guidance rather than a law, it has informed the IRS tax collection approach for all crypto enterprises, including staking. It means that staking rewards are taxed immediately at creation since they are considered income.
Crypto Experts' Views on Staking Rewards Taxation
Many in the crypto industry have disagreed with the U.S. approach to tax treatment for staking rewards. In their view, staking rewards are created property and should be taxed on the gains realized from selling it rather than its value at the time of receipt.
This view falls in line with the Internal Revenue Code. Many also believe it solves several problems that come with taxing at receipt. For example, virtual currencies are volatile, which makes it difficult to determine the exact value of staking rewards at the time of receipt.
Experts believe staking rewards do not qualify as income. They have created property in the same way crops, raw minerals, paintings, etc., are created property. Staking as an activity requires locking digital assets in a smart contract and validating transactions. This applies to at least staking on a proof of stake consensus mechanism, if not other forms of staking.
While it doesn't require as much computing power as proof of work mining, staking is still similar. Validators, like miners, create new cryptocurrencies by verifying transactions. No individual or entity is issuing the tokens as rewards, and the issuance is not recorded on any ledger. So, it is hard to classify staking rewards as income.
Jarretts v. United States
The controversy on when new tokens created from staking become taxable was highlighted in the Jarrett v. United States case. In 2019, Joshua and Jessica Jarrett made 8,876 Tezos tokens (XTZ) as staking rewards. It was worth $9,407 at the time, and they reported it as income and paid taxes on it.
However, they filed an amended tax return in 2020, asking for a tax refund of $3,793. The Jarretts later filed a complaint on May 21, 2021, where they asserted that the new tokens being Jarrett's creation were taxable only at the point of sale.
They argued that tokens earned from their staking enterprise are similar to a cake by a baker and a book by a writer. In the same way, their creation will not be taxed until they sell it; they also staked Tezos tokens on the public blockchain using their computing power.
The U.S. Department of Justice directed the IRS to refund the tax, which amounted to $4,001.83 with interest. The Jarretts rejected the IRS's refund offer, claiming the tax authorities did not give a reason for the refund.
Such a reason would have created a precedent for other individual stakers and staking enterprises in the future. Instead of accepting the refund, they decided to pursue the case in court.
The case has generated widespread interest for obvious reasons. It shows taxpayers' need for clear guidance on the tax treatment of staking rewards. The move by the IRS to settle the case also raises the possibility that the Jarretts might have had a chance of setting a precedent.
So far, the DOJ has filed a motion to dismiss in February 2022 on mootness grounds, stating that there is no issue remaining to settle. The case shows the possibility of taxing tokens earned from staking after the sale. The case is in the United States District Court for the Middle District of Tennessee, and the court has set the bench trial for March 2023.
Until the court decides on the case or the IRS issues further guidance, the general tax reporting requirement for your staking income is to file for taxes at the time of receipt.
Staking Rules in Europe
Unlike the U.S., the European Union already has a law on cryptocurrency. The Markets in Crypto-Assets (MiCA) regulation is set to become effective in 2024, and it will cover several aspects of cryptocurrency, including crypto mining. But the law does not make any provision for crypto staking.
This means that staking in Europe is the same as in the US. It is neither prohibited nor permitted. However, there might be concrete laws on crypto staking soon.
European Central Bank President Christine Lagarde recently discussed the need to regulate staking. She recommended a follow-up to MiCA to focus on regulating crypto asset staking and lending.
Crypto Staking Regulations and Taxation of Staking Rewards in Australia
Australia does not have any laws on crypto mining or staking. Financial regulators in the country have adopted a non-interventionist approach toward the industry. However, the government treats cryptocurrency as property and taxes it.
Virtual currencies in Australia are subject to capital gains tax. According to the Australian Taxation Office, staking tokens is similar to earning ordinary income.
Thus, stakers have to pay tax on the money value of the tokens at the time of receipt. Crypto stakers in that country must then add the staking reward money value to their other sources of income and pay ordinary income tax on it.
Crypto traders who decide to sell their staking rewards trigger a capital gains event. In such situations, traders must pay capital gains tax on the profit from selling the staking rewards.
Crypto Staking Regulations and Taxation of Staking Rewards in the United Kingdom
There are no specific laws regulating crypto staking in the United Kingdom, but the country has tax guidance. Her Majesty's Revenue and Customs (HMRC) issued guidance on the taxation of crypto staking revenue. The HMRC states that it will depend on whether the staking returns are revenue or capital.
According to the regulator, stake returns are revenue if the reward was agreed upon during staking. Alternatively, it will be capital if the stake returns are uncertain and speculative.
Other factors that affect the classification include whether the return was periodic and whether the return came from the disposal of capital assets, in which case it would be subject to capital gains tax. Additionally, the nature of the staking reward determines whether you will pay income or capital gains tax.
Crypto Staking Safety
Although staking offers numerous rewards, investors in that sector must consider the risks before opting for this investment option. Significant threats associated with crypto staking include:
Proof of stake networks reward validators for staking their tokens and verifying new blocks. However, these networks can also punish them for being inactive or malicious behavior.
The essence of this is to discourage such destructive behavior. The slashing differs from one network to another. It could be losing a percentage of the stake, the whole stake, or temporary or permanent removal of the validator from the network.
Cryptocurrency markets work based on considerable speculation, which means all tokens are volatile. Since staking requires locking up tokens, the cryptocurrency’s price might fall during the staking period. The amount of the staked tokens and reward might be lower after the lockup period expires.
Rug Pulls & Exploits
This is usually common with DeFi staking. Rug pulls occur when developers behind a project steal all the funds. Exploits involve hackers taking advantage of vulnerabilities in the protocol. Both can lead to the loss of staked assets.
Read this guide to learn more about crypto staking safety.
Crypto Staking Insurance
Due to the lack of regulations in the crypto staking space and the inherent risks, the need to insure against those risks has become paramount. As a result, several decentralized finance protocols have developed specific insurance products for crypto stakers.
Most of these products focus on slashing the most likely risk for validators on a proof of stake blockchain network. DeFi insurance platforms such as Unslashed and Nexus Mutual offer slashing insurance, ensuring that validators are secured against the risk of slashing, which is highly likely.
Furthermore, those who stake with centralized staking enterprises such as a crypto exchange or any of the "Stake as a Service" (StaaS) operators usually have insurance on their deposits.
Since there is no law regulating the sector, investors have to be cautious and might not be able to get a full refund if they lose their stake due to one risk or the other.
Learn more about crypto staking insurance.
In most countries, regulations for crypto staking are still under development. This means there are few or no established legal principles to tackle crypto staking. It is, therefore, important to consider the rules in your jurisdiction before you start staking your assets.
If cryptocurrencies are illegal in your country, then crypto staking will likely be illegal too. If it is permissible, you must note the tax rules on crypto staking rewards. This is usually what most regulators focus on.
We must clearly state that this article is for general information only and does not amount to tax or legal advice. Therefore, it is important to consult experts such as tax advisors when crypto staking to know the applicable law in your jurisdiction. In some cases, it is advisable to act cautiously by paying the tax first and then asking for a refund rather than refusing to pay the staking taxes.