Investing in cryptocurrencies comes with significant risk. You could lose all the money you invest. Please read our risk warning here.
Cryptocurrency staking refers to the practice of locking up digital assets for rewards. The reason why assets are locked up can be very different from one network or protocol to the next. 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. Because of this, most financial regulators around the world have not made rules to guide it.
Even though there aren't any rules about staking that are the same everywhere, financial authorities in some countries have already made laws to regulate staking in their own countries. 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 have not made much headway.
Similar to how authorities handle "proof of work" in mining, there are no federal laws that say you can't stake. 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 haven't paid much attention to it.
But the value of the cryptocurrency industry is starting to get the attention of the right people, which means that more rules are on the way. 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, sale, or use of virtual currency that can be turned into real money or used as payment for real-world transactions will have tax consequences for the federal government.
In the Frequently Asked Questions about the policy, the IRS said that any rewards from crypto mining will be 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.
Even though the policy statement is not a law, it has helped the IRS figure out how to collect taxes for all crypto businesses, including staking. It means that since staking rewards are considered income, they are taxed as soon as they are made.
Crypto Experts' Views on Staking Rewards Taxation
Many people in the crypto industry don't agree with how the U.S. treats staking rewards when it comes to taxes. They believe that staking rewards are property that should be taxed based on the profits made when sold rather than the value they had when given.
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, the value of virtual currencies changes all the time, which makes it hard to know the exact value of staked rewards when they are given.
Experts believe staking rewards do not qualify as income. They have created property in the same way crops, raw minerals, paintings, etc., have created property. For staking, digital assets must be locked in a smart contract, and transactions must be checked. 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 one or thing is giving out tokens as rewards, and the giving out of tokens is not recorded anywhere. So, it is hard to classify staking rewards as income.
Jarretts v. United States
The controversy over when new tokens created from staking become taxable was highlighted in the Jarrett v. United States case. In 2019, Joshua and Jessica Jarrett earned 8,876 Tezos (XTZ) as 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. Later, on May 21, 2021, the Jarretts filed a complaint in which they claimed that the Jarrett-made new tokens were only subject to tax at the point of sale.
They made the case that the tokens they earned from their staking business were comparable to cakes made by bakers and books written by writers. 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 told the IRS to give back the tax, which, with interest, came to $4,001.83. The Jarretts turned down the IRS's offer to give them a refund because they said the government didn't explain why they were giving the money back.
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 the case on the grounds of mootness in February 2022. This means there is no longer a problem to be resolved. 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 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 go into effect in 2024. It will cover many aspects of cryptocurrency, including cryptocurrency 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 may be concrete laws on crypto staking in the near future.
European Central Bank President Christine Lagarde recently discussed the need to regulate staking. She suggested that MiCA hold a follow-up meeting to talk about how to regulate the staking and lending of crypto assets.
Crypto Staking Regulations and Taxation of Staking Rewards in Australia
Australia does not have any laws on cryptocurrency 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 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.
The regulator says that stake returns are income if the reward was agreed upon when the stake was made. Alternatively, it will be capital if the stake returns are uncertain and speculative.
The classification also depends on whether the return was made on a regular basis and whether it came from the sale of capital assets, in which case it would be subject to capital gains tax. Also, the type of reward you get from staking determines whether you pay income tax or capital gains tax.
Crypto Staking Safety
Even though there are many benefits to staking, investors in that area should think about the risks before choosing this type of investment. The following are significant risks associated with crypto-staking:
Slashing
Proof-of-stake networks reward validators for staking their tokens and verifying new blocks. But these networks can also punish them if they don't do anything or do something bad.
The essence of this is to discourage such destructive behavior. The slashing differs from one network to another. It could mean losing part of the stake, losing the whole stake, or being kicked off the network temporarily or permanently.
Volatility
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.
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 like Unslashed and Nexus Mutual offer slashing insurance. This protects validators against the high risk of being slashed, which is why slashing insurance is so important.
Also, people who stake with centralized staking businesses like a cryptocurrency exchange or any of the "Stake as a Service" (StaaS) operators usually have their deposits insured.
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 another.
Learn more about crypto staking insurance.
Conclusion
In most countries, regulations for cryptostaking are still under development. This means there are few or no established legal principles to tackle crypto staking. Before you start staking your assets, it is important to think about the rules in your area.
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 situations, it's better to be careful and pay the tax first, then ask for a refund, than to refuse to pay the taxes.
Disclosures
The content is only provided for informational purposes. It is not meant to be tax or financial advice, and it does not recommend any particular investment plan. Every investment has risk, including the possibility of a cash loss. Past performance does not guarantee future results.
Bitcompare does not guarantee good investment outcomes. The way a security or financial instrument did in the past does not show how it will do in the future. Before investing in options, clients should carefully assess their financial goals and risk tolerance. Due to the importance of taxes in all staking transactions, a customer who is thinking about staking should talk to a tax expert to find out how taxes affect the outcome of any staking strategy.
