While members of the Ethereum blockchain community have endured the criticism of how long it is taking to move to a new mechanism called ‘staking’, it is hard not to also note that there is no definitive guidance yet from the Internal Revenue Service (IRS) on how those who ‘stake’ their blockchain ‘tokens’ and receive rewards will be taxed either.
It certainly is not addressed on the Ethereum Foundation as the major risks are listed as losing Ethereum for going offline, malicious actions, and failing to validate; however, the idea of understanding the tax consequences for your efforts in securing a blockchain network is certainly something for the masses to consider.
In November 2019, a paper first addressing this issue called ‘Cryptocurrency Economics and the Taxation of Block Rewards’ was written by Abraham Sutherland, University of Virginia School of Law. Sutherland notes in his paper he believes no law from Congress or regulation from Treasury is needed to provide proper taxation of block rewards.
The paper offers an analogy for those attempting to understand this nuanced concept by suggesting that we consider an imaginary ‘cryptocurrency kitty’. Sutherland notes, “A sign on the kitty reads, ‘These tokens are for those who maintain the network.” Those who maintain the network are allowed to take tokens from the kitty and keep them. Treasury wants to tax those who take tokens from the kitty.”
The ‘Proof-Of-Stake Alliance’ (POSA), a trade group in Washington D.C. is highly focused on what the wrong kind of tax policy may mean for the future of blockchain in the United States and abroad. Led by Evan Weiss, the founder of POSA, who noted in an interview, “It’s a watershed moment that staking is here to stay. It is really important for us as people in industry to really try to socialize this and make sure regulators and policymakers understand the benefits of these systems and how they can have a huge impact on our economy and the way they interact.”
Why should an Ethereum stakeholder care? Now, according to Weiss, “you actually can be compensated for securing the network and earn block rewards for doing that… staking these networks need to have a different view than the guidance issued in 2014. In some networks you are earning rewards every six plus seconds.”
Congress wrote a letter that was supported by Coin Center, a think tank in D.C. that has promoted the Bitcoin and Ethereum ecosystem to Congress for years, where it argues that these ‘block rewards’ should not be taxed as income. The Blockchain Association also has started a ‘Staking Working Group’ that is similarly focused on these issues. The other major non-profit for cryptocurrency and blockchain in Washington D.C. – the Chamber of Digital Commerce – launched a Tax Task Force in October 2019 and on its website notes it is developing feedback to the IRS.
Weiss indicated his respect for all three organizations and a strong desire not to ‘step on any toes’. His hope is to see more education of policymakers in what is somewhat of a difficult concept to grasp as to its importance, is capable of having a negative impact on the industry should action not be taken.
Gary Gensler, the former Chair of the Commodity Futures Trading Commission (CFTC) and Professor of Practice at MIT who is heading up the Biden transition team’s efforts on evaluating U.S. financial regulators, may weigh in on this issue. While he has suggested that he believes XRP is a security and also that Ethereum is likely a security as well, Gensler has opined that ‘Crypto Kitties’ is not a security. Perhaps Gensler will similarly feel that the tax enforcers should tread lightly on taking blockchain tokens from crypto kittens.
Disclosure: I personally stake for block rewards on the Proton blockchain. I do not own any crypto kitties; however I do have a physical cat named Sundance.