Blockchain Staking Rewards: Volatility & Risks

Summary

  • Agree with the Australian Tax Offices’ taxing of crypto currencies except for staking rewards.
  • Current taxing of staking rewards does not accurately reflect underlying mechanisms of a Proof of Stake blockchain, attitude and purpose of investors who stake, and can be detrimental to financial liquidity of investors.
  • Staking rewards are akin to creation of new assets, not proportional allocation of annual profit (as share dividends would be), therefore should be taxed on sale only, not distribution.

While cryptocurrency is often bought and sold by speculators for profit, other investors in blockchain assets enjoy the returns created through staking rewards. However, cryptocurrencies are not defined as ‘financial products’ and therefore are not afforded the protections of ASIC laws. 

Adding to this burden of high volatility and risk, the Australian Taxation Office (ATO) has ruled that staking rewards are deemed income at the point of distribution for the purposes of s15.2 of the Australian Income Tax Assessment Act 1997. As the implications of this ruling gradually impact investors in blockchain assets, a discussion needs to occur on whether this policy is having its intended effects, and whether, in fact, staking rewards are income at the point of distribution.  

Blockchain stakeholders weather the storm of extreme volatility and risk

While many speculators buy and sell cryptocurrency for profit, another group of investors in blockchain assets enjoy the returns created through staking rewards. Staking rewards are part of the architecture of a Proof of Stake (PoS) blockchain and are designed to incentivise token holders and validators to secure PoS networks and promote good behaviour and decision making. From the perspective of blockchain technology, the main rationale behind staking rewards is not the short-term gain of stakeholders, but long-term capital appreciation resulting from good decisions and the value creation of a blockchain ecosystem. 

A long-term investment strategy in blockchain assets, however, is not for the faint hearted. Long-term token holders are generally called “hodlers” because they endure the wild swings (of up to 90%) on the crypto market by ‘holding on for dear life’.  Furthermore, as the chairman of the Australian Security and Investment Commission (ASIC), Joe Longo, recently warned Australian citizens, cryptocurrencies are not defined as ‘financial products’ and therefore are not afforded the protections of ASIC laws. This means, according to Longo, that there are no reimbursements or insurance against scams, hacks, or artificial volatility risks to be guaranteed by the government as it is with the traditional financial market. 

The ATO taxes staking rewards at the point of distribution 

To add to the burden of high volatility and risk the Australian Taxation Office (ATO) has ruled that staking rewards are deemed income at the point of distribution for the purposes of s15.2 of the Australian Income Tax Assessment Act 1997. The assessment of taxable income is based on the market value of the tokens at the point of distribution, and if the market value of the asset is greater at the point of disposal, than at the point of distribution, it is also subject to a capital gains tax. As the implications of this ruling gradually impacts investors in blockchain assets, it is clear a discussion needs to occur on whether this policy is having its intended effects, and whether, in fact, staking rewards are income at the point of distribution.  

To anyone who is unfamiliar with the staking rewards system, the ATO’s ruling might seem an obvious and fair conclusion. After all, isn’t the crypto investor receiving a payment for staking their holdings on the blockchain? Isn’t it a form of income derived from an investment? As is commonly recognised, such returns are deemed income whether payment is made in Australian dollars or another form of property, such as crypto tokens. This conclusion is only partially correct. It is true that staking rewards are a form of income and are linked both to an investment and to a service, however, as a question of fact, staking rewards are not generated out of profits, and do not represent a payment of interest on an investment, nor are they strictly speaking a ‘distribution’.

Staking rewards are generated from two sources that change in relevance depending on the stage a PoS blockchain is in its development life cycle, a topic that shall be expanded upon in our next article.

Source: Harry Hoang | CEO of Tailored Accounts

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Staking rewards for both delegators and stake pool operators are taken from two sources: the Reserve and Transaction fees. Staking rewards generated from the two sources change in relevance depending on the stages in the development cycle a PoS blockchain is in.

To treat staking rewards sourced from newly minted tokens resulting from inflationary monetary policy as taxable income at the point of distribution, without including the impact of dilution, results in systematic over-taxation and in some cases, impossible accounting burdens.

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