Through staking, stakers validate, verify and submit blocks to be added onto a blockchain. In addition, stakers also re-check blocks as the blockchain expands and remain synced to the blockchain until it becomes well established. Staking provides remarkable value to cryptocurrency communities, users, and blockchains alike. To put it simply, staking is an effective and efficient method of blockchain validation, allowing crypto users to earn rewards. The exact staking process differs slightly depending on the project, but fundamental aspects remain the same.
On a high level note, by initializing vault protocols, stakers are able to gain the benefits of staking without needing to handle the verification, re-verification and addition to the blockchain. Staking vaults essentially only require two parties, those being: the coin owner, and the staking manager.
Let’s take it a step back. What exactly are vaults?
A cryptocurrency vault is essentially ‘a custody service offered by an exchange or other trusted source to help you store your crypto and digital currency offline.’ Generally, when users want to store large amounts of cryptocurrencies offline, but don’t want to open a cold wallet, they use the services of a crypto vault. By using crypto vaults, the staking manager removes tokens from hot wallets which are connected to the internet and instead stores them offline.
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After Ethereum’s well known upgrade earlier this year to proof-of-stake, many questions about staking rewards became of importance to investors. Since there is not really ‘official’ guidance on how staking should be taxed we thought it best to explore exactly how the IRS views staking taxability in real time:
Units received will likely be treated as capital assets in the hands of the receiver.
Units received from staking are taxable upon receipt.
Delegation of units to a staker is also likely not taxable (please note, this is only the case if only the staking rights are transferred and not actual units).
The first act of staking crypto is likely not a taxable event in itself, although there is probably an exception in regards to ‘liquidity staking’.
The fair market value (‘FMV’) is treated as the gross revenue from staking, and can also be reduced by costs of staking.
Net income is treated as ordinary income and may be subject to self-employment tax if the level rises to where staking can be qualified as either a “trade or business”.
As time goes on, most of the uncertainty surrounding the subject will be resolved as the IRS continues to issue guidance. As the digital asset space continues to grow in popularity it will be all but critical for the IRS to issue guidance clarifying the tax treatment of certain activities, such as staking.