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Tax Implications of Staking Crypto
Staking has seen a surge in popularity as a way for investors to generate passive income from their digital assets. With the ability to earn rewards for helping secure the blockchain network, staking has become an attractive option for those looking for a steady stream of income with low risk. However, it's important to note that staking can also have tax implications, and it's crucial for investors to understand how these rewards will be taxed.
In this article, we'll not only delve into the world of staking, but also examine the tax considerations that come with earning rewards through this investment strategy. Whether you're a seasoned cryptocurrency investor or just getting started, this guide will provide you with all the information you need to make informed decisions about staking and its impact on your finances.
What is staking and how does it work?
If you're familiar with Bitcoin, you've likely heard of proof of work (PoW). This mechanism involves miners recording transactions into blocks and competing to solve complex equations in order to have a chance to add the next block to the chain. However, there are several drawbacks of this method of consensus, including high initial equipment costs, continued operational expenses and heavy energy usage.
This is where proof of stake (PoS) comes in. Since late last year, Ethereum shifted to a full PoS consensus mechanism and with it came the continued rise of the staking industry. Participants in PoS systems lock up a predetermined number of coins (such as ETH) in a smart contract to become a validator. As transactions are added to a blockchain’s mempool, a validator is randomly chosen to validate a transaction block at specific intervals. the protocol randomly selects one to validate the next block at specific intervals.
Normally, to become a validator for the Ethereum blockchain, participants must lock up 32 ETH as their “stake” and, at the same, run an Ethereum validator. For many, this commitment is unachievable, leaving smaller investors locked out of this potential opportunity to earn yield on their ETH.
This is where Swell comes in.
Swell is Ethereum liquid staking protocol designed to make it as easy as ever to stake your ETH and optimize your yield, no matter how much ETH you own or your technical ability.
This is made possible by Swell’s innovative smart contract-driven protocol, which forms a staking pool that seamlessly deposits your ETH into the Ethereum blockchain so you can start earning rewards in a few simple clicks on the Swell DApp. so that you can start earning rewards. In addition, Swell’s staking pool is managed by the protocol’s node operator network, which is a vetted group of institutional and professional Ethereum validators who collectively have deep experience running thousands of Ethereum validators.
Moreover, Swell stakers receive a liquid staking token, Swell Ether (or “swETH”), after depositing, which reflects your staked ETH token. Your swETH continues to accrue the rewards so that swETH is backed by an increasing amount of ETH over time. The redemption rate between swETH and ETH is always 100%, so your swETH is fully-backed.
This unlocks a whole world of opportunities for stakers, who can earn yield on their ETH while retaining a highly liquid asset in their wallet
Is staking crypto taxable?
In short, the answer is yes. Staking cryptocurrency and the staking rewards you receive from it may be taxable in many countries around the world.
The tax implications of staking depend on where you reside and how your transactions are structured. Usually, moving your coins or tokens to a staking pool or wallet, or using a third-party staking service is not considered a taxable event, similar to transferring cryptocurrency from one wallet to another. However, it does depend on the exact situation, as some tax jurisdictions may deem a staking deposit with a third party to be a disposal event, which could have tax implications. The associated fees, such as gas or deposit fees, may have different tax consequences.
On the other hand, staking rewards are often taxed as income when you receive them, and can create a capital gain event if they are sold in the future.
How is staking taxed?
The tax implications of staking vary greatly across tax jurisdictions. As this is a relatively new activity, many tax authorities have not yet released specific guidance on staking. If you are unsure on how your tax jurisdiction treats staking deposits and rewards, speak to a licensed tax professional.
Staking Deposits
In most cases, transferring your coins or tokens to a staking pool, wallet, or third-party staking service is treated similarly to transferring cryptocurrency from one wallet to another, and is not considered a taxable event. However, this may not always be the case, as some tax jurisdictions may view a staking deposit with a third party as a disposal event, which could have tax implications. The deposit is generally more likely to be seen as a taxable event if another token, such as a liquid derivative or receipt token, is received in return for the staking deposit.
Staking Rewards
The tax treatment of staking rewards varies by jurisdiction depending on how staking is classified by the tax authorities. Usually, staking rewards are regarded as income and are liable for Income Tax calculated on the fair market value at the time they are received. When selling the staked coins, Capital Gains Tax may also come into play. The exact tax classification of staking rewards in the world of crypto varies by country.
Example scenario (Using Swell staking)
Staking Deposit:
On March 1st, an investor purchased 5 ETH for $13,000. One month later, on April 1st, this investor decided to stake with Swell following their architecture upgrade. To do this, the investor deposited your 5 ETH worth $15,000 at the time, and received 5 swETH tokens in return.
It's crucial to note that in some tax jurisdictions, this could be considered as a disposal event, resulting in a capital gain equal to the difference between the value of the tokens at the time of disposal and the original cost of the tokens:
$15,000 - $13,000 = $2,000
It's important to consult your local tax authority to determine if this is a taxable event. Additionally, any gas fees involved in the deposit transaction could have their own tax implications, which will not be addressed here.
Staking Rewards:
After the investor staked their ETH, the swETH tokens that represent the stake were transferred to the investor’s wallet. The investor decided to keep the swETH until December 1st, before selling them. The swETH tokens had accrued the ETH rewards from staking, and were now backed by 1.04 ETH per token. This meant that the entire 5 swETH had the same value as 5.2 ETH, which had a value of $20,000 at the time they were sold.
Due to the accrual of rewards as backing to the swETH token, it is unlikely that the staking rewards would be treated as income. This scenario would likely trigger a capital gains tax event at the time of disposal. This would be calculated subtracting the cost basis if the swETH at the time it was received ($15,000) from the market value at the time it was sold ($20,000).
$20,000 - $15,000 = $5000
In other staking scenarios where the rewards are not accrued to a token like swETH, there could be income tax applied to the rewards.
In that case, you started to receive token rewards. You regularly collected your rewards throughout the rest of the financial year, and waited until they were worth $100 before claiming them, which you did 6 times. In jurisdictions where staking rewards are considered income, this would equate to $600 in income that needs to be declared.
After collecting your rewards, you decided to hold onto the tokens, which were now worth $800. Before the end of the financial year, you chose to sell them. In many tax jurisdictions, this would be considered a taxable capital gains event. The gain would be calculated as the difference between the value at the time of disposal and the cost basis, which is equal to the value of the tokens at the time they were received, or in this case, the same as your declared income amount:
$800 - $600 = $200
In jurisdictions where this is a taxable event, $200 would need to be declared as a gain. Any gas fees involved in the rewards claiming or disposal transactions could have their own tax implications, which will not be addressed here.
How to calculate your staking taxes
It is important to note that accurately tracking staking transactions is crucial for tax purposes. This can be achieved through the use of crypto tax software such as CryptoTaxCalculator, which offers both automatic and manual tagging options for staking rewards. CryptoTaxCalculator was built by crypto natives trying to do their own on-chain taxes, so the platform is built specifically for complex transactions such as staking. The software generally recognizes staking transactions automatically, making it a convenient solution for those with multiple staking transactions. In instances of more complex staking transactions, manual tagging may be necessary to ensure an accurate tax report.
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