Staking “Income” Should Not be Taxed

Staking income from tokens should not be taxed. Since staking income is generated by inflation it doesn’t create new wealth but simply lowers the total value of the token. Thus staking income is really just a transfer from non-stakers to stakers.

Abraham Sutherland covers the law and the economics in Phantom Income and the Taxation of New Cryptocurrency Tokens, a piece for Tax Notes, Here’s one bit on the economics:

Consider a simple proof-of-stake cryptocurrency in which 10 people each hold 1,000 tokens. To make sure that holders are encouraged to stake — that is, to validate transactions and add blocks to the blockchain — block rewards increase the total number of tokens by 10 percent over the course of a year. So a year later, 11,000 tokens will be on the network.

If every holder stakes and acquires a proportionate share of these new tokens, each will end the year with 1,100 tokens. Everyone has 10 percent more tokens, but no one is better off from staking. Taxing each staker’s 100 new tokens as income would be wrong. It would be like taxing the new shares created in an 11-for-10 stock split.

There is indeed an economic incentive to help keep such a cryptocurrency network secure by staking, but it’s not the one suggested by bitcoin miners making a profit even after spending on specialized computer hardware and the electricity needed to run it. The incentive in this proof-of-stake example is to avoid losing out. If everyone stakes, no one gains.

This is a profoundly elegant, equitable, and cost-effective solution to a deep coordination problem. It allows everyone who holds tokens to participate in adding new blocks and keeping the network securely decentralized. It eliminates major costs — specialized computer hardware, electricity — as requirements for fairly distributing the right to create those new blocks. In its Platonic form — in which everyone participates — no one gains at all from the new tokens, which means no one loses, either.

But this model simply won’t work if it’s taxed incorrectly. If the government sees phantom income and taxes it, the value of the network will be siphoned off to the treasury even if no one has actual gains from staking.

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