Tax tips: Income tax implications of cryptocurrency ‘staking’ – Crain’s Cleveland Business

Tax tips: Income tax implications of cryptocurrency ‘staking’ – Crain’s Cleveland Business

After years on the fringes of the financial world and wild swings in value, cryptocurrency has become increasingly accepted as a financial asset and as a means of payment. While the technology behind cryptocurrency has continued to evolve rapidly, guidance on the tax treatment of cryptocurrency has moved much more slowly.

The only published guidance from Treasury and the IRS regarding cyptocurrency transactions is Notice 2014-21, 2014-16 IRB 938 (“Notice”). The Notice addresses the tax implications of “mining” virtual currencies, the predominant method of creating cryptocurrency at the time the Notice was issued.

Virtual currencies are based on digital ledgers (“blockchains”). Because blockchain transactions lack a traditional third party to verify transactions, parties to these transactions must rely on an algorithm to achieve consensus among participants as to the validity of sets of transactions (each set is referred to as a “block”).

This validation process ensures that each block of transactions added to the blockchain represents the most current transaction to avoid the possibility of a user spending the same unit of digital currency more than once.

The “mining” process is based on a decentralized consensus mechanism that requires members of a network to expend effort solving an arbitrary mathematical puzzle to prevent participants from misusing the system. As a result, cryptocurrency mining is sometimes referred to as “proof-of-work” or “PoW,” because personal services need to be provided to validate transactions, and the work is rewarded with new tokens.

The Notice states that rewards from mining activities are includable by a miner in