What is Staking Crypto and How is it Taxed?

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What is staking cryptocurrency?

Staking is a way of effectively earning interest on your crypto in return for allowing your coins to support a blockchain using ‘proof-of-stake’ (PoS) to confirm transactions across the network.

It can also be described as part of a consensus mechanism by which blocks are verified before they get added to the blockchain.

Only proof-of-stake cryptocurrencies offer these rewards, often paid at a much higher rate than interest on cash. They include:

• Ethereum (ETH)
• Cardano (ADA)
• Tezos (XTZ)
• Cosmos (ATOM)
• Solana (SOL)
• Polkadot (DOT)

Proof-of-work (PoW) cryptos, such as Bitcoin, need physical mining hardware to crunch the numbers and process transactions to be added to the blockchain.

This has led to considerable criticism about the impact of PoW cryptos on the environment, especially those using electricity generated by burning fossil fuel. You can’t stake PoW coins.

To stake your PoS crypto you can either leave it on an exchange that supports staking, such as Coinbase or Binance, or withdraw it to a wallet before joining a staking pool compatible with the PoS crypto you own.

If you’re in a pool you have a better chance of increasing your staking rewards as PoS works almost like a lottery where a participant is chosen at random to validate the newest block.

Pooling your resources with others effectively means you have more ‘tickets’ in the ‘lottery’, aka staking pool.

The advantages of staking include allowing you to grow your crypto in a relatively environmentally friendly way without needing to spend a fortune on dedicated mining equipment.

However, crypto prices are notoriously volatile so your staked crypto could end up being worth less than you paid for it, even with the interest payments added.

One of the reasons for this is that in order to stake your funds you have to lock them away for a set period of time meaning you can’t act quickly on market movements.

Smaller projects tend to pay the highest interest rates to attract participants, but are often at greater risk of large price swings or possibly complete failure.

Is staking crypto taxable?

So far we’ve looked at how staking crypto works and how you can earn interest by locking in your PoS coins.

But the big question is – are your profits from staking crypto taxable?

If you transfer your coins from a cryptocurrency exchange to a wallet in order to join a PoS pool then, at present, this is not a taxable event as you haven’t disposed of the underlying asset.

But this is under review, as you’ll see below, and the situation may be about to change in the UK at least.

The actual rewards you earn through staking are taxable and in many countries around the world, including the UK and the US, would fall under Income Tax rules.

In the UK, for example, any earnings from staking would need to be declared to Her Majesty’s Revenue and Customs (HMRC) on a self-assessment form.

They would then be added to any other income you received through the course of the year, such as freelance work, to form the basis of your tax calculation.

If you decide to cash in your staked crypto and sell it for fiat money, then any profits you make would be liable for Capital Gains Tax (CGT).

In the UK, you get an annual tax-free allowance (£12,300 in the UK at the time of writing) after which CGT is charged on any profit above this (less the cost of buying the crypto).

The rate varies dependent on whether you pay higher rate or basic rate Income Tax and the size of the gain.

Related link: How to avoid Capital Gains Tax on crypto

Update to HMRC guidance on staking and DeFi lending

In addition to staking, a growing number of people are lending their crypto through various DeFi (Decentralised Finance) platforms, such as Nexo.

In updated guidance released in February 2022, HMRC has stated that how profits from staking or lending are taxed will depend on whether they’re classed as capital or revenue.

Deciding how to classify the returns is dependant on a number of factors, including the frequency of the profit, the length of time the stake or loan is made for and whether the return was fixed at the point of the initial agreement.

There’s also a question mark over whether HMRC will now treat staking through a platform or transfer to staking pool as a disposal, in which case it would immediately be subject to CGT even though the asset hadn’t actually been sold.

HMRC is never one to make life simple!

Ian Taylor, from CryptoUK, said: “This treatment of crypto lending and staking creates an unnecessary burden for any crypto investor who will now be required to include details of any lent assets on their tax returns.

“They will also have to carry out additional reporting which could require individuals to report hundreds or even thousands of transactions.

“This is out of step with the Government’s stated aim for the UK to be open and attractive as a destination for investment and innovation post Brexit.”

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