Taxing DeFi Staking, Preposterous or The New Status Quo?

“Ludicrous!”

That would be the word that embodies the most the overall response to the announcement of French deputy Éric Bothorel submitting an amendment to the upcoming budget bill to tax income from cryptocurrency staking.

Probably because, if there is one thing that seemed impossible to tax in the crypto space, well, it was staking.

To make it short and simple, crypto staking involves locking up and holding a certain amount of a cryptocurrency in a wallet to support a blockchain network’s operations, usually for months on end.

In return, participants receive rewards or interest in that cryptocurrency, that can be considered a fixed yield/return.

Just thinking of the logistics of paying taxes on staking is giving a collective headache to crypto investors.

In France, up until now, staking was lost in legal limbo.

There were two options to remedy it:

• The ‘Flat Tax’ road: One would only pay taxes on taxable transactions that generated a capital gain. The taxpayer would then need to report each sale to the tax authorities.
  TL;DR: You got lucky with your Pepe coin investment and made $100,000, which you decided not to keep as $PEPE but to cash out for the down payment on your first house. According to French tax law, you would need to pay approximately 30% in flat tax.
• The Taxation of non-commercial profits (NTBs) road: One has to report every reward upon its receipt, even if they do not convert them into fiat. Crypto mining is already subject to this regimen. The Council of State decided to subject mining profits to taxation as non-commercial profits starting in 2018.

If Éric Bothorel had chosen the flat tax route, well, the news would have been met with varying levels of discontent, but it would have been generally accepted. In the grand scheme of taxation, levying capital gains is nothing new.

But what Éric Bothorel proposes, much to the dismay of all, is to officially classify staking income as non-commercial profits (NTBs). If his amendment is adopted, the rewards received in cryptocurrency would be subject to taxation, even without converting them into fiat currency, and this would take effect in the year 2023.

According to Waltio, a crypto-tax management company, the general consensus among legal experts favored staking being subject to taxation as non-commercial profits.

Furthermore, for Éric Bothorel, his amendment is nothing more than the “simple legalization of a jurisprudential decision by the Council of State from 2018.”

If we look beyond the caricatural discourses that denounce this latest development as the French tax addiction striking again, the concerns raised by crypto users have merit — even if you are a tax enthusiast.

Crypto Market Volatility

If France follows the US approach, it will be the responsibility of the taxpayer to determine the fair market value of the crypto staking rewards when they receive them.
However, one doesn’t need to spend a month in the crypto space to understand that it’s a virtual embodiment of a rollercoaster. It can induce absolute vertigo, and when you’re brutally liquidated, it makes you feel nauseous.
For a taxpayer, this could mean, for example, that the staking rewards they received at a specific moment in 2023 could be assessed at 700€, but by the time they have to pay the taxes the following year, the actual value of those same staking rewards could have dropped to 53€.

An issue that Éric Bothorel not only knows well but also raised in an amendment in 2021, concerning the holding of crypto-assets by businesses.

The amendment said:

“The taxation of exchange operations leads to the following issues: […]

A problem related to volatility: if the company does not immediately sell a portion of the digital assets received for euros, and the value of the asset significantly decreases, the company then becomes liable for a tax it cannot afford to pay. […]’

So, companies should not become liable for taxes they cannot afford to pay, but retail investors should?

Small Retail Investors

Let’s make things clear: the crypto population that could truly be economically impacted by this new tax policy on staking consists of the most vulnerable individuals. It’s the small retail investors who dabble in crypto, often living paycheck to paycheck, investing their meager savings in crypto with hopes of striking it big but often losing it all. If one of them gets lucky, puts his meager fiat coins into a coin that skyrockets and brings in some substantial staking rewards for 5 months, which he continues to hold without cashing out, investing all his savings in it, and then on the 6th month, the value plummets to 0, what happens then?

How can a retail investor become liable for taxes they cannot afford to pay?

Taxing Twice?

If we, once again, follow the US approach, which is quite likely, you will be required to pay taxes based on your staking rewards when you receive them. Now, what if, after you’ve received your coins and held onto them, they greatly increase in value due to the volatility of the crypto market?

If you keep your coins and later sell them at a profit, compared to the original cost basis when you received the rewards, you would be subject to the flat tax (capital gains tax).

Let’s say you received 1 ETH in staking rewards in January 2023.

At that time, this 1 ETH is worth 2,000€, and you would need to pay non-commercial profits tax on it.

Six months later, this same 1 ETH is worth 3,000€, and you decide to cash it out for fiat. In this case, you would be subject to the flat tax because you’ve made a capital gain.

For some crypto investors, this kind of tax policy is perceived as an unfair double taxation.

Who is Doing What, Where and with Whom

Sigh. The thing is, getting people to pay their taxes in the crypto space is already challenging enough due to the very Cypherpunk ideas that underlie it. The primary appeal of the crypto space lies in the perception that it is a virtual land of freedom, or even more so, a foundational element in building through independence from any form of authority by providing individuals with full access and control over their finances.

When you try to push policies in this kind of environment that are antithetical to everything this space stands for, the pushback is violent. As well as astute.

Cryptoexchanges are doing KYC? Let’s go on KYC-free DeFi protocols.

Staking is now taxed? Let’s employ all the obfuscation techniques available, from mixers to private currencies, to ensure that no one will ever be able to trace back the staking rewards.

Let’s put it bluntly, if a French taxpayer decided to cash out his staking rewards as simple capital gains because he needs the cash, who is going to stop him? Who can prove what he just did?

He can hold his staking rewards in stablecoins and release them gradually in a manner that conceals their origins.

Unless the French Tax department is fully equipped with highly skilled crypto tracers, enforcing the staking taxes, under these conditions, could have a pernicious effect.

It is very likely to push crypto investors to find innovative ways to evade them.

Every time a new regulatory framework is implemented in crypto, it is often emphasized that the reason for its existence is to create a better and safer environment for its users.

While resistance to any form of control in this space is expected, the fact that this new tax policy does not take into account the crypto market volatility is being perceived as extremely uninformed and disconnected from the reality of crypto users.

In such a way, this policy, while lawful, would be seen as nothing less than unethical.

Under these circumstances, crypto investors will more likely than not develop new habits that enable them to circumvent the law rather than comply with it. Even the ones who never dreamed of doing so.

This could lead them to take undue economic risks by engaging with shadier crypto actors for staking and obfuscation, which, in turn, might result in falling victim to a scam or losing everything to the hacks that plague the crypto space.

Not to mention the legal risks associated with deceiving the tax administration.

But the thing is, this whole affair is almost as good as old news, especially considering the possible new crypto tax reporting rules that could be implemented by the U.S.

Rules which have the potential of transfiguring the whole crypto industry.

Forcefully propelling the crypto space into a new paradigm, and killing the crypto of old in its wake.