What is Staking
Staking is a term and process that has exploded in popularity within the crypto world. If you’re new to the space, you might be wondering… what exactly is staking?
Put simply, staking is a way of earning rewards by delegating or locking up certain cryptocurrencies. It’s comparable to putting money into a savings account, and earning a set amount of interest as time goes on.
For an individual, staking makes sense because you can lock up a specified amount of cryptocurrency in the custody of a certain protocol or platform, and receive rewards or ‘interest’. For the network facilitating the staking process, there are several benefits. The first being that when tokens are staked by users, this limits token supply. A reduced token supply has the potential to increase value, as demand increases and supply drops. The second is that staking literally provides the network in question with more processing power, and enables it to validate transactions more efficiently. The third is that it increases the decentralized nature of the network; stakers become part of the transaction validation process, and as such, there is no centralized point of authority determining what or how often transactions are processed.
Cryptocurrencies maintain their decentralized natures by relying on something called a ‘consensus mechanism’. At present, there are two main types of consensus mechanisms; Proof of Work and Proof of Stake.
Cryptocurrencies which use the consensus mechanism known as ‘Proof of Work’ rely on miners, people and processes generated all around the world in a race to validate transactions. If you’re the first to solve the cryptographic puzzle needed to validate a transaction as a miner and then actively verify blocks of transactions, you receive a designated amount of crypto in return for your work. As you can imagine, this is an energy-intensive process and requires a lot of processing power.
Proof of Stake differs from Proof of Work in that it relies on transactions being validated by users who invest in the blockchain in question through staking. Proof of Stake blockchains allow users to put forward their cryptocurrency in the hopes that they’ll be selected to add a new block onto the network in exchange for a reward. You can either participate in staking by becoming a network validator; a process that requires a much larger buy-in, or you can participate by providing a smaller amount of liquidity by staking on a platform that supports this process, such as Uniswap, SushiSwap, Curve etc.
The inherit way that proof of stake blockchains are designed means that the networks are built on the requirement of people staking. Where Proof of Work blockchains rely on miners solving cryptographic puzzles, Proof of Stake blockchains require stakers to provide liquidity in order to power transaction processing. This is why you can only stake on Proof of Stake blockchains.
Here’s a (slightly conflated) example of what staking can look like:
You hold 100,000 Bitcoin in a pool on SushiSwap for the purpose of staking. Your pool reaches consensus and you receive an additional 10,000 Bitcoin as a reward. Happy days!
Most countries have caught up with the popularity of staking and have now provided basic guidelines as to how staking and staking rewards will be treated come tax time. In most regions, any rewards received from staking are treated as regular income. In this case, you would be required to declare these rewards as you would any typical income stream. Once again, in most regions, when you choose to cash out your staking rewards (e.g. swapping your $SUSHI rewards for USD), you will be subject to capital gains tax.
Using the example from earlier, if you’re in a region that follows the above guidelines; that 10,000 Bitcoin you received as a reward would be subject to income tax. If you decided to then sell your Bitcoin for USD, that action would be subject to capital gains tax.
This can vary depending on your region so if you have any questions, reach out to us or a qualified tax professional!
Lucky for you, we have a specific category for staking rewards in our software! If you’ve been staking, all you have to do (if our algorithm hasn’t already categorized it for you!) is select ‘staking rewards’ from the drop-down menu in our ‘receive’ options.
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