Consensys Software Inc. (“Consensys”) appreciates the opportunity to engage with the Committee on Finance (the “Committee”) regarding the taxation of digital assets.1 A tax regime that provides clear and timely rules, is flexible in its application to new technologies and informed by stakeholders’ views is a critical part of the effort to support innovation and make the U.S. a global hub for investment in new and emerging technologies. That regime should place particular emphasis on efficiency in reporting obligations (and a correlative reduction in enforcement risk), protection of practical and steadily increasing use of technological development, and avoidance of disparate treatment for transactions involving digital assets relative to other economically similar transactions.

I. Overview of Consensys

Consensys is a leading software company on the Ethereum network, which is the largest programmable blockchain in the world. In general, Consensys provides software tools for builders to create and deploy software applications on the Ethereum and other similar computational networks, and for users to interact with these applications and thereby create new social and economic networks in cyberspace. Its software suite includes, among other products, MetaMask, the leading self-custodial wallet for over 100M users annually, Infura, a platform for web3 development and Linea, a Layer 2 protocol for aggregating transactions using Ethereum functionality with high throughput, low gas fees and the security of Ethereum settlement. Consensys Diligence is a smart contract security auditing service that is widely used to ensure new smart contract-based protocols are technically sound and secure. Consensys Staking helps users engage in staking transactions while eliminating risk, complexity, and reliance on third parties.2

Consensys is very much on the technology side of the blockchain ecosystem as opposed to the investment side of the ecosystem, the latter of which has captured the majority of the public’s and policymakers’ attention. Consensys’s product offerings and initiatives in the digital asset ecosystem are designed to bolster technological development in and use of blockchain protocols. To the extent that digital assets are treated for federal income tax purposes as investable assets, it is critical to the US’s participation in blockchain technology development and the computer networks, applications and tokenized ecosystems that are being created, that the tax Code’s approach to digital assets does not encourage the technology to move offshore.

Because Consensys publishes software that touches every component of a transaction involving digital assets, including providing a user the ability to swap a token in one cryptocurrency for a token in another cryptocurrency, a tax system that acknowledges, and does not interrupt, how the technology works and develops, and that supports efficient and predictable reporting, is of particular importance to Consensys. It would be, at best, heavily burdensome, and at worst, impossible, for cryptocurrency players to operate if the tax system in the US were to stifle further advancement in the digital asset ecosystem, which would force emerging technologies to move their operations and the attendant economic activity abroad.

II. Summary of Proposed Recommendations

The technological innovators that operate in the digital asset space in the US endorse clear and understandable tax rules. In particular, those rules must support continued US-based innovation and must not disincentivize the building of, or participation in, the computer protocols that underpin transactions in digital assets in the US. Congress should provide a reasonable and measured set of rules around the acquisition, use, and disposition of digital assets that is both clear enough for taxpayers and their advisors to determine whether and how to apply specific rules to cryptocurrency, and flexible enough to expand and change in response to the evolution in how Americans participate in the digital asset economy.

The Committee’s letter dated July 11, 2023 asks for stakeholder input on nine specific topics relating to the tax treatment of digital assets. As a preliminary matter, Consensys strongly encourages the Committee to pay very close attention to the public commentary submitted in response to the Treasury Department’s recent Notice of Proposed Rulemaking on broker information reporting for transactions involving digital assets.3 As many of those comments will observe, the proposed regulations have the potential to dramatically hamper the development of a competitive US-based blockchain technology industry.

As the Committee considers the responses to its July 11, 2023 letter, Consensys respectfully asks that the Committee also consider legislative measures that may avoid or mitigate negative policy outcomes that would flow from the proposed digital asset broker reporting regulations being finalized in their current form.

With respect to the nine topics, most can be addressed through targeted legislative text that, where appropriate, expands upon existing provisions of the Code to cover digital assets and treat them consistently with existing economically equivalent activity. Such a targeted approach would, in most cases, be preferable to clarifying the character of digital assets for tax purposes more generally, which could trigger (or not trigger) current provisions of the Code applicable to, e.g., commodities and securities, in less certain and predictable ways.4

  • Marking-to-Market for Traders and Dealers (IRC Section 475).5 In general, the mark-to-market method of tax accounting should be available, on an elective basis, to dealers and traders in certain cryptocurrencies.

  • Trading Safe Harbor (IRC Section 864(b)(2)). Transactions in cryptocurrencies that are traded in established markets should qualify for a trading safe harbor under Section 864(b)(2), through enactment of an amendment to that provision that expands its application to cryptocurrencies.

  • Treatment of Loans of Digital Assets (IRC Section 1058). Loans of digital assets should generally not be treated as a taxable sale or exchange of property, and thus should not result in the realization of gain or loss by the lender, as long as the arrangement otherwise satisfies the existing requirements under Section 1058.

  • Wash Sales (IRC Section 1091). To ensure economic equivalency, the wash sale provisions of the Code should be updated to address transactions in cryptocurrency, but the updated framework should allow for certain exceptions or safe harbors where the potential for realization of uneconomic tax losses is outweighed by the burden of compliance.

  • Constructive Sales (IRC Section 1259). The interaction of cryptocurrency and the constructive sale rules is not clear in the absence of guidance that explicitly applies the existing regime to digital assets. This uncertainty can be clarified through targeted statutory amendments that make clear the contexts in which Section 1259 applies to digital assets.

  • Timing and Source of Income Earned from Staking and Mining. Rewards received by users that engage in staking or mining transactions should be taxed only when those rewards are subsequently disposed of.

  • Valuation and Substantiation (IRC Section 170). While the existing legal framework for the valuation and substantiation of contributions of cryptocurrency should be tailored to account for the unique nature of cryptocurrency assets, this issue can be addressed by a grant of regulatory authority to the Treasury Department.

  • Nonfunctional Currency (IRC Section 988(e)). An exemption similar to the de minimis exemption for nonfunctional currency should apply to certain transactions in cryptocurrency.

III. General Overview of Issues in the Digital Asset Space

The Code often categorizes investable assets into two distinct buckets: “securities” and “commodities.” It is unclear under existing federal income tax law, however, whether particular cryptocurrencies constitute (a) commodities, (b) securities, or (c) other specific types of property. This makes application of various Code provisions that turn on specific characterizations of property uncertain and raises reporting and compliance challenges for taxpayers and enforcement challenges for the IRS. This uncertainty could be addressed by defining broad categories within which different digital assets would fall based on their character, with existing tax rules following. That approach would, however, inevitably involve some degree of subjectivity and could have unintended consequences, particularly in the context of new applications and technologies. Accordingly, Consensys suggests a more targeted approach consistent with the Committee’s inquiry, whereby specific provisions of the Code are amended to cover “digital assets” by name.

IV. Responses to Committee Questions
A. Marking-to-Market for Traders and Dealers (IRC Section 475)

Section 475 allows dealers and traders in commodities to elect to use a “mark-to-market” method of tax accounting. Under this Code provision, in general, a “commodity” is any commodity for which there is an established financial market, such that the commodity is “actively traded.” The mark-to-market method in general involves adjusting the value of an asset to reflect its current market value. While a dealer or trader in commodities can elect to use a mark-to-market method of tax accounting with respect to commodities held by the dealer or trader, as applicable, it is not clear under current law whether and when cryptocurrencies are considered commodities for purposes of making the mark-to-market election.

To ensure similar tax treatment of similar economic activity, in general, dealers and traders in certain cryptocurrencies should be able to elect to use a mark-to-market method of tax accounting, especially in light of the volatility of token prices over the year. Because of the varied nature of tokens generally, this election should not be available for all cryptocurrencies, only those that qualify as “actively traded property” (within the meaning of Section 1092(d)(1), modified to cover the unique markets in which cryptocurrencies can trade). Consensys believes that this issue can be addressed through targeted amendments to Section 475 that allow for a mark-to-market election to be made with respect to actively traded digital assets.

B. Trading Safe Harbor (IRC Section 864(b)(2))

In general, non-US persons are only subject to federal income tax to the extent their income has a nexus to the US, including if that income is “effectively connected with the conduct of a trade or business within the United States.” Section 864(b)(2)(B) provides two safe harbors under which certain income earned by non-US persons from trading in commodities will generally not be treated as “effectively connected” with a US trade or business, if such income is earned as a result of (i) trading through a US-based broker, or (ii) trading for the non-US person’s own account. It is unclear under existing law whether these safe harbors are available in respect of some or all cryptocurrencies that may be traded by non-US persons.

Consistent with the policy goals of encouraging inbound investment in emerging technologies and providing certainty under the tax law, the commodities trading safe harbors in Section 864(b)(2)(B) should be extended to the trading of digital assets (as it was to trading in derivatives in the late 1990s).

C. Treatment of Loans of Digital Assets (IRC Section 1058)

In general, Section 1058 provides that an owner of “securities” will not recognize taxable gain or loss when the owner transfers the securities to a borrower in exchange for the contractual obligation of the borrower to return securities that are “identical to the securities” originally loaned. This nonrecognition rule applies only to the loan of a “security,” which includes stock, notes, bonds, debentures, or evidence of indebtedness, or any evidence of an interest in or right to subscribe to or purchase any of the foregoing. There is no direct guidance addressing whether the lender of cryptocurrency in an arrangement that otherwise satisfies the requirements of Section 1058 will realize gain or loss in connection with making the loan or upon return of the lent cryptocurrency, although there is general agreement that Section 1058 does not, by its terms, apply to most digital assets.

Congress should make clear through targeted amendments to Section 1058 that a cryptocurrency loan will generally not be treated as a taxable sale or exchange of property, and thus will not result in the realization of gain or loss by the lender. As long as the lender’s right to a return of the cryptocurrency is not materially different from the lent cryptocurrency itself, the lender should not be taxed on a transfer pursuant to a cryptocurrency loan arrangement.6

1. Please describe the different types of digital asset loans.

The underlying economic structure of a digital asset loan is in many ways comparable to a securities lending transaction, and therefore should benefit from similar tax treatment. Like a digital asset loan, a securities loan involves two steps: first, a transfer of securities from a lender to a borrower against the borrower’s promise (typically secured through collateral) to transfer the equivalent securities back to the lender at a later date, and second, a transfer of such equivalent securities from the borrower to the lender at a later date, and a return of collateral to the borrower. In the context of digital assets, one particularly popular lending mechanism involves the loan programmatically defaulting and the collateral automatically reverting to the lender if the loan-to-value ratio of the loan (and therefore, the value of the collateral) falls below a certain threshold.

2. If IRC Section 1058 expressly applied to digital assets, would companies allowing customers to lend digital assets institute a standard loan agreement to comply with the requirements of that section? What challenges would compliance present?

With respect to decentralized finance (“DeFi”), because many cryptocurrency loans are made in transactions through smart contracts wherein blockchain software uses coded logic to effect the lending transaction (i.e., without any need for legal documentation, third-party custodians, or off-blockchain payments), it is unlikely that many digital asset loans will employ written loan agreements. Unlike in most securities loans, in DeFi lending there is no fixed date for when the parties will re-transfer the original assets, but the platform itself will automatically re-transfer the staked assets on demand by virtue of the smart contract programming, thereby eliminating the need for a written agreement between the lender and the borrower. Digital asset lending transactions also take place in the context of transactions facilitated by centralized exchanges, which may have different documentation requirements.

Due to these structural and practical differences with typical securities lending transactions, Consensys recommends that any amendment of Section 1058 not require that a qualifying loan arrangement be evidenced by a written loan agreement, since that could exclude DeFi loan transactions that are economically similar to the securities loan transactions currently the subject of Section 1058.

3. Should IRC Section 1058 include all digital assets or only a subset of digital assets? Why?

The income tax law should distinguish among digital assets based on their characteristics, as it does for derivatives, for example. Without specifically addressing the characterization framework of digital assets, amendments can be made to Section 1058 to expand the provision to apply to loans of digital assets in certain specified circumstances, akin to the treatment of securities loans under Section 1058.

4. If a digital asset is lent to a third party and the digital asset incurs a hard fork, protocol change, or air drop during the term of the loan, is it more appropriate for there to be a recognition of income for the borrower upon such transaction or subsequently by the lender when the asset is returned? Please explain.

Are there any other transactions similar to a hard fork, protocol change, or air drop that may occur during the term of a loan? If so, please explain whether it is more appropriate for the borrower or the lender to recognize income upon such transaction.

Consistent with a securities loan under Section 1058, gain or loss should not be recognized on the transfer of digital assets in the context of a lending transaction. The tax treatment of hard forks, protocol changes, air drops, or other similar transactions should track, to the extent possible, the tax treatment of analogous circumstances covered by Section 1058, including the receipt of dividends and stock splits for assets subject to a securities lending transaction, with flexibility for the parties to negotiate the economics of these events (with the tax treatment to follow) and applicable default rules. This approach (1) promotes consistency of tax treatment by achieving the same economic outcome as for securities lending (e.g., receipt of dividends, stock splits), and (2) is the simplest option for taxpayers, which will facilitate tax compliance and enforcement.

D. Wash Sales (IRC Section 1091)

In general, a sale or other disposition of property results in gain or loss to the seller of such property, depending on whether or not the sold property has appreciated or depreciated from the time when the seller acquired the property and any intervening adjustments to tax basis in the property. Subject to character matching provisions and other limitations, when a seller disposes of property at a loss, the seller is typically entitled to deduct the loss from its taxable income, thereby reducing the taxpayer’s overall tax liability. Section 1091(a), however, provides an exception to that general principle for “wash sales.” A “wash sale” describes a situation where a taxpayer sells a loss position in “stock or securities” and, within a specified time frame, purchases a substantially identical position. Section 1091 provides that a taxpayer cannot take a deduction for losses sustained from the sale of stock or securities if the taxpayer acquires substantially identical stock in a wash sale. No guidance has been issued regarding whether or not digital assets fall within the scope of Section 1091’s loss deferral rules, although it is generally assumed that they do not.

Consistent with the broader policy goal of treating economically similar transactions alike for federal income tax purposes, Consensys believes that the application of the wash sale rules under Section 1091 to digital assets should be addressed through targeted amendments to Section 1091 that extend its application to digital assets. These amendments should, however, take into account the unique nature of digital assets by providing authority for the Treasury Department and the IRS to promulgate rules allowing for certain exceptions or safe harbors where the potential for realization of uneconomic tax losses is outweighed by the burden of compliance (including, e.g., transactions involving short-term capital loss).

E. Constructive Sales (IRC Section 1259)

When a taxpayer holds appreciated property, the capital gains tax on the appreciated value can be a strong incentive not to sell or exchange the property. A transaction that is structured to offer the economic benefits of a sale without triggering tax can provide the taxpayer with access to capital from the appreciated property without the immediate tax burden. The “constructive sale” rules of Section 1259 were implemented to require that the economic benefits realized by a taxpayer through these types of structured transactions be subject to tax, consistent with the treatment of other sale transactions under the Code. Section 1259 requires a taxpayer to recognize gain upon certain sales of “stock, debt instruments, or financial positions,” including appreciated financial positions, and generally includes “short sales of the same or substantially identical property.”7

Currently, digital assets “are not expressly within the scope of [S]ection 1259,” which creates uncertainty as to whether and when investors in digital assets can monetize certain positions in cryptocurrencies through constructive sale transactions without paying current tax.8 In particular, unless Congress adds a new statutory provision to provide that digital assets, like “stock, debt instruments, or financial positions,” are subject to Section 1259, it is not clear that the constructive sale rules (or common law equivalents) would capture cryptocurrency transactions to require taxpayers to recognize gain when they economically dispose of cryptocurrencies in the types of transactions the constructive sale rules were intended to address. Congress should consider targeted amendments to Section 1259 to clarify whether and in what circumstances the statute applies to digital assets.

F. Timing and Source of Income Earned from Staking and Mining

Because there is no third party to maintain the ledgers at the heart of a decentralized blockchain protocol, users must come to a consensus on any changes to the record. The process by which users validate new transactions and the current data state is called a “consensus mechanism,” and protocols allow users to earn cryptocurrency, either via “staking” cryptocurrency rewards or “mining” rewards, in exchange for proposing and/or validating blocks of transactions as entries on the blockchain. There are two general types of consensus mechanisms: “proof-of-work” and “proof-of-stake.” Proof-of-work allows users to validate new transactions and add them to the blockchain, in which case cryptocurrency rewards are allocated to the “miner” for being the first to solve the cryptographic puzzle that underlies the validated transaction. Proof-of-stake requires validators to explicitly stake their own cryptocurrency holdings into a smart contract on the blockchain. The validator must then validate new transaction blocks and must occasionally create new transaction blocks itself, and in exchange, will receive a share of the protocol’s next block reward.

From a tax perspective, Sections 61(a)(1) and 83(a) provide that the receipt of cash or property in exchange for services generally is taxable to the service provider as ordinary income. Treas. Reg. §§ 1.61-3 and 1.61-4 provide that income with respect to self-created property (such as manufactured goods, farmed crops, and certain self-created intellectual property) generally is not realized by a taxpayer until the property is later sold or otherwise disposed of (i.e., not when the property is created), and Section 1221 provides that certain property created by a taxpayer’s “personal efforts” is not treated as a capital asset for federal income tax purposes.9

In the context of cryptocurrency, IRS Notice 2014-21, 2014-16 I.R.B. 938 provides that a taxpayer who receives virtual currency as payment for goods or services must include in its gross income the fair market value of the virtual currency, as of the date the taxpayer received the virtual currency.10 Notice 2014-21 also provides that “when a taxpayer successfully ‘mines’ virtual currency, the fair market value of the virtual currency as of the date of receipt is includible in gross income.”11 The IRS recently stated in published guidance that, under current law, the validation rewards received when a taxpayer stakes cryptocurrency native to a proof-of-stake blockchain qualify as current income.12

While uncertain and subject to debate under long-standing principles of gross income codified in Section 61, which describes “income” for federal income tax purposes, block rewards should be taxed only upon sale or other disposition as “created property” (the product of validating transactions). Although this position is inconsistent with the IRS’s published guidance on the receipt of virtual currency in exchange for services, Congress can clarify the law to ensure that (i) it comports with existing tax law treatment of created property and does not create disparate treatment under the Code for digital assets relative to other types of self-created assets, (ii) it facilitates taxpayer compliance and Treasury Department enforcement, and (iii) it mitigates the risk inherent with an unclear regulatory framework that staking activities will migrate overseas, thereby complicating enforcement and eroding the US tax base.13

1. Please describe the various types of rewards provided for mining and staking.

The mining and staking rewards that users receive in exchange for validating transactions on the blockchain generally consist of either newly-minted protocol rewards or of transaction fees paid by the users whose transaction the miner or staker validates. In some cases, a user may use a “staking services provider” to earn staking rewards, where the service provider often manages the staking process entirely on the user’s behalf (and retains custody of the user’s private keys for the user’s staked cryptocurrency) or the user delegates its staked cryptocurrency to a staking pool while maintaining custody of its private keys. In each case, the service provider removes access barriers to staking and typically earns a fee for supporting the user’s staking activities, but the latter decentralized staking pool method runs its operations entirely on smart contracts and allows the user to retain the private key (and therefore, access to its funds) during the validation process.

In a decentralized staking process on the Ethereum network, liquid staking pools issue sets of fungible Ethereum tokens (called “ERC-20” tokens)  upon a user executing a transaction to participate in the proof-of-stake consensus mechanism. They are commonly called “liquid” staking derivatives (“SDTs”) since they provide the staker with a limited form of liquidity on the staker’s staked position that it otherwise would not have while its assets are staked. SDTs can be freely traded and used across compatible smart contracts in the DeFi ecosystem. The person who controls those SDTs will have a readily usable claim on the staked Ethereum from which the SDTs derive and which continue to generate staking rewards. SDTs usually trade at a small discount to the underlying locked collateral, representing the time value of liquidity and other considerations such as technical and smart contract risks.

2. How should returns and rewards received for validating (mining, staking, etc) be treated for tax purposes? Why? Should different validation mechanisms be treated differently? Why?

Protocol rewards should be taxed only upon subsequent disposition of the rewards, for the reasons set forth below. One alternative that has been proposed with respect to staking transactions is to treat such transactions as giving rise to a disposition for income tax purposes (a) upon sending assets to a liquid staking pool, and (b) when exchanging SDTs for staked assets. This proposal is, however, inconsistent with the treatment of similar existing transactions under the Code and would incentivize users to stop their staking activity in order to free up tokens for conversion into fiat currency to pay applicable taxes. A tax regime that creates an incentive to limit staking activity could undermine the integrity of the consensus mechanisms at the core of proof-of-stake blockchain.

Alternatively, the portion of the staking rewards that is attributable to transaction fees could be taxed upon receipt by the user, which is consistent with the treatment of property received in exchange for services under Section 83. However, disentangling the transaction fees from the protocol rewards could be complex and burdensome for taxpayers, and may, as a practical matter, be so complicated as to be unable to be administered.

3. Should the character and timing of income from mining and staking be the same? Why or why not?

The character and timing of taxable income is of particular importance in circumstances where differences in the timing of revenue recognition can arise between accounting methods and tax principles, which differences can sometimes create taxpayer-favorable tax deferrals. While these comments do not explore accounting considerations relative to the tax considerations the Committee has raised, it is difficult to identify a strong basis for treating staking rewards differently than mining rewards for purposes of the tax character of the rewards. Economically, both types of rewards are generated by the protocol or transferred by other network participants in exchange for validating transactions and participating in the protocol’s consensus mechanism, and the income realized by a taxpayer from those economically identical rewards should be treated the same for tax purposes.

However, with respect to the timing of when the taxpayer realizes income from the rewards, there are certain practical differences between the receipt of staking rewards versus the receipt of mining rewards that may merit different treatment under the tax rules. In a proof-of-work system, a miner will immediately receive its mining rewards and fees as soon as the rewards are earned, and there are typically no restrictions on the miner’s use of the rewards as soon as the miner earns them. In a proof-of-stake system, however, a staker must “unstake” the rewards, which means that the staker will not receive the rewards or fees until the staker makes an affirmative election to enter an unstaking queue and waits to receive the rewards. As it is now, the interregnum between electing to unstake and receipt of the rewards in the staker’s wallet, where the staker will have access to the staking rewards, is around one week, but the timing varies depending on how many stakers have elected to unstake their rewards. The tax rules should account for the timing difference between the time that a taxpayer earns its staking reward and when it can access its reward by considering the staking income realized for tax purposes at the point when a taxpayer can exercise control over the rewards, instead of when the reward is earned and allocated to the staker from the proof-of-stake-specific smart wallet.

4. What factors should be most important when determining when an individual is participating in mining in the trade or business of mining?

Consensys reserves comment on the factors that would be most important when determining when an individual is participating in the trade or business of mining.

5. What factors should be most important when determining when an individual is participating in staking in the trade or business of staking?

Consistent with the principles developed under Section 162 for determining whether a taxpayer is carrying on a trade or business, the following factors that would indicate that an individual is participating in the trade or business of staking:

  • the individual must be involved in staking “with continuity and regularity,”14 which can be determined based on how frequently the individual deposits staked cryptocurrency with proof-of-stake-specific smart contracts associated with the underlying blockchain protocol,

  • the individual carries on the activity consistent with a business, including with respect to its recordkeeping practices (i.e., staking is not merely a hobby or recreational activity for the individual), which can be determined based on the individual’s expertise and recordkeeping practices with respect to its staking activities, and

  • the individual’s primary purpose for staking must be for income or profit, based on the facts and circumstances.15 Because staking activity requires relatively fewer upfront costs, including less hardware and energy, than mining activity, there is a lower barrier to entry for stakers to engage in casual staking activity, and it is thus more difficult to differentiate, based solely on transaction volume and time spent, those stakers that are professionals and those that are not.

6. Please describe examples of the arrangements for those participating in staking pool protocols.

There are four primary models for proof-of-stake staking, some of which involve pools and others that do not:

1) Solo staking

Solo staking, which does not involve staking pools, means running an Ethereum node independently without the support of any third parties. Solo staking requires a minimum of 32 Ethereum tokens (“ETH”), as this is the amount that is required to activate a validator. Solo stakers are responsible for running their own software, which generally was developed by a third party, and generating and securely storing validator keys (used to perform the validator’s on-chain duties) and withdrawal keys (used to withdraw one’s staked ETH once the Ethereum protocol is upgraded to enable withdrawal of staked ETH).

2) Staking as a Service (“SaaS”)

Staking through a SaaS provider also requires a minimum of 32 ETH. Stakers delegate the responsibility for technical and operational risks to the SaaS provider, which typically maintains the software that supports users through the process of depositing 32 ETH and generating their signing and withdrawal keys. Like in solo staking, the user maintains custody of its private keys, meaning the user is the only one who can withdraw its original 32 ETH deposit and the staking rewards earned by its validator. However, unlike solo stakers, the validator keys are held by the software and systems provided by the staking provider. Typically, users pay SaaS providers a portion of the rewards generated by the user’s validator in exchange for these technical services, obviating the need for, and avoiding risks attendant to, the user itself performing the technical duties as described above with respect to solo staking.

3) Non-liquid pooled staking

Staking pools enable users who hold less than 32 ETH to combine their deposits with others and fund a new validator each time the pool reaches a cumulative value of 32 ETH or more. Pooled staking is similar to SaaS in that stakers outsource the technical complexity of operating validator hardware and software to a third party. In contrast to liquid staking pools (described below), users do not receive a liquid token in exchange for depositing their assets.

The most common type of non-liquid pooled staking is through a centralized exchange. Since centralized exchanges hold custody of users’ assets on the users’ behalf, the exchanges can pool user assets and run large numbers of validators.

A notable difference between pooled staking and other staking models is that no single user deposit is tied directly to any single validator in the pool’s validator set. In solo staking and when staking via an SaaS provider, the relationship between the staker and validator can be thought of as a one-to-one relationship (a single user with 32 ETH funds a single validator). In pooled staking, the relationship between stakers and validators can be thought of as a many-to-many relationship (multiple users’ funds are distributed to the multiple validators that make up the validator set).

This many-to-many relationship means there is limited traceability between a user’s deposit and the validator(s) which the user’s deposit is directed towards. Due to this lack of traceability, all of the staking rewards earned, and penalties incurred, by the pool’s validators must generally be mutualized across all pool depositors. The mutualization of rewards and penalties means that no single user will benefit more than others if one of the pool’s validators earns outsized rewards, and similarly, no single user will suffer disproportionate losses if one of the pool’s validators is penalized.

4) Liquid staking pools

A popular subset of staking pools offers what is known as “liquid staking,” which provides depositors to the pool with an ERC-20 token that represents their staked ETH. This token is implemented differently by different liquid staking pools, but broadly, it enables users to track their initial deposit and their share of the staking rewards earned by the pool’s validators. Most ⸺ if not all ⸺ of these pools operate using smart contracts that accept and manage user deposits, track each user’s stake, and allocate staking rewards in proportion to each user’s share of the pool. Liquid staking pools have risen in popularity due to the nature of the Ethereum 2 beacon chain, which required users who were participating in early staking to commit to leaving their staked ETH “locked” in the protocol for an extended period of time. Generally, all staking requires a commitment to remain staked for some period of time until staking withdrawals were permitted by the protocol.

7. Please describe the appropriate treatment for the various types of income and rewards individuals staking for others or in a pool receive.

The economics of a liquid proof-of-stake staking transaction are comparable to a securities lending transaction governed by Section 1058 and discussed above.

Like a securities loan, an ETH liquid proof-of-stake staking transaction involves (a) a transfer of ETH to a liquid proof-of-stake staking platform against the platform’s mandate to exchange SDTs back to ETH (as hardcoded into the logic of the smart contract), and (b) at a later stage, a transfer of SDTs from the user to the liquid proof-of-stake staking platform, whereby the user receives ETH in exchange for SDTs. As discussed above in the context of digital asset lending transactions, so too should staking rewards only be taxed upon disposition of those rewards. However, any fees received by an SaaS provider or pooled staking provider in connection with services provided to stakers should be treated as taxable income to those providers, like any third-party fee in a lending transaction would be under existing tax law.

8. What is the proper source of staking rewards? Why?

The sourcing rules for passive income under US tax law are varied. Interest and dividend income, for example, are sourced to the payor’s jurisdiction of tax residence or incorporation, as applicable, while compensation income is sourced to the jurisdiction where the service giving rise to the income is performed. Rent and royalty income are sourced to where the property is located or used, as applicable. The sourcing rules for staking rewards should follow as closely as possible the existing sourcing rules for economically similar activities. For example, as discussed above, because staking rewards are economically similar to compensation for services, the sourcing rules applicable to wages and personal services could be expanded through a targeted statutory amendment to Section 861 in order to account for staking rewards. In practice, however, that would require stakers to report their location when engaging in staking activities, which may be untenable in the digital asset context where the parties’ jurisdictions of tax residence are often unknown and unverifiable, and may need to be paired with a grant of regulatory authority to the Treasury Department to administer the sourcing rules in a practicable way.

9. Please provide feedback on the Biden Administration’s proposal to impose an excise tax on mining.

Mining activity is highly mobile and can move to a more favorable jurisdiction if the taxes on it are disproportionate to other jurisdictions. Any disparate treatment by US tax law of mining activity relative to other jurisdictions will encourage emerging technologies and economic activity to move offshore and will erode the U.S. tax base.

G. Nonfunctional Currency (IRC Section 988(e))

In general, Section 988 prescribes rules for the treatment of exchange gain or loss from transactions denominated in a currency other than a taxpayer’s functional currency. For taxpayers using the U.S. dollar as a functional currency, the disposition of foreign currency results in the recognition of gain or loss, and exchange gain or loss is accounted for separately from any gain or loss attributable to an underlying transaction. Under Section 988(e)(2), however, an individual will not recognize taxable gain upon the disposition of foreign currency in a personal transaction unless the gain exceeds $200. Since digital assets are not treated as currency under the Code, the de minimis exemption of gain recognized from the disposition of foreign currency that was not held in connection with a US trade or business or held for the production of income does not apply to dispositions of cryptocurrencies.

Consistent with the policy goal of expanding and adapting the existing federal tax framework to treat cryptocurrency transactions the same as other similar transactions, the nonfunctional currency exemption should apply to transactions in cryptocurrency. Consensys believes this issue can be addressed through targeted amendments to Section 988 that extend its application to digital assets.

H. Valuation and Substantiation (IRC Section 170)

Section 170 generally allows a donor to deduct from its taxable income the value of any charitable contributions made during the taxable year. If a deduction in excess of $5,000 is claimed with respect to an in-kind donation of property (with certain exceptions), under Section 170(f)(11), the donor must obtain a “qualified appraisal” of that property. While charitable contributions of cryptocurrency may, like the donation of other in-kind property, be deducted at their fair market value at the time of their transfer to an exempt organization, such donations are subject to existing appraisal and substantiation requirements without the existing carve-outs for publicly traded securities and other liquid assets.

The current legal framework for the valuation and substantiation of charitable contributions should be adapted by a grant of regulatory authority to the Treasury Department in order to account for contributions of cryptocurrency assets.

V. Conclusion

Consensys applauds the Committee’s efforts to empower Americans to use digital assets in new cyberspace ecosystems, whether as business owners or consumers, without confusion or fear of inadvertently running afoul of the tax rules that carry with them severe consequences. The taxation of peer-to-peer transactions, including DeFi activities where a single user is conducting a transaction on his or her own using on-chain software, is a relatively new area of interest for tax authorities, although Consensys is aware of a number of jurisdictions actively exploring different approaches. This is an opportunity for Congress to create reasonable and informed rules that can provide certainty for taxpayers, reduce compliance risk and enforcement burden, and serve as an example for other jurisdictions, including by ensuring the technological growth of blockchain networks in the US is not unduly hampered by the tax Code.

In submitting this response, Consensys seeks to employ its position as a leader in the cryptocurrency economy to assist the Committee in any way that it can.

Respectfully submitted,



William C. Hughes 

Sulolit Mukherjee


[1] For purposes of this letter, Consensys has assumed, and its comments rely on, the definition of “digital assets” in Section 6045(g)(3)(D) of the Internal Revenue Code of 1986, as amended (the “Code”), as such section was amended by the Infrastructure Investment and Jobs Act, Pub. L. 117-58 § 80603 (2021).

This letter does not provide comments on the definition of “digital assets,” including whether or not non-fungible tokens should qualify as “digital assets,” and does not comment on proposed tax information reporting regulations published in the Federal Register on August 29, 2023. Gross Proceeds and Basis Reporting by Brokers and Determination of Amount Realized and Basis for Digital Asset Transactions, REG–122793–19, 88 Fed. Reg. 59576 (Aug. 29, 2023). Because we reserve comment on the proposed information reporting regulations, we are also not responding here to the Committee’s request for input on Specified Foreign Financial Asset, Withholding, FATCA, and FBAR Reporting.

[2] A full list and description of Consensys offerings may be found at

[3] See generally Gross Proceeds and Basis Reporting by Brokers and Determination of Amount Realized and Basis for Digital Asset Transactions, supra note 1. See also U.S. DEP’T OF THE TREASURY, Press Release, U.S. Department of the Treasury, IRS Release Proposed Regulations on Sales and Exchanges of Digital Assets by Brokers (Aug. 25, 2023),

[4] Consensys’s comments here are limited to the treatment of cryptocurrency and digital assets for purposes of the federal tax law only.

[5] All “Section” references are to sections of Code, unless otherwise indicated, and all “Treas. Reg. §” references are to sections of the Treasury Regulations promulgated under the Code.

[6] Although not raised by the Committee’s letter, aside from cryptocurrency lending transactions, there are other circumstances, including the use of smart contracts to exchange a token on one chain for a “wrapped” version of that token on another chain and transfers of cryptocurrency into a “staking” pool (discussed infra at section IV.F), where there has been no change in a person’s economic circumstance and there should also be no realization event under Section 1001. These circumstances frequently arise in interactions between different blockchains but may fit more readily into accepted non-realization paradigms.

[7] Section 1259(c)(1).


[9] Section 1221(a)(3)(A).

[10] See IRS Notice 2014-21, 2014-16 I.R.B. 938 (Mar. 25, 2014).

[11] Id. at 939.

[12] See, e.g., Rev. Rul. 2023-14, 2023-33 I.R.B. 484 (July 31, 2023).

[13] See Bill Hughes, Opinion: The Right Tax Treatment of Staking Rewards Is Clear: Taxation Only After Sale (CoinDesk, April 18, 2022), -sale/. See also Mattia Landoni and Abraham Sutherland, Dilution and True Economic Gain From Cryptocurrency Block Rewards (Tax Notes, Aug. 17, 2020), wards/2020/08/14/2ctmc.

[14] Comm’r v. Groetzinger, 480 U.S. 23, 35 (1987).

[15] See also Treas. Reg. § 1.182-3(b).