Pre-Migration OHM Staking Considerations

Although the migration to gOHM is well underway, many US based Ohmies are going to be a bit more focused currently on the tax implications of staking pre-migration sOHM as that is the token many of us interacted with during 2021. This article elaborates on content that was originally presented during Episode 4 of Agora TV. The video for that event can be found on YouTube and is linked below.

While we were able to hit the high points during that discussion, we wanted to develop the thoughts and concepts outlined in greater detail. By adding additional context, we hope that readers from non-US jurisdictions will be able to relate these concepts to the specific tax rules within their countries so that they might be able to appropriately discuss with their tax advisors.

Given the absence of official guidance from the tax authorities, we try to provide a conceptual framework through which to view cryptocurrency transactions. For purposes of this article, we are going to focus on the concept of staking pre-migration sOHM and the associated potential tax implications.

Staking 101:

It is likely that most new crypto enthusiasts will get exposed to the concept of staking through the purchase of certain cryptocurrencies on a centralized exchange such as Coinbase. Holders of coins as diverse as ETH and XTZ can earn an APY of 2–5%, or even more in some cases, and the exchange handles all of the messy stuff behind the scenes.

As with many other crypto tax issues, the IRS hasn’t specifically issued guidance on how to handle staking transactions so we are once again working from first principles. Within the tax law, there is a hierarchy of support starting with the Internal Revenue Code, Treasury Regulations, and Court cases at the top of the heap. Guidance stemming from items like Frequently Asked Questions (“FAQs”) are among the lowest forms of authoritative support. Naturally, most of the support we have received so far is in the form of a slowly expanding list of FAQs.

In the absence of formal guidance, we look to what type of transaction where guidance does exist in order to attempt to come up with a reasonable approach. From the perspective of the investor, staking on a centralized exchange or through a wallet such as Vauld, Trust, or Exodus most closely resembles the receipt of interest or dividends if we are thinking about the transaction in TradFi terms. Various platforms will likely offer different APYs as well for the same coin. Accordingly, the consensus within the crypto community for these types of investments has become that any such staking rewards are treated as taxable income upon receipt.

Staking sOHM:

With regards to sOHM, does that mean we rely upon the above consensus around staking and conclude our analysis since Ohmies also receive staking rewards based upon their holdings?

Sorry to break it to you Ohmie, but the staking rewards received from sOHM have some unique characteristics that need to be appropriately considered in order to reach a reasonably supportable position for purposes of filing your 2021 US tax return.

The more significant variances between the two staking situations are as follows:

Unlike the scenario described above, all stakers of sOHM receive the same reward percentage whereas other staking mechanisms provide different rates based upon the platform;

sOHM are staked within the protocol themselves and not on a third-party staking platform through the utilization of a service provider;

The sOHM staking rewards received by an investor represent their share of a proportionate increase in the amount of total OHM in circulation which is not the case in the scenario described above. This is due to the rebasing nature of OHM.

As tax practitioners, we need to focus on the specific facts and circumstances associated with a transaction and thus need to consider whether these variances have any impact on the crypto staking analysis that has been done previously with regards to other tokens.

With regards to these variances, our feeling is that the first and last variances are intertwined and are of key importance. Having the same rate of return for everyone receiving staking rewards is an indication that something different might be going on here. If earning staking rewards on ETH, for example, we can easily see that the rates received across platforms are not consistently uniform. With OHM the rate is the same for all stakers. A staker of ETH is simply receiving additional ETH but the receipt of that ETH is not proportionately distributed to all stakers. The overall supply of ETH is not increasing in synch with the receipt of the staking rewards by an individual investor.

For an Ohmie, however, all stakers receive rewards at the same rate which is due to the fact that the underlying currency is actually undergoing a “rebase” each time that staking rewards are distributed. A rebase is mechanism through which the protocol has minted new coins (expanding the available supply) and since the value of the circulating coins are pegged 1:1 with the value of the staked coins, investors that have staked coins with the protocol also need to receive a proportionate increase to their staked balance to keep everything in synch.

Now that we understand some potentially significant differences arising from the variances in the staking mechanism, we need to put our TradFi hat back on to see if staking OHM still most closely resemble the receipt of interest or dividends. Based upon our identification of the variances and our analysis, it would seem that it does not. Given the rebasing mechanism, the receipt of sOHM staking rewards most closely resembles a stock split — an unusual one, understandably as they happen roughly every eight hours and are spread like peanut butter. Stock splits do not impact the underlying economics or entity capitalization in any way, but simply increases the number of shares that those values are spread across. Stock splits do not result in a taxable event requiring the recognition of income currently, but they do require adjustments to the cost basis of our holdings which we will outline in a subsequent article.

We wish to make clear that this analysis and proposed treatment is speculative in nature as we do not have formal guidance from the IRS on these types of transactions, but we wanted to share this concept with the Olympus community so that each holder to can evaluate it based upon their individual facts and circumstances in conjunction with their personal tax advisor.

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, and tax matters

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And written by….@BowTiedNaga

Want to especially thank Da,vid for his help and support throughout this process. Much appreciated Ohmie!