In the constantly evolving global blockchain ecosystem, one legal grey area is staking. While some countries (e.g. Hong Kong) aim to blaze the global legislative trail, arguing that specific regulations provide clarity and safety, others (e.g. New Zealand) are wary of premature restrictions that could stifle innovation, particularly given Singapore's decision to ban staking for retail clients and the controversial IRS Revenue Ruling of August this year.
Staking is a process that involves 'locking' up a certain amount of a digital currency in a blockchain network to support its ongoing operations. In return for this commitment, participants or 'stakers' are rewarded with additional cryptocurrency. Staking has gained popularity as a way for cryptocurrency holders to earn passive income while contributing to the maintenance and security of the blockchain network.
Europe has taken significant steps toward comprehensive cryptocurrency regulation with the introduction of the Markets in Crypto Assets law (MiCA). While MiCA covers a wide range of crypto-related activities, staking is conspicuous by its absence. European Central Bank's Christine Lagarde has called for the inclusion of staking in a MiCA sequel, but there is currently no timeline for a MiCA2, leaving uncertainty in the interim.
Staking is a fundamental aspect of the blockchain ecosystem and should not be overlooked, especially following the recent one year anniversary of The Merge, where the Ethereum blockchain (the native blockchain of ETH, the second largest cryptocurrency in terms of market capitalisation) switched from a proof-of-work system to a proof-of-stake system, with a baked in staking return to reward those securing the network. The lack of clarity has forced regulators to consider categorizing staking as either a form of custody (when in the case of Eth it is plainly not custodial in nature), banking or a yield based product, leading to confusion within the industry.
Source: https://ethereum.org/en/roadmap/merge/
Switzerland is a prime example of how an ambiguous regulatory environment can create problems. The Swiss Blockchain Federation recently warned of a shift in practice by financial regulators at Finma, restricting staking to licensed banks. This move has raised concerns about stifling innovation and competitiveness in the country. Regulators argue that in some forms of staking, bankruptcy could jeopardise client assets, necessitating a more stringent, bank-like approach.
Singapore has also taken a restrictive stance, forbidding crypto providers from facilitating staking for retail clients. Even in the European Union, new tax rules like DAC8, designed to cover staking, have been introduced before a clear definition of the practice exists. These regulations would require crypto providers to report staking profits made by their clients, adding to the legal uncertainty surrounding staking.
The Cardano Foundation, a nonprofit promoting a major blockchain that relies on staking for transaction validation, shared its concerns about the regulatory landscape with CoinDesk in a recent article on this issue. The Foundation's Chief Executive Frederick Gregaard believes that the situation in Switzerland can be resolved, but it highlights the challenges posed by the lack of clear staking regulations, particularly in the context of The Merge.
While discussions are ongoing in Europe and the UK regarding staking regulations, there is a delicate balance between providing legal clarity and allowing the sector to mature. Rushing into hastily drafting regulations can stifle the growth of an industry that has the potential to revolutionise various sectors of the economy.
These regulatory gaps must also be addressed in Australia. Although it is disappointing that the Board of Taxation's report on crypto-tax was delayed from 30 September 2023 to 29 February 2024, this delay offers an opportunity for a more comprehensive and technologically neutral approach to be adopted.
It is imperative that lawmakers and regulatory bodies take their time to understand the nuances of blockchian technology fully and craft regulations that not only address the specific challenges of the blockchain industry, but also promote innovation and fairness. Australia has a unique opportunity to lead in creating a regulatory framework that fosters innovation, safeguards investors, and promotes a level playing field for all participants. By Michael Bacina, Steven Pettigrove and Luke Higgins