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Taxation of Ethereum Staking in Germany

Ethereum 2.0 enables staking

Staking on the Ethereum blockchain offers crypto investors the opportunity to generate additional revenue. Staking is enabled by the proof-of-stake mechanism, in which investors, in simple terms, withdraw Ether (ETH) from their power of disposition and make it available to the network. Staking on Ethereum became possible with an update in December 2020.

Ethereum moves to proof-of-stake

Ethereum's developers have been working for some time to transition the network from the proof of work (PoW) consensus mechanism to proof-of-stake (PoS). Such procedures are necessary for blockchains to determine which participant is authorized to verify transactions and record them in what are known as blocks. The objective is to make Ethereum more efficient, environmentally friendlier and more future-proof by moving away from proof of work and making power-intensive mining obsolete in the long run. Accordingly, Ethereum's developers plan to rely exclusively on the significantly less power-intensive variant to ensure the network's functionality in the future.

This needed to be achieved by a complete transition to proof-of-stake (PoS). Phase 0, which was initiated with the start of the update in December 2020, already enabled staking on Ethereum 2.0 on the beacon chain. This new blockchain is based on the proof-of-stake architecture and existed in parallel with the original Ethereum proof-of-work blockchain (Ethereum Mainnet) until 2022. In September 2022, both blockchains merged.

How does Ethereum staking work?

To ensure the security and functionality of the beacon chain, the network needs active participants - known here as validators - who propose blocks, verify them and vouch for the validity of the blocks. For this service, participants collect commissions (staking/block rewards).

To become a validator, investors must provide 32 ETH, which will be deposited and frozen on the Ethereum blockchain (Ethereum mainnet). In return, investors then receive 32 ETH2 on the new beacon chain. The deposit serves as a proof-of-stake that the necessary collateral security has been provided and that the investor is allowed to participate in the consensus building of the network. For the time being, a retransfer is not possible for the contributed coins.

However, for investors who want to record profits due to the staking process, depositing the 32 ETH is not the end of the story. In addition, investors are required to have some technical knowledge as they must permanently run Ethereum validator software (client node software) online on their computer. However, the requirements for the necessary hardware are low, which is why the power costs are also low. In this respect, Ethereum staking nevertheless requires the performance of an active part of the staking operators in a way. For this purpose, the Ethereum 2.0 Launchpad provides a step-by-step guide to successful staking to interested users.

Ethereum staking pool

As an alternative, you can also stake less than the required 32 ETH with various providers. Staking pool providers such as Rocket Pool have the advantage that, in addition to the smaller amount of ETH required, users are relieved of the technically demanding hurdle of implementation.

On Rocket Pool, a staker receives one rETH as compensation for each ETH that is staked. Since this rETH increases in value each year (e.g., 5 percent), the staking reward is embedded in the rETH. Staking profits are therefore not distributed on a daily or weekly basis, but can be realized by exchanging rETH back into ETH at any time in the future. This creates a certain degree of leeway in taxation.

What are the staking rewards in Ethereum 2.0?

The profit and thus the amount of staking rewards depends on how many people have contributed their 32 ETH to the network. Accordingly, the return depends on the absolute number of validators or the number of Ethereum contributed. The more active participants involved in staking, the lower the rewards are, but, on the other hand, the more secure the network is. Thus, conditional to this figure, the maximum annual return can range from 2 to 20 percent.

What are the risks when staking with Ethereum 2.0?

Stakers will always receive their full bonus only if the validator operated by them is online and up to date. In this respect, stakers must ensure the proper operation of all technical requirements.

Moreover, validators will face severe penalties if they act in breach of duty or in bad faith. Accordingly, attempts to defraud the system result in the (pro rata) loss of deposits (known as slashing).

The contributed coins (32 ETH) cannot be withdrawn at this stage, which is why the transfer is irreversible until further notice. Stakers are therefore at risk of not being able to access their deposits for a long time, as they will remain locked until the Ethereum 2.0 update is completed.

How are Ethereum staking rewards taxed in Germany?

The tax assessment with regard to the staking rewards in Germany has still not been conclusively clarified to date.

1. Classification as commercial income

The concept of commerciality from Paragraph 15 (2) of the German Income Tax Act (Einkommensteuergesetz, EStG) is decisive for the existence of commercial income. If the income is deemed to be commercial, it is also subject to trade tax. However, the commercial nature of the business is contingent to high requirements. In particular, independence must be granted here, which is generally denied in the case of staking. Investors who make their ETH available to the network lose control over their coins. Similarly, the selection of participants called up for verification, and, by extension, those who receive rewards at all, is random. Since the participant therefore has no control whatsoever over the income from staking, this argues against the concept of independence and, consequently, against its classification as commercial income.

Notwithstanding, the tax authorities, however, have occasionally, in the past, regarded the received staking rewards as commercial income in individual cases. This is also the approach taken by the German Federal Ministry of Finance (BMF). Albeit, a final supreme court decision on this issue is still pending.

2. Classification as income from other services

It seems more plausible to tax the staking rewards as income from other benefits pursuant to Paragraph 22 No. 3 EStG based on their inflow value. The scope of application of the standard is very broad, which is why, in principle, any action, tolerance or omission results in taxation, provided that a consideration is thereby initiated. This is to be affirmed in the case of participation in staking. In order to serve the functionality and security of the network, the participant makes their crypto assets (ETH) available to the network and may, in some circumstances, receive a reward as consideration. The income received is then taxed at the participant's personal tax rate.

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Specifics of the taxation of Ethereum staking

A prerequisite for taxation, however, is always that the staker has actually received the rewards (inflow/outflow principle). There are doubts about this in Ethereum staking within the scope of the Ethereum 2.0 update, which has not yet been completed.

What is necessary is that the taxpayer obtains the (economic) power of disposition over the staking rewards. When this is the case, it depends on the circumstances of the individual case. Thus, it can be argued that the economic power of disposition occurs only from the moment when the staker can trade the rewards and use them as a means of payment. However, since Ethereum stakers cannot access their rewards at this point in time because they are still locked until the final completion of the Ethereum Update 2.0, there is still no economic power of disposition and therefore no inflow for this period. Accordingly, taxation would only be possible once the Ethereum 2.0 update is completed.

For the determination of the economic power of disposition, however, a case-by-case consideration is decisive, which is why one could also, with good reasons, come to a different conclusion here. On account of this, it makes sense to seek advice from an experienced crypto tax lawyer or tax consultant in order to develop an optimal strategy for action and to minimize corresponding tax risks. We will gladly make ourselves available to support you.

What is the impact of staking on the holding period of the staked coins (32 ETH)?

Stakers do not have to be concerned about a holding period extension. Although this was discussed intensively for a long time, the holding period extension was ultimately deleted from the final version of the German Federal Ministry of Finance (BMF) letter. Crypto investors can therefore breathe a sigh of relief and should not have to anticipate a 10-year extension of the holding period from the tax office in the future.

WINHELLER advises on tax issues regarding Ethereum staking

Do you have questions about the taxation of Ethereum staking? Would you like to know if your cryptocurrencies are subject to a holding period? Do you need help with your crypto tax return? Your contact persons for cryptocurrencies are

  • Attorney Stefan Winheller (Certified Specialist for Tax Law) and
  • Tax Advisor Jürgen Schwendemann.

Take advantage of our many years of expertise in the taxation of cryptocurrencies. Contact us by phone (+49 69 76 75 77 80), via e-mail (info@winheller.com) or via our contact form for taxation of cryptocurrencies.

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