Taxation of Ethereum Staking in Germany
Ethereum enables staking
Ethereum's switch to the Proof of Stake (PoS) model opens up numerous new opportunities for investors to stake their ETH and earn rewards in the process. Staking on Ethereum was made possible with an update in December 2020. The developers of Ethereum have long been working on converting the network from the Proof of Work (PoW) consensus mechanism to Proof of Stake (PoS). By moving away from Proof of Work, Ethereum became more efficient, environmentally friendly and future-proof. The full transition to Proof of Stake (PoS) took place in mid-September 2022 and went down in history as “The Merge”.
Why are tax issues so important for ETH staking?
Ultimately, a potential investor wants to increase the return on his assets. Therefore, tax considerations should also be taken into account, as these have a considerable influence on the after-tax return. It is clear that returns that are taxed at the marginal tax rate of 42-45 percent effectively result in less asset growth than returns that may be received completely tax-free or may be subject to the flat tax rate of “only” 25 percent.
ETH staking with own node
Staking with your own node is considered the “gold standard” in the Ethereum network. To become a validator, investors must provide 32 ETH, which are deposited and frozen on the Ethereum blockchain (Ethereum mainnet). This ETH must be paid into a special smart contract to enable the validation of transactions. In return, investors then receive 32 ETH2 on the new beacon chain. The deposit serves as proof of stake that the necessary security has been provided and that the investor may participate in the network's consensus building process. For the time being, the coins deposited cannot be transferred back.
Requirements:
- Minimum amount: 32 ETH
- Technical requirements: A stable server or computer that is constantly online to run the validator software client node software (e.g. Prysm, Lighthouse, Teku).
- Technical know-how: Basic knowledge of how to set up and maintain a node is required.
How it works:
As a validator, you have full control over the setup and receive all rewards for staking. The rewards vary depending on the network status and can range from 4 to 8 percent per year. This means that an investor with 32 ETH could earn around 1.6 ETH per year with an average return of 5 percent.
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What are the risks of staking with Ethereum?
Stakers only ever receive their full premium if the validator they operate is online and up-to-date. In this respect, stakers must ensure that all technical requirements are met.
In addition, validators face severe penalties if they act in breach of duty or in bad faith. Accordingly, attempts to defraud the system will result in the (pro rata) loss of deposits (slashing).
ETH pool staking with validator position
Pool staking offers a flexible way for investors to participate in Ethereum staking without having to provide the full 32 ETH themselves. Several investors can pool their resources to jointly operate a validator.
Examples:
- Rocket Pool:
With Rocket Pool, users can participate as node operators from as little as 16 ETH. The other half is provided by the pool. Rocket Pool is also a tokenized variant, which is discussed separately below.
- StakeWise:
This platform also allows users to act as validators by depositing their ETH into a pool to reach the required 32 ETH. StakeWise offers the possibility to stake in so-called “vaults”, where users can set specific conditions for staking, including the selection of node operators. The platform shows how many osETH (StakeWise's liquid staking token) will be paid out. StakeWise is also a tokenized variant.
To act as a node operator, you must create your own vault on the StakeWise platform. This requires the necessary technical knowledge to operate a validator node. The validator software must be installed and configured. Once the vault is set up, delegations can be accepted from other users who wish to stake their ETH in this vault. This makes it possible to reach the required 32 ETH for the validator position by bundling the deposits of other users. The osETH can be used for minting up to 90 percent of the stake.
Requirements:
- Minimum amount: Rocket Pool requires at least 16 ETH, StakeWise also requires at least 16 ETH.
- Technical requirements: A certain amount of technical knowledge is required for both cases.
How it works:
Rewards are distributed proportionally to all participants based on the validator's stake and performance. A node operator with 16 ETH could earn around 0.8 ETH per year with a return of 5 percent.
ETH staking without a validator position
For investors who do not want to or cannot act as validators themselves, there are various options for staking without a direct validator position.
a) Staking pools
- Rocket Pool:
Without the need to act as a node operator, Rocket Pool allows participation for users holding less than 16 ETH. This platform also provides a tokenized option, which will be discussed in more detail later.
- Ankr:
Ankr provides a decentralized infrastructure for Ethereum staking and allows users to act as validators with any amount (less than 32 ETH). This is done by providing liquid staking tokens (ankrETH), which represent the staking rewards and at the same time open up access to DeFi opportunities. This provider is therefore also a tokenized variant.
b) Staking on exchanges
Centralized crypto exchanges such as Binance or Kraken offer staking services. Here, users can make their ETH available without having to operate a node themselves.
Requirements:
- Minimum amount: Often there is no minimum requirement or only very small amounts (e.g. 0.1 ETH).
- Account with an exchange: Users must have an account with the relevant exchange.
How it works:
The exchange operates the validator and distributes the rewards to the users. This is usually done after deducting a service fee (e.g. 1 percent).
c) PPS models (Pay Per Share)
PPS is a remuneration model in which miners receive a fixed remuneration for each “share” they make available. Miners are paid for each valid share, regardless of whether the pool finds a block or not. This provides a predictable source of income. Since payments are not dependent on luck, the risk for miners is lower, especially for those who do not want to stay in the pool for long.
Requirements:
Participation in a mining pool: Users must join a mining pool.
How it works:
For example, if a miner contributes 10,000 shares and the pool offers a PPS reward of 0.001 ETH per share, they would receive a reward of 10 ETH. This reward is paid regardless of whether the pool finds a block or not.
Examples of pools with a PPS model are Ethermine and F2Pool.
Ethermine procedure:
- Registration: Users must register on the Ethermine website and deposit their ETH (from 0.1 ETH) into the staking pool.
- Pool staking: The collected ETH are bundled in a pool to reach the 32 ETH for the validator position.
- Rewards: Users will receive rewards based on the staking revenue generated by the validators. These rewards are distributed in proportion to the amounts deposited.
Process at F2Pool:
- Deposit: Users can deposit their ETH into the F2Pool staking pool. There is no minimum requirement of 32 ETH, which facilitates access.
- Validators: F2Pool pools deposits to reach the required amount for validator staking. Validators are then selected from the pool deposits.
- Rewards: Similar to Ethermine, users receive rewards based on the pool's earnings. These are regularly distributed to the participants.
d) PPLNS models (Pay Per Last N Shares)
PPLNS is a performance-based model where rewards are distributed based on the last N shares. This model can lead to higher rewards if miners are able to generate many shares within the PPLNS window, but also carries the risk that they will not receive any rewards in times without block discovery.
Requirements:
Participation in a mining pool: Users must join a mining pool.
How it works:
When a pool finds a block and a miner has participated in the last N shares (e.g. the last 1,000 shares), their reward is calculated based on their share of those shares. For example, if a miner has contributed 200 of the last 1,000 shares and the pool receives a block reward of 2 ETH, they would receive (2001000)×2=0.4 ETH(1000200)×2=0.4 ETH.
Examples of pools with a PPLNS model are SparkPool and Nanopool.
SparkPool procedure:
- Registration: Users must register on the SparkPool website and deposit their ETH into the staking pool.
- Pool staking: Deposits are pooled to reach the required 32 ETH for the validator position.
- Rewards: The platform uses a PPLNS payout system that distributes rewards based on recent shares. The amount of the reward depends on the number of shares provided by users during the relevant period. Users receive rewards based on the earnings of the pool. These are distributed to participants on a regular basis.
NanoPool process:
- Deposit: Users can deposit their ETH into the NanoPool staking pool.
- Validators: Deposits are pooled to reach the required amount for the validator position. NanoPool selects the validators from the pool deposits.
- Rewards: The platform uses a PPLNS payout system that distributes rewards based on recent shares. Similar to SparkPool, users receive rewards based on the pool's earnings. These are paid out several times a day.
The choice between PPLNS and PPS depends heavily on the miner's individual preferences and risk appetite. Those looking for stability and predictability might prefer PPS, while miners willing to take some risk to achieve potentially higher rewards should consider PPLNS.
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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.
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
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