Taxing times at the OECD as Proof of Stake Ethereum ready to hit the shelves
The OECD is an intergovernmental organisation founded on stimulating progress in world trade. With an annual budget of €386m it is far from the largest economic body of its kind. But its proclamations still hold serious weight.
So it was particularly interesting to see the 37-country body release a detailed report on the emerging issues around the international tax treatment of cryptoassets. And especially to see the implication that the OECD vastly prefers Proof of Stake to Proof of Work.
The first phase of Ethereum 2.0 is due to land on 1 December 2020. In this, Vitalik Buterin’s ‘world computer’ network will begin its massive switch from Proof of Work to Proof of Stake. So the growing interest in Proof of Stake mechanisms makes a lot of sense.
And the OECD gives Ethereum a much more glowing report than Bitcoin. The authors write: “Due to differences in design, Ethereum, the second-largest virtual currency by market value, processes more than twice as many transactions as the bitcoin network while using less than one-third of the electricity consumed by Bitcoin.”
Ethereum is moving towards Proof of Stake in an effort to reduce its energy intensity, they write, noting that staking instead of mining “could help to reduce energy use while also addressing scalability and latency issues.”
That the OECD favours Proof of Stake cryptoasset projects comes down to two very specific points.
The first is that changing consensus mechanisms from mining to validation means that the tax treatment of cryptoassets could be more easily defined under existing laws.
Regulators and financial bodies in particular much prefer the line of least resistance when adjudicating on fintech products. Creating vast new laws for cryptoassets has made gigantic headaches for lawmakers worldwide. Especially when understanding is so thin on the ground.
Only two countries thus far have ruled on the tax treatment of proof of stake: Finland and Australia.
The Vero Skatt, Finland’s tax administration, clarified in 2020 that income from Proof of Stake ‘forging’ or ‘staking’ is considered to be a return on existing assets — the cryptoassets that validators already own. Income gained from block rewards or transaction fees is therefore treated as capital income. By contrast income from mining on Proof of Work cryptos like Bitcoin is treated as non-capital income.
The Australian Tax Office says that new cryptotokens received from forging or staking “are treated as ordinary income when the new tokens are received”, whereas tokens received via mining should be taxed for the first time when they are sold.
The inherent complexity of determining when mining rewards are sold means that tax offices are unlikely to gain as much revenue from Proof of Work crypto rewards compared to Proof of Stake.
So that’s the first point.
The second really big difference for the OECD comes down to the environmental impact of Proof of Work. It should come as no surprise to regular readers that the largest Proof of Work cryptocurrency is Bitcoin.
So let’s dig into this.
The nature of the Proof of Work consensus mechanism — the method by which the network is secured — are that miners compete to validate blocks of transactions by using computing power to solve increasingly difficult cryptographic puzzles.
This state of affairs has produced an ever-growing ASIC-chip arms race, as more powerful machines can tear through mathematical calculations faster.
“The energy use of the Bitcoin network is…both a security feature and a side effect of relying on the ever-increasing computing power of competing miners to validate transactions through Proof of Work,” says George Kamiya, writing for the International Energy Agency’s Bitcoin Energy Use: Mined the Gap report.
In truth, the extreme energy use needed to secure the Bitcoin blockchain and process transactions has become a stick to beat the cryptocurrency with in the world press. It was only in August 2020 when reports started to surface that Bitcoin’s SHA256 hashrate was using more power than seven nuclear plants combined.
One widely-reported study published in Nature Climate Change journal in October 2018 also suggested that power-hungry Bitcoin could produce enough CO2 emissions to push global warming above the critical 2°C level inside 30 years.
This came with an author caveat that this would be the result “should [Bitcoin] follow the rate of adoption of other broadly adopted technologies”. Despite a decade of scepticism there now appears little doubt that Bitcoin will proliferate in this way.
Across 2019 the Bitcoin network consumed around 63.95 TWh of energy, according to the Cambridge Judge Centre for Alternative Finance. That’s about 0.25% of global electricity use, and by comparison more than the energy consumption of Switzerland (8m population) and Czechia (10.5m population).
2020’s results show no sign that Bitcoin is slowing down.
As of 20 November 2020 Bitcoin’s total annual electricity consumption was 87.785TWh, which makes it larger than Finland with 82.79TWh per year and Belgium, which consumes 82.19TWh annually. Bitcoin’s closest rival for energy usage is Pakistan, a country of 212 million people.
The implication is that — if it were a country — Bitcoin would be the 35th largest on earth. And it is growing daily. The consequences for future world energy use are really rather spectacularly large.
So, because it removes miners from the equation and instead relies on validators who already own a stake in the cryptocurrency or cryptoasset they are seeking to secure, Proof of Stake effectively ends the struggle for ever-greater computing power.
That’s the OECD’s take, anyway.
Ethereum’s much-lauded switch away from Proof of Work and into Proof of Stake is mentioned in the report as a harbinger of where the cryptoasset industry could head in future.
So the fruit of this cryptographic labour could not only have an immediate impact on the industry, but also on how favourably the world’s biggest economic authorities view crypto itself.