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U.S. lawmakers struggle to understand the blockchain industry. But some blockchains are more misunderstood than others, according to the latest crypto-focused lobbying group taking the fight to D.C.
A group of cryptocurrency industry insiders and attorneys recently launched the Proof of Stake Alliance (POSA)—an organization dedicated to educating regulators on the key differences between proof-of-stake (PoS) blockchains, such as the much-ballyhooed Cosmos, and the energy-guzzling proof-of-work systems, like Bitcoin.
With any luck, they hope to convince both Congress and regulatory agencies, such as the SEC and FinCEN, that not all blockchains should be treated the same. And with Ethereum’s planned transition from a proof-of-work to a proof-of-stake system scheduled for 2020, the way in which these specific networks are regulated could have vast implications for the industry.
“Stakable assets have unique legal, regulatory and tax issues, which—given the number of protocols utilizing this consensus mechanism—must be addressed sooner rather than later,” said Ryón Nixon, a founding board member of POSA, in an interview with Decrypt.
Nixon, a founding partner of blockchain law firm Horizons Law, is joined on POSA’s board by fellow attorney Evan Weiss, Polychain Capital COO Matt Perona, and Santiago Roel Santos, the president and co-founder of EON, a staking-as-a-service blockchain company. The group is also supported by a strong contingency of a dozen inaugural members, including the Binance-backed Harmony, Blockfolio, the Interchain Foundation (a Cosmos-focused organization), and TQtezos (a Tezos incubator).
The goal, Nixon said, is for POSA to achieve the oft-discussed but seldom defined “regulatory clarity” that the cryptocurrency industry so desperately seeks—all while promoting the growth and adoption of PoS networks.
Blockchain not Bitcoin
Unlike Bitcoin and Ethereum currently, PoS blockchains don’t require large amounts of computational power to mine or validate block transactions. Instead, “mining” power is based on the amount of the underlying digital token that each miner (referred to as “validators” on PoS systems) owns—their “stake” in the network. These validators essentially bet on which block will be added next to the chain and receive rewards in proportion to their stake when they are right.
And while regulators are beginning to get a handle on how to treat cryptocurrencies like Bitcoin, the same can’t be said for their proof-of-stake counterparts, including Ethereum-based tokens down the road, according to Nixon. “Currently, there exists no framework for the proper legal or tax treatment of stakable assets,” he said.
The tax issue is a big deal—in fact, it’s the most pressing issue that PoS blockchain businesses currently face, said Angela Angelovska-Wilson, an attorney and co-founder of DLx Law, and an advisor to POSA. “Tax treatment for rewards and tax implications on staking-as-a-service providers” are particularly important to sort out, she said.
Nixon offered the following example: When users on PoS networks delegate tokens to a validator, who then stakes the assets, the validator takes a small cut of the rewards from the PoS network before giving the remainder back to the user. “In this scenario, how many taxable events would this be?” he posits. Is it taxed as income or capital gains? “The stakes, no pun intended, of addressing these issues are obvious,” said Nixon.
High stakes
POSA is particularly concerned with ensuring that Congress gives “clear and reasonable guidelines for the treatment” of these assets. But other regulatory issues, such as lingering questions surrounding the applicability of federal securities laws, are similarly urgent, according to the Alliance.
It’s unclear, for example, if such agreements between blockchain network asset holders and validators—referred to as “delegations”—could be considered “investment contracts” and therefore fall under the purview of the SEC, Nixon said.
“From our conversations with the SEC, we understand they are looking into the issue of whether a delegation constitutes an investment contract,” he said. “POSA will be engaging [international law firm] Paul Hastings to draft a staking whitepaper to be used to engage with the SEC,” said Nixon. POSA plans to make the whitepaper, as well as any other similar documents, available to each of its members.
Additionally, POSA is working closely with Angelovska-Wilson’s DLx Law to draft a no-action letter addressed to the Financial Crimes Enforcement Network (FinCEN) that could potentially have wide-reaching ramifications. “This no-action letter will request a ruling stating that staking as a service providers and validators are not considered money-service businesses (MSBs) under the [Bank Secrecy Act],” said Nixon. “We believe there is a high likelihood of response given our conversations with key officials at FinCEN, and FinCEN's May 2019 guidance—which stated mining-pool operators are not MSBs.
Without getting clear answers from each of the relevant agencies, as well as Congress, businesses on the cutting-edge of this technology—including those building on PoS networks such as Cosmos, Tezos, Polkadot, and soon, Ethereum—will continue to flee overseas, according to POSA.
And while the rapidly evolving crypto industry could, as a whole, do with some much-needed clarity from Washington, POSA’s singular focus is based on where it believes the industry is going, and not where it’s been.
Said Nixon: “The crypto-community already has a myriad of issues under the current securities and tax regimes. PoS networks and their participants potentially face even more issues.”