The First Shoe Drops

On Monday Janet Yellen convened the President’s Working Group on Financial Markets, with an agenda item to “regulate stable coins with a quickness”. On Tuesday Blockfi received a cease and desist order from the NJ state AG’s office. NJ’s jurisdiction only applies to NJ but the way the law is written “securities fraud” is prosecuted per case meaning if there are 1000 Blockfi customers in NJ there are 1000 lawsuits. It appears the government is going to consider interest bearing stable coin sales as sales of unregistered securities. This may blow a hole in DeFi projects. Staking protocols while they pay rewards for allowing the use of the token to validate the block chain are a different thing. I haven’t participated in any DeFi projects because to me they represent direct competition to banks and you know banks are going to push back. Yellen made 7M in doing speeches before banks in the 2 years between her FED gig and her Treasury gig.

The staking tokens has a different issue. It turns out when “property “is created de novo it is not taxed until it’s sold. Lets say you grow corn. Basically you plant seeds, add sun and rain and come the end of the season you have corn. You then sell your corn and either make a profit or take a loss. The corn becomes taxable upon sale. I recently bought some DOT and decided I like ADA better so I converted my DOT to ADA but the conversion was 2 step from a tax perspective. 1. DOT cash and 2. cash to ADA. It works just like a stock purchase, you buy a stock at a specific basis and sell it at a profit or loss. If profit pay the tax, if loss bank the loss against future profits. My sale generated a small short term capital loss.

I’m staking Ethereum. My stake helps validate the network and that validation pays me “5% rewards”. I get paid in Ethereum. All of the Ethereum I get is brand new and never existed before, just like a farmers corn is brand new corn. In 2014 the IRS determined crypto was property. I just presumed my “stake rewards” would be treated as ordinary income like interest income and taxed yearly, but the way the law is written, if I don’t make a sale, I don’t generate a capital profit or loss, which is what gets taxed. This means I can hold my newly generate ETH for > 1 year and turn a short term event into a long term event. If the market is going up my newly minted reward goes up without being taxed until I sell it. Eventually upon sale the government gets it’s due.

A lawsuit was filed in TN Federal court to determine the tax implications of staking. It provides an interesting wrinkle. Basically one could ladder “rewards”. Lets say I stake 100 ETH. This would throw off 5 ETH/yr. I would then stake that 5 ETH which would throw off 5.25 ETH. 110.25 throws off 5.5125 for a total of 115.7625 total ETH and so forth. 1 year and a day after the first 5 ETH get thrown off they become LT cap gain eligible. In 3 years your ETH has increased 15% with no taxable event and no additional funding. Of course if ETH goes from $2K to $20K those 5 coins go from $10K to $100K in value.

I’m steering away from stable coins right now. Blockfi is a monster player and will likely fight this “ruling” in NJ since their business model is to trade in DeFi. DeFi will be a world wide market and the rules in NJ will not be the last word in this. I haven’t decided about doing more staking. I need to further research the implications. So many rabbit holes, so much complexity, so little time. If you don’t attempt to own the complexity, in the end it will own you. You can’t jut stick your head in the sand with a 60/40 portfolio and a 25x 4% rule.

4 Replies to “The First Shoe Drops”

    1. Coinbase It’s paying 5% but it pays in ETH. The price of ETH went up so it’s paying about 800/mo right now, more than I expected.

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