Proposal to address tax and regulatory considerations surrounding liquid staking

As Lido continues to innovate, and liquid staking becomes popular across networks, we must ensure that the ecosystem can continue to thrive in the United States and globally.

About POSA:

Since 2019, the Proof of Stake Alliance (POSA) has sought to create conditions that allow staking to flourish through wider adoption. To date, we’ve:

  • Pushed back on the notion that newly created tokens should be treated as income by bringing the first lawsuit on crypto taxation against the IRS and engaging top legal experts to educate many others on the proper taxation of staking rewards.
  • Worked (and are still working) to remove almost overlooked onerous reporting requirements on peer-to-peer crypto transactions in the Senate Infrastructure Bill.
  • Collaborated with FinCEN/OFAC to facilitate the commercial development of staking as a service (“StaaS”), with the goal of ensuring that validators are not treated as financial entities.
  • Worked with the SEC to ensure that staking service providers were not viewed as offering investment contracts

And we’re now dedicating our resources to address regulatory, policy, and tax concerns surrounding liquid staking, as we believe its success is crucial for the future of Proof of Stake (PoS) networks.

Context:

To date, most regulators have not provided specific guidance with regard to PoS; instead, they’ve focused (somewhat minimally) on addressing basic issues surrounding Proof of Work (PoW) networks. This has resulted in a regulatory and legal gray area that is even more pronounced for PoS networks. As liquid staking involves the creation of complex primitives on top of these PoS networks, there is even more complexity and legal uncertainty surrounding how various tokens and smart contracts in these ecosystems should be understood, taxed, and regulated.

To ensure that Congress, Regulatory Agencies (CFTC, SEC and FinCEN) and the broader public are educated on these issues, and that these ecosystems can continue to flourish, we propose working with a top law firm to develop two white papers.

Deliverables:

The first will center on tax issues that might arise from interacting in liquid staking ecosystems (ensuring, for instance, that transitioning between stETH and ETH is not a taxable event) and rewards for participating in liquid staking ecosystems.

The second will focus on regulatory issues surrounding liquid staking, which may include, but are not limited to the legal classification of the underlying staking token and exploring regulatory uncertainty with Commodities and Securities Regulations (it may also be prudent to explore potential Banking Regulations issues that may be relevant).

We will also:

  1. Form a liquid staking working group focused on the US regulatory environment with an expert group of industry and ecosystem players. We will discuss these and other issues to ensure that we are addressing the most pertinent issues on a go forward basis.
  2. Collaborate to develop industry-driven principles for liquid staking and develop shared messaging that the industry can rally behind.

POSA has previous success working with top tier law firms to produce legal backed white papers, similar to what we did on initial staking issues presented to the SEC and FinCEN.

Ask:

We have already engaged and negotiated a fee structure with a top law firm, Perkins Coie, who is excited to partner with us. We are requesting $150,000 to cover the cost of this work, which should begin imminently. There is much to be done, and we hope to follow on with additional advocacy as new and more pertinent issues arise.

3 Likes

I believe this is a no brainer for the liquid staking industry as a whole. Getting involvement from other liquid staking providers and firms looking to stake will be incredibly valuable in shaping the opinion of regulators here in the US instead of simply waiting for it to come.

There is a massive market opportunity if we can find a way to explore the problem space and build best practices on how that approach would work.

I fully support this initiative.

3 Likes

I’ve worked with the POSA team for a few years now. They are the best representatives of the PoS space in the industry and have deep understanding of the nuances of various networks and mechanisms. It is crucial that tokens like stETH are properly understood by regulators and tax authorities worldwide. Failing in this regard could result in significant headwinds in stETH adoption by institutions and DeFi protocols.

Their funding request is very reasonable. Unlike the legal fund from Uniswap, which received $20m upfront, POSA has already been funded and operational for several years. This additional funding enables it to expand its scope to take on this additional important issue, rather than bootstrapping the org from zero.

I’m happy to provide any further context or reference checks so feel free to reach out here or on Twitter. This is a total no-brainer for Lido imo. Thanks!

3 Likes

Should this be thought of as a general contribution to POSA or funding for specific deliverables produced by Perkins Coie (briefs/reports, legal counsel in specific engagements or lawsuits)?

POSA seems to be doing great advocacy work, and I do think that Lido would certainly benefit from working with POSA and funding their work.
This just seems like a broad request, but then there are mentions of specific deliverables and engagements which don’t include many details on what the form of the deliverables would be or what work the engagements would entail.

This funding will support specific deliverables – the two white papers produced by Perkins Coie on tax and regulatory issues, as well as managing the working group. We will of course continue to advocate generally for liquid staking ecosystems but these funds will be dedicated to producing those deliverables.

Are there other organizations contributing to the same deliverables or is the contribution from Lido expected to cover the full engagement cost on these two white papers?

While others are contributing to POSA’s facilitation of the white papers, Lido’s contribution is expected to cover the full cost of the legal fees specifically. We are also reaching out to others to fund additional work on this issue.

1 Like

Ok, thank you for these responses. I think this is a worthwhile cause to support for any user of staking services and Lido specifically.

It’s hard for me (and I assume others) to evaluate the merits of these deliverables and the value of using Perkins Coie’s services for this type of engagement. It would be helpful to hear more from your team or other knowledgeable members of the community discuss why Lido should cover legal costs for these deliverables in their entirety, and what the value to Lido might be in addition to being a good citizen of the PoS ecosystem. It doesn’t seem to me that these are issues that are specific to Lido.

I expect one answer might be: “Lido is the gorilla in the room on liquid staking and the sooner there is clarity on these issues the easier it would be for Lido to convert its early lead into long-term market share.” I personally would just want to see more discussion before the DAO allocates the funds for the sake of responsible treasury management.

Is Perkins Coie a firm that has worked with POSA on related issues? Are they clear subject matter experts on tax treatment and regulatory classification for liquid staking providers?

In short, getting this work done immediately is a key for Lido’s further adoption (especially by enterprises and large institutions). Given that Lido is currently the industry leader, the ecosystem has the most to gain by getting regulatory clarity. We are actively reaching out to other groups to contribute to further work on liquid staking tax and regulatory issues, but to ensure this is expedited and work starts now we need direct support for legal fees – which are extremely discounted to the tune of 3x-5x. PC is one of the leading crypto white shoe law firms. We’ve worked with them before and not only feel confident in their ability to do this work, but also excited that they want to be a leader on liquid staking and building a regulatory framework for a very key and growing part of the ecosystem.

1 Like

My thinking is that this work needs to be done and better sooner than later, but it won’t have an immediately noticeable impact on the staking landscape.
What matters, in that case, are GC’s of funds and individuals giving a green light to stake with Lido, and for that to happen we’ll need more than just two well-written white papers from a great legal firm. But to get there we need to actually need to take steps in this direction and this is a good step.

3 Likes

While the rest of the liquid staking industry will benefit from these sort of initiatives there is a collective action problem in the industry. In an ideal world all liquid staking protocols would share the burden. Someone needs to shoot first. Since this is not an overly large ask it made sense to prioritize execution over stagnation and waiting to see where other teams landed.

As @vsh mentioned, this will not have a direct ROI from the cost perspective but will create artifacts from neutral third parties that can become a focal point for the longer term conversations around tax and regulation that will inevitably come at some point.

The working groups that come out of this will also be a meaningful coordination point for the whole liquid staking industry and help to get us in front of the narrative instead of waiting for the ax to fall.

2 Likes

lex_node here, responding with a LeXpunK_Army perspective:

We definitely think this proposal is much needed, and would represent money well spent. The legal complexities with liquid staking are enormous and the regulatory and other legal challenges will be numerous in the years ahead

If this wasn’t already on your radar, Chorus One published a “Liquid Staking Report” with a pretty comprehensive legal report in the appendix. However, this is when DeFi was relatively new, and thus the report consists mainly of legal “issue-spotting” rather than concrete actionable conclusions.

One of LeXpunK’s main focuses is in being action-oriented, pragmatic and utilitarian. Legal scholarship, theory and broad “issue-spotting” (high level identification of potential legal issues) are nice, but we believe builders need tools that they can act with now. Issue-spotting etc. are easy and lucrative tasks for law firms, but do not move the needle. Similarly, broad principles-based ‘suggestions for regulatory reform’ are already in abundant supply but tend to go nowhere while merely generating favorable law firm publicity.

Accordingly, we suggest the proposal be slightly recalibrated to focus on getting pointed, actionable work product from Perkins Coie (certainly a wonderful and competent firm). In order to achieve this, we also suggest that the scope of the proposal be narrowed (while keeping the same budget).

Here are a few ideas for a narrowed scope:

  • In general, tax issues around liquid staking have not received as much detailed attention and could justify an entire report unto themselves. We suggest focusing in-depth on a tax issue that was “issue-spotted” in the Chorus report, such as:

    • optimal staking protocol design for U.S. tax purposes (for example, is non-liquid staking definitely NOT a sale of the underlying assets; under what conditions does it become a sale and what protocol features can be added to make clear it is not a sale?)
    • revenue/income recognition on liquid staking arrangements - what is the timing on this recognition and how is it affected by different protocol design choices?
    • whether liquid staking tokens represent “bearer instruments” which are subject to punitive excise tax penalties - Note: Gensler in a talk yesterday repeatedly emphasized that he views crypto as “bearer value” and that “bearer instruments” are highly disfavored under regulation?
  • Which liquid staking tokens are “swaps” and which are not “swaps”, and what protocol design features make them less likely to be “swaps”?

Happy to be helpful where we can!

10 Likes

Very much appreciate this perspective @lex-node! I would definitely take a small but actionable insight over a a broad overview of landscape.

2 Likes

Thanks @lex-node! We saw the Chorus One report and agree that we’re beyond the issue spotting stage. The goal is and was always to produce papers with very actionable and concrete recommendations. For example, the papers we’ve produced in past for (and with) SEC and FinCen have have been very pointed and have come to strong legal conclusions and we expect the same here. We’ll bring these issues to the fore in our discussions with Perkins Coie as we narrow scope (completely agree with re: sales tax and swaps btw) and will be working with experts to like you as the work kicks off to make sure we narrow sufficiently and push for legal conclusions that will help us all to push this forward!

4 Likes

IMO this question of what is a “swap” is the key regulatory question for liquid staking. It seems like the definition of what constitutes a “bearer instrument” is a lot broader than anything to do with staking, but I have seen Gensler and others make that sort of comment in reference to cryptocurrency in general.

2 Likes

Would it be possible to have some sort of dialogue with the POSA team as the engagement moves along, even just a progress report to see where things are headed? I’m not sure what the expected timeline is for those or for forming the working group, but perhaps the working group could have a regular catch up on these items with PC and the POSA team.

As an aside, I saw the Snapshot vote is live and I think it would be helpful to let people know when a vote is live and be clear where there are calls to action. Just posted in the Discord but maybe there could be a more formal announcement when those are happening.

2 Likes

In support of this proposal. From where I stand there is a serious issue in our industry around regulator attention centred around proof-of-work. At the minimum efforts like the one proposed here gets proof-of-stake more “airtime” in regulatory circles. That alone is a valuable start to pave the way for regulatory action that does not stop the industry in its tracks. Also agree with @vsh in that it’s never too early to get moving on cogs that (normally) move slow.

On @lex-node’s point about specificity, largely agree, with some reservations on how easily digestible an effort with more specificity would be by the desired audience.

This then raises an important question: “who is the intended audience?” If it’s builders then specificity is warranted. If on the other hand it’s regulators, then this is likely a first step in a long line of steps and therefore setting the tone and context would be preferred to specificity.

Sidenote: as the largest player in the ecosystem, Lido would be well served to lead the effort in funding the report and kickstarting a working group. For the sake of symbolism, however, the broader effort would be better served in a (potentially) public matching round.

4 Likes

Absolutely agree and I have been speaking with POSA about launching this through Gitcoin or similar in order to allow for this specific mechanism.

1 Like

I also wanted to make sure this gets posted. The snapshot went live but did not directly get linked here: Snapshot

The outcome if passed (looks likely) is to then focus on the suggestions mentioned here. Target audience, specific outcomes desired and presentation. @POSA will be providing multiple updates about the progress and will have open working sessions once it has been stood up.

2 Likes

Thanks for linking @jbeezy! Confirming everything that was mentioned above - we’ll continue to provide updates about the status of our work once it formally kicks off.

1 Like