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TAX CLINIC

to as “cryptocurrencies” and are defined transactions in a “block” of computer (one would exempt only miners from
as “any digital representation of value code and is then added and linked to broker status, and one would exempt
which is recorded on a cryptographically previous blocks to form a chain — there- both miners and stakers) before ulti-
secured distributed ledger or any similar fore, the term blockchain. The updated mately failing to pass either amendment.
technology as specified by the Secretary” ledger is then distributed across the With that said, the primary drafters of
(Sec. 6045(g)(3)(D)). network, such that all computers on the the legislation have publicly stated that
Although Congress can hardly network are constantly verifying that the it was not intended to result in reporting
be faulted for seeking to promote tax blockchain is correct. Thus, the block- responsibilities for miners and stakers
compliance in the cryptoasset arena, the chain itself is, theoretically at least, both and wrote a letter to Treasury Secretary
approach taken attempts to apply the immutable and accurate. Janet Yellen to that effect (Sens. Rob
existing cost basis reporting framework Mining (through proof of work) Portman, Mark Warner, Mike Crapo,
used for stocks and securities to digital is the original validation process and Kyrsten Sinema, Pat Toomey, and
assets, despite the fact that there are generally is associated with bitcoin. Cynthia Lummis, Letter to Yellen (Dec.
significant differences between the Essentially, the first “miner” to solve a 14, 2021)). A subsequent legislative
digital asset ecosystem and the stock and crypto puzzle or algorithm to validate a proposal — the Keep Innovation in
securities markets. This raises a number given transaction and broadcast to the America Act, H.R. 6006 — has echoed
of significant issues (a few of which are network is rewarded with newly minted/ this interpretation.
considered below) that Treasury will have created bitcoin as well as transac- Treasury offered encouraging signs in
to grapple with when it provides cost tion fees. a letter released in February, which states
basis reporting guidance. Staking (through proof of stake) is that in “the Treasury Department’s view
generally associated with the Ethereum … ancillary parties who cannot get access
Miners and stakers consensus layer (formerly known as to information that is useful to the IRS
The Infrastructure Act’s cost basis re- Ethereum 2.0). At a very high level, are not intended to be captured by the
porting provisions prompted a great deal “validators” contribute and lock up (or reporting requirements for brokers. For
of consternation from the cryptoasset “stake”) their own crypto in exchange example, persons who are just validating
industry because reporting rules would for a chance of getting the opportunity transactions through a consensus mecha-
(at least in the view of some tax practi- to validate a new transaction, update nism are not likely to know whether a
tioners) create a requirement that certain the blockchain, and earn a reward. If transaction is part of a sale” (Jonathan
participants (including so-called miners those validators are selected and suc- Davidson, Treasury Assistant Secretary
and stakers) provide cost basis reporting cessfully verify a given transaction, then for Legislative Affairs, Letter to Sens.
information to other market participants, the network updates the blockchain, Lummis, Warner, Portman, Sinema,
notwithstanding the fact that these par- and staking rewards (new tokens) Toomey, and Crapo (Feb. 11, 2022)).
ticipants would not have the information are awarded. Thus, it would appear that, consistent
to do so. Miners and stakers are the backbone with congressional intent, miners and
To illustrate this issue, a bit of of the blockchain, but they are not stakers will not be subject to cost basis
background is necessary. Generally, cryp- omniscient. They generally do not know reporting in forthcoming cost basis re-
toassets use a peer-to-peer model that is the identities of the parties transact- porting regulations.
decentralized, in the sense that no single ing on the blockchain and do not have
company or person operates the network. detailed information regarding the gross Wallet providers
Instead, blockchain technology, which proceeds or cost basis of the digital assets Cryptoassets are held in “wallets.” Some
is sometimes referred to as distributed transferred. In short, they do not have wondered if the creator of wallet software
electronic ledger technology, enables this the information required to provide cost could be considered a broker because
peer-to-peer model to function. When- basis information to parties transacting software is used to effectuate cryptoasset
ever a given cryptoasset transaction oc- on the blockchain. Notwithstanding this transfers. Again, the primary drafters of
curs, it is first broadcast to its network to fact, many were concerned that miners the legislation clearly indicated that wal-
be verified or validated. and stakers could be considered brokers let software providers were not intended
Validation occurs using cryptography because their validation activities could to be covered. Treasury appears to agree
(that is, encryption and decryption) be considered “effectuating transfers of with this interpretation and stated in
through a consensus process called min- digital assets.” its recent letter that “persons who are
ing or staking. Once confirmed, each Congress did not help matters by put- only selling storage devices used to hold
transaction is then recorded with other ting forth two conflicting amendments private keys or persons who merely write

20 June 2022 The Tax Adviser