Is the pledge token cut off? BitGo co-founder talks about the vicious circle of Staking drive

Beginning in 2018, more and more currencies have chosen PoS as their consensus mechanism, and the total market value of such currencies is in the billions of dollars.

At first glance, holding such currencies is very attractive. By pleasing your currency, you can earn 4% to 15% of your income each year. But where did these benefits come from? Of course, it can only come from one place, that is, those who do not pledge tokens.


Staking (PoS mining) rewards are created through inflation. If everyone holding a particular crypto asset Stakes all the coins, then each person gets a more currency over time (out of thin air), depending on the amount of currency they hold. After a period of time, everyone's ownership of the assets in the pledge is constant.

If only a portion of the currency is pledged, the owner of the portion of the coin (stakers) will indeed become richer, and the non-stakers will not pay the price. The ownership of non-stakers will be diluted as stakers get more new coins.

As a concrete example, suppose a coin is called PIE. The Staking reward at PIE is 10% per year. At the beginning of the year, the total amount of PIE was 100, with 10 holders, each holding 10 PIE coins. Suppose half of the holders pledged their coins for one year, while the other half chose not to pledge. A year later, each stakers will receive an additional PIE, that is, 5 stakers will eventually get 11 PIEs, while the other 5 non-stakers will still have only 10 PIEs per person.

It can be seen that the total supply of PIE has increased by 5% to 105. Each staker that previously had 10% PIE now has a PIE of 11/105 = 10.47%. The amount of coins held by each non-stakers is reduced to 10/105 = 9.52%. It's worth noting that although the stokers received a nominal 10% yield, their actual yield was only 4.7%, which is exactly the same as the non-stakers' loss of ownership.

So, obviously, if you want to hold this type of currency, you must be a member of the stokers, otherwise your ownership will be diluted by other stakers. Therefore, based on this conclusion, the balance of achieving long-term stability is that almost everyone needs Staking. (Even if the ownership or related performance does not change, the proportion of non-stakers will decrease year by year, for the simple reason that the currency dilution problem.)

However, if everyone is involved in Staking, then non-stakers have no return, leaving only inflation, and inflation does not bring real returns. Of course, there will always be some irrational people who choose not to participate in Staking. But in general, Staking's rate of return should be seen more as a punishment for non-stakers than as a reward for stakers. So, this means that as a holder of a PoS coin, you need to do something, or put the token at risk, but you won't get paid for it. But what if we accept this burden? Just like accepting the cost of holding a PIE, because this is a great coin. In fact, such a choice is even worse.

The IRS, the US Internal Revenue Service (and possibly many other tax authorities around the world) can see the 10% nominal rate of return you get, and then say, “For me, it’s like income. Please give me a little PIE. By the way, I only accept dollars. "Although you have not become richer by holding PIE, IRS is happy to make you poorer.

To put it simply, assume that all PIE holders are US taxpayers and pay a marginal tax rate of 35%. Of course, they also pay taxes honestly. Since everyone is involved in Staking and they receive a nominal 10% yield, they are required to pay a tax rate of 3.5% of the initial market value (or about 3% of the market value of the year-end inflation). What do they use to pay taxes? May have to sell some PIE, bringing downward pressure on prices. This happens when you impose an annual property tax on non-productive assets. How bad can it be? Anyway, only 3.5%, right?

Let's do a thinking experiment, assuming IRS is willing to accept PIE to pay taxes, and they are willing to let go (of course, they will also pledge their own currency). The table below shows how the PIE's ownership base changes over time. By the 22nd year, IRS will have more than half of the PIE.


This thought experiment actually shows the best case, that is, the IRS is a loyal holder and never sells coins. As time went by, they took less and less from other holders because they already had most of the coins. After 70 years, the IRS can hold 90% of the currency. But the reality is even worse, because IRS doesn't want your PIE, so you have to find new buyers every year. (In any case, this may have an impact on prices.)

The higher the Staking income, the more serious the problem. With a 20% yield, the IRS can hold half of the currency in just 12 years. Assuming a rate of return of 5%, they take 41 years, although it is very long… but they still achieve this goal.

The question is whether the Staking revenue is really taxable. In the securities sector, companies may sometimes issue dividends consisting of new shares of the same stock ("stock dividends"). For example, when a company splits a stock, it will issue an additional stock for each existing stock. These are tax-free, and the exact reason is that no economic benefits are obtained from the transaction.

The problem is that Staking benefits are not stock dividends, both in law and in practice. In fact, they are fundamentally different from dividends, because you have to do something to get the Staking benefits. In other words, you must participate in Staking, profit from non-stakers, or at least to avoid losses. Although Congress is likely to consider making the PoS machine reward tax-free… but I will not expect it.

The conclusion is that holding a PoS currency means:

– You have to do something or put your currency at risk.

– You don't get real rewards unless other holders are irrational, lazy, and not involved in Staking.

– You will actually get a negative rate of return due to taxation issues.

Note: The author of this article is Ben Davenport, co-founder of BitGo, a digital asset escrow company, which represents only personal opinions and does not constitute tax and investment advice.

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