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Practical Insights for Liquid Staking Accounting

Explore accounting insights and strategies to enhance your accounting processes, mitigate inconsistencies, and ensure compliance in the ever-evolving world of digital assets.

Accounting for Liquid Staking Tokens Demystified

Liquid staking brings unique challenges for crypto accounting and tax professionals. From inconsistent transaction data to the complexity of recognizing staking rewards, navigating these issues can be daunting.

In a recent comprehensive webinar, Jozef Vogel, COO of EtherFi, and Jason Schwartz, tax partner at Fried Frank Harris Shriver & Jacobson, provided valuable strategies to manage these complexities. 

Watch the full conversation to gain deeper insights into these challenges and learn practical solutions from industry experts.

Liquid staking tokens (LSTs) are a type of blockchain asset that represents the ownership of staked digital assets while maintaining liquidity. 
When users stake their cryptocurrencies in a Proof-of-Stake (PoS) network through a liquid staking platform, they receive LSTs in return.

These tokens reflect the value of the staked assets and any accrued rewards, allowing users to engage in other activities within the decentralized finance (DeFi) ecosystem without having to wait for the unbonding period typically required in traditional staking.

Different types of LSTs include rebasing tokens, non-rebasing tokens, fixed income tokens, and dual-service tokens, each offering unique features and benefits, and so different accounting and tax implications.

Below are key highlights from their conversation: Practical Insights for Liquid Staking Accounting

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    Applying Accounting Standards to Liquid Staking

    One of the primary challenges in liquid staking is tracking all transactions on-chain. Jozef Vogel emphasizes, “Trying to track all transactions on-chain is the first challenge everyone faces. Applications are improving, but integrating thousands of transactions into an accounting system remains complex.”

    This complexity is exacerbated by the nature of liquid staking tokens, which introduce an additional layer of complexity compared to traditional digital assets.

    Vogel explains that liquid staking tokens, such as stETH or wstETH, add complexity due to their built-in yield mechanisms. “Now I have this liquid staking token that has native yield built into it, adding an additional layer of complexity,” he notes.

    Recognizing these gains accurately continuously remains a significant hurdle for accountants.

    Addressing Data Inconsistencies and Reconciliation Issues

    Data inconsistencies and reconciliation issues are common in liquid staking. Vogel highlights the importance of using specialized tools to track and reconcile transactions, rather than relying solely on spreadsheets. He advises, “I recommend anyone using a spreadsheet to move to a tracking tool designed for this purpose. The complexities arise when dealing with wrapped assets or liquidity provision.”

    When it comes to handling data reconciliation, Vogel stresses the importance of understanding the nature of transactions deeply. “Understanding what’s happening in reality and figuring out the best approach is crucial. Consistency in your approach helps ensure accuracy,” he asserts.

    To gain further insights into managing liquid staking complexities, 
    Watch the full webinar now.

    Impact of Staking Reward Recognition

    The timing of staking reward recognition is a critical consideration in liquid staking accounting. Jozef Vogel explains that while some rewards may only be realized when assets are withdrawn, accountants must still record unrealized gains on a monthly basis. 

    Jason Schwartz adds, in his view, that the tax implications of staking rewards vary depending on the type of token. “If you exchange ETH for a non-rebasing token like wstETH, I believe that’s a taxable exchange. However, rewards accruing inside the smart contract are not taxed on a current basis,” he explains.

    Schwartz underscores the importance of understanding the specific characteristics of the tokens involved to determine the appropriate tax treatment.

    Key Tax Considerations and Compliance Strategies

    Navigating the tax implications of liquid staking requires a nuanced understanding of the evolving regulatory landscape.

    Jason Schwartz provides insights into the complexities of taxing different types of liquid staking tokens. “With a rebasing token, like stETH, the IRS is fairly clear that you do have to include those rewards currently that are credited to your wallet as ordinary income. And accordingly, I think, it’s fair to not recognize gain or loss on the way in, or the way out”​​.

    Schwartz underscores the importance of understanding the specific characteristics of the tokens involved to determine the appropriate tax treatment.

    In his article, “The Latest DeFi Alpha Is Tax-Optimized Staking,” Schwartz elaborates on this by stating, “Unless you are sitting on a pile of highly appreciated crypto, swapping into a token that represents a proportionate share of a changing pool of assets (e.g., wstETH or cTokens) is likely to be more tax-efficient than receiving streaming rewards (e.g., stETH or aTokens)“​​. This highlights the strategic considerations for tax optimization in staking activities.

    There are multiple views on the taxation of liquid staking tokens. It’s essential to have a reasonable position and apply it consistently.

    Jason Schwartz, Partner Tax at Fried Frank

    He further explains the differences in tax treatment between rebasing and non-rebasing tokens. “In my view, ETH to stETH is not taxable, but the rewards credited to your wallet must be included as ordinary income. Conversely, ETH to wstETH is a taxable exchange, but subsequent rewards are not taxed on a current basis,” Schwartz elaborates.

    Valuation Methodologies and Error Minimization

    Accurately valuing liquid staking tokens and minimizing errors in accounting is vital for maintaining compliance and transparency. Vogel suggests adopting valuation methodologies that reflect the unique characteristics of liquid staking tokens.

    A simplistic approach might be to take the increase in value month over month, but in practice, it gets more complicated.

    Both experts agree on the importance of using specialized tools and platforms that support comprehensive tracking and reconciliation. Schwartz cautions against relying solely on general tax preparation software, which may not fully accommodate the complexities of liquid staking. “For larger clients, it’s crucial to work with crypto-native accountants who understand the technology and can provide accurate guidance,” he recommends.

    Conclusion

    Liquid staking presents unique challenges for crypto accounting and tax professionals, but with the right strategies and tools, these complexities can be managed effectively.

    By applying appropriate accounting standards (if they exist or applying consistent reporting methodology), addressing data inconsistencies, understanding the timing and impact of staking reward recognition, navigating key tax considerations, and adopting accurate valuation methodologies, professionals can confidently navigate the world of liquid staking.

    For a more in-depth follow-up of this panel conversation, watch the full webinar where Jozef Vogel and Jason Schwartz delve deeper into these topics, providing practical insights and strategies for managing liquid staking accounting.

    Talk now to a Crypto Accounting Expert
    Cryptoworth provides partners a growth opportunity for accounting firms, CPAs, and technology consultants. Let’s get in touch.


      About the Speakers:

      Jozef Vogel is the COO of EtherFi, a liquid restaking protocol, with extensive experience in digital asset accounting. 

      Jason Schwartz  (@cryptotaxguy.eth) is a tax partner and co-head of digital assets at Fried Frank Harris Shriver & Jacobson, specializing in the tax implications of digital assets and decentralized finance.

      For more detailed guidance on liquid staking accounting, subscribe to our newsletter and never miss an update on the latest trends and strategies in crypto accounting.

      FAQs:

      When reporting liquid staking tokens (LSTs) in your books month over month, consider recognizing any unrealized gains from value appreciation as income, even if not withdrawn. This involves marking the tokens to market each month and recording the increase in value. Ensure consistent application of accounting methods and comply with jurisdiction-specific tax regulations, as some tax authorities may require recognizing income as it accrues.

      Yes, you need to account for both liquid staking tokens (LSTs) and staking rewards. LSTs should be marked to market each month, reflecting any unrealized gains or losses in value. Staking rewards, whether realized or unrealized, should be recognized as income, as they accrue value month over month. Consistent and accurate accounting for both ensures compliance with tax regulations and provides a clear financial picture.

      There are several types of liquid staking tokens (LSTs), each offering unique features and benefits:

      1. Rebasing Tokens: These tokens increase in quantity over time as staking rewards are added. An example is stETH (staked Ether) from Lido Finance, which reflects accumulated rewards directly in the token balance​​​​.
      2. Non-Rebasing Tokens: These tokens maintain a constant quantity, with the value increasing as rewards accumulate. An example is wstETH (wrapped stETH) from Lido, which holds its value in a single token​​​​.
      3. Fixed Income Tokens: These tokens, like those from Tempus Finance, allow users to earn a fixed income from their staked assets, providing a predictable yield​​.
      4. Dual-Service Tokens: Rocket Pool offers rETH for users who stake ETH and run nodes, providing higher rewards due to dual-service offerings​​​.

      Author

      • Ariel Eiberman

        Ariel Eiberman is the marketing lead at Cryptoworth, a leading crypto accounting software that helps web3 accountants speed up month-end closing. He has more than 6 years of experience in product marketing for software companies and a background of organizing olympic games and polyglot meetups in multiple cities.

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      Ariel Eiberman

      Ariel Eiberman is the marketing lead at Cryptoworth, a leading crypto accounting software that helps web3 accountants speed up month-end closing. He has more than 6 years of experience in product marketing for software companies and a background of organizing olympic games and polyglot meetups in multiple cities.

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