Skip to main content
SearchLoginLogin or Signup

ESG, Crypto, and What Has the IRS Got to Do With It?

ESG in general and an agenda focused on sustainability in particular can and should be applied to taxation to ameliorate the impact of the crypto industry on society and the planet.

Published onJan 10, 2023
ESG, Crypto, and What Has the IRS Got to Do With It?


Regulation almost always lags behind innovation, as is the situation with many FinTech-based products and services, and particularly those offered by crypto industry players. The crypto sector is a new and innovative one, which has proven to be defined not only based on highly technical concepts, but also by high levels of volatility and financial risk. In attempting to understand how to address many of the issues it raises in legal fields ranging from to financial regulation, such as tax requirements, to environmental law, and specifically matters that relate to climate change and energy waste, regulators often find themselves trying to implement existing legal frameworks rather than creating new, clear rules. Much has been written about the SEC’s regime of regulation by enforcement of the crypto industry, and the impact of this type of rulemaking on businesses and persons. However, other financial regulators adopting a similar style of rulemaking—such as the IRS—have gotten much less attention for the impact of their regulatory actions. As noted within this Article, prominent industry associations continue to push back against applying existing tax law and protocols to specific crypto activities. One such notable example, which is relevant in the Environmental, Social and Governance (“ESG”) awareness era, relates to the unintended consequences of the IRS’ regulation by enforcement, given the impact that such new rules have on the transition to greener energy. This impact also occurs in the crypto industry in connection with proof-of-stake (“PoS”) consensus mechanisms—one of the two prominent transaction validation mechanisms. The PoS mechanism includes staking rewards—reward tokens that are earned/generated from securing a PoS blockchain—that validators, also known as stakers, receive when they validate transactions. The IRS has asserted that cryptocurrencies are considered property for income taxation purposes, which means that every transaction results in a gain or loss equating to the difference between the price of the crypto asset at purchase and the price of the sale.

In the case of the PoS mechanism’s staking rewards, the debate behind deciding whether the rewards should be classified as taxable income when received versus when sold can also be framed as either applying existing tax code, word for word, to what many consider a new asset category, or eventually changing the code to reflect new economic models supported by some industry actors. This issue, which might seem minor, has recently become the subject of a lawsuit that one validator brought against the IRS, arguing that staking rewards should be taxed at the time they are sold, rather than created as the IRS has argued. Despite being just one specific court case with limited implications to other taxpayers, it is illustrative of the frustration felt by some market participants. In early October 2022, the case in question was dismissed by the court. Much like the Department of Justice several months earlier, the court found that Jerret presented no case or controversy, as it was moot. The reason for this is that the case had no issue that remained unsettled because the IRS had issued a full refund, including the interest, as was initially requested by the taxpayers. Ultimately this ongoing debate and conversation highlights the following question: under strict application of existing tax rules, staking rewards are taxable when received, but should that be the case? Practically speaking, following the dismissal of the Jerret case, the immediate consequence is that taxpayers should assume that staking income is taxed as income at the time of receipt, unless explicitly excluded by the IRS in future tax guidance. That said, this Article argues that having legal clarity is important and that regulation by enforcement is less equitable. Additionally, this Article argues that proper lawmaking is especially needed in this PoS-based staking situation, given the importance of incentivizing persons to use PoS mechanisms due to environmental considerations, and the implications of financial regulation’s nudges on the behavior of persons and the promotion of ESG-based goals. Indeed, this clarity is needed because current legal ad-hoc structures do not have the capacity to keep pace with the negative impact on the environment and the energy consumption issues that the crypto sector causes and also prompted the Ethereum merge. It is clear, therefore, that we need additional behavioral incentives for the law to rely on to support and facilitate the objectives of greener environment goals’ promotion.


Regulation by enforcement has characterized much of regulators’ and government agencies’ interaction with businesses and persons since the inception of the crypto industry in the United States. This approach has been especially noticeable in the work of financial regulators such as state agencies,1 as well as the Securities and Exchange Commission (SEC),2 the Commodity Futures Trading Commission (CFTC),3 and the Internal Revenue Service (IRS).4

In many respects, regulation by enforcement of new, novel, and complex products and services in general, and of the crypto industry in particular, makes sense. The crypto sector is an innovative one, which has proven to be not only based on highly technical concepts, but also one that is very volatile and financially risky.5 Attempting to understand how to address many of the issues it raises in legal fields ranging from securities regulation to tax law, and others, regulators often found themselves trying to use existing law and enforce already in place regulation, rather than announcing new, clear rules and guidelines. When criticized for doing so, some lawmakers have argued that it is imperative to “be able to adapt quickly to innovation and to changes,”6 instead of waiting for long legislative procedures and rulemaking processes. Additionally, many commentators have argued that the policies underlying financial laws, such as the Howey Test, which is a four-prong test used for determining whether certain transactions qualify as "investment contract,”7 were intentionally designed to be broad, in order to cover various types of cases and situations that could not have been foreseen in advance.8 Particularly, because “broad rules that are not targeted at a specific deal structure or type of investment,” limit the ability to structure transaction in ways that seek to avoid regulatory coverage.9

But regulation by enforcement is far from ideal for businesses and persons—which need predictability and clear rules to succeed and thrive—in addition to being less effective, and sometimes not justified. Indeed, many aspects of the design and workings of blockchain technology and cryptocurrencies are well established at this point such that regulators are no longer justified in implementing deficient industry boundaries—for better or worse. For instance, in the years following the development of blockchain technology, two different transaction validation mechanisms have become the leading consensus mechanisms: Proof-of-Work (PoW) and Proof-of-Stake (PoS).10 Each mechanism entails different advantages and disadvantages, and is based on different reward systems, with one of the main arguments against PoW being its negative impact on the environment. Indeed, popular claims suggest that if Bitcoin was a country, its annual carbon footprint would range between one that is as big as Portugal and Bolivia.11 Such a large carbon footprint is the result of the significant amount of electricity required in order to create, or “mine,” most cryptocurrencies,12 and it has gotten much attention since 2020, when the crypto industry became a mainstream financial markets conversation topic. But while studies suggest that the PoW consensus mechanism is to blame for the massive amount of energy consumption of cryptocurrency13—regulators have not encouraged or incentivize participants to change to greener, more eco-friendly consensus mechanisms,14 such as PoS. Moreover, some might even argue that there were specific instances in which regulators did quite the opposite. For example, in the Telegram case, there was an attempt to try to introduce a PoS blockchain that would hopefully be more efficient, and the attempt was shut down.15 Since environmentalism advocates for the preservation, restoration, and improvement of the natural environment and the protection of the entire ecosystem, from an environmentalist perspective, given that PoS mechanisms offer a less energy-intensive alternative, industry participants should have been motivated to initiate such a change to their protocols.16 And while this nudging to use eco-friendlier consensus mechanisms could also take place via market self-regulation processes, without any regulatory initiatives, through changes in the supply and demand forces—for instance, if green investors reject Bitcoin, its value would crash by itself—regulators can do a lot to motivate via regulation.

In the context of finance, much has been written about regulation by enforcement in general, and regarding the crypto industry in particular.17 Interestingly enough, among those discussing this type of lawmaking were commentators that after the 2022 crypto market crashes, which caused many investors to lose their life savings, wondered where the regulators were, and why they did not take clearer stands.18 However, some financial regulators, such as the IRS, that have adopted a similar type of rulemaking approach as the SEC, have gotten far less attention for the impact resulting from their actions. One such notable example—which is especially relevant in the era of Environmental, Social and Governance (ESG) awareness—relates to the unintended consequences of the IRS’ regulation by enforcement, given the impact that such new rules have on the transition to greener energy. Such impacts are apparent in connection with the PoS mechanism’s staking rewards–the reward tokens that are earned/generated from securing a PoS blockchain—that validators, also known as stakers, get when they validate transactions.19 As further explained and discussed in this Article, the IRS’ position in connection with how staking rewards should be classified is an issue of concern for some industry groups and trade associations. This debate continues even with the October 2022 dismissal of the Jarrett court case, which the court held as moot, given the refund that the IRS has issued to the plaintiffs in the first such case explicitly seeking an exemption or carve-out for staking rewards.20 In particular, a distinction between income and property in this context is important especially for accounting purposes and is the focus of the IRS Notice 2014-21 publication (Ruling 2014-21).21 Although not always a dichotomy, the IRS’ position on income versus property, in connection with how staking rewards should be classified is, to some groups and investors—at least as a theoretical matter—not a clear cut case. In Ruling 2014-21 the IRS asserted that cryptocurrencies were now considered property for purposes of income taxation22— meaning that every transaction results in a gain or loss equal to the difference between the price of the crypto asset at purchase and the price of the sale.23 Under most scenarios, therefore, the crypto assets will be considered capital assets taxed at capital gains and losses rates.24

In the case of the PoS mechanism’s staking rewards, the rationale behind deciding whether these should be classified as income versus property is, in effect, deciding whether a taxpayer should recognize income at the time of receiving the staking rewards, or at the time selling these rewards to a third-party. To somewhat oversimplify, can we argue that a person should realize income when she mines gold from a mine, or does that actually occur only when she sells it? Many scholars and tax practitioners agree with the application of existing tax code, as is, to block rewards and so currently the consensus is—while waiting for court cases to provide clarity over specific cases—that block rewards are taxable income upon receipt.25 This position has been reinforced by the dismissal of the Jarrett case, but that does not signify the end of the debate. Specifically, some commentators, including trade associations such as the Proof of Stake Alliance (“POSA)”, a leading blockchain industry association, have written whitepapers and engaged policymakers, arguing for a policy position that would only tax block rewards when these rewards are part of a transaction.26 Likewise, in addition to the tax arguments they have also put forward the economic implications of requiring all staking recipients to file and pay taxes owed whenever a staking reward is earned, advocating that doing so would be impractical and presents notable compliance challenges.27 They have also raised questions such as (i) who is responsible for filing the form 1099s, (ii) what entity should review the accuracy of these 1099, and (iii) the entirety of decentralized staking platforms would be severely curtailed by such obligations.28 Highlighting this risk, in September 2022, following the Ethereum merge, which entailed an upgrade of the Ethereum network from PoW to PoS,29 it appears that approximately 30% of all staked ether is staked by Lido, a decentralized staking exchange. With such a large, and decentralized, wealth creation mechanism (the PoS), the implications of directly apply IRS code—reinforced by the dismissal of the Jarrett case—could create a situation where taxes are assessed and payable, but identifying responsible parties is difficult. Applying the existing tax treatment would, therefore, harm every participant in the staking space, as this would result in tax compliance, reporting, and payments to be evaluated on a continuous basis as block rewards are created. In addition to the potentially onerous compliance requirements this would create, attempting to make estimated payments for such a possible volatile income stream could result in repeated over-and-under payment of estimated taxes.30 Therefore, the POSA argues that block rewards should be considered newly created property, and receive the same tax treatment that is applied to other new property.31 This would mean that taxation would occur during the sale, rather than at receipt / creation of the staking rewards.32 As of this writing, in the immediate aftermath of the Jarrett dismissal, POSA has indicated its support of continued appeals.33

This issue of the taxation of block rewards has recently become the subject of a lawsuit that Josh Jarrett, a Tennesseean and a validator on the Tezos blockchain, brought in 2021 against the IRS, arguing that staking rewards should be taxed at the time they are sold, not the time they are created.34 In 2022, Jarrett also rejected the government's offer to settle and accept a tax refund for income taxes he paid on his cryptocurrency staking rewards.35 Jarrett argues that the IRS’ application of the tax law hampers U.S.-based blockchain innovators. Therefore, his argument is that since no changes have been considered to the application of the law via a traditional rulemaking process, the judicial branch should look into the policy, and confirm or reject the regulators view of staking rewards.36

This Article argues that given the predicted rise in staking, following the Ethereum merge, and the increased public interest in whether staking rewards should be taxed upon receipt or not, there would be many advantages resulting from having an open discussion on these matters. In addition, streamlining the process for paying taxes, potentially lessening the administrative burden on taxpayers and the government, and getting more legal clarity are all extremely beneficial and important. Additionally, this Article acknowledges the veracity of Jarrett’s specific claims in connection with the IRS’ classification of staking, as it relates to taxation policies that focus on the time of sale rather than the moment of creation. Indeed, paying taxes on assets when sold is not tax avoidance, and without adopting this approach, the IRS would, de facto, make some stakers experience taxable events every few seconds.37 Moreover, locking money as part of the staking activity minimizes liquidity and people would potentially be on the hook for substantial tax burdens that unrealized gains could not cover.38 Finally, last but not least, this Article argues that this PoS-based taxation issue could have a great impact on incentivizing persons to use PoS mechanisms which in turn would have environmental implications, as it could serve as a nudge on the behavior of persons, promoting of ESG-based goals.

The Article is structured as follows: The first part discusses the blockchain technology and transactions’ validation mechanisms, while focusing on the differences between PoW vs. PoS, describing what digital assets are, and examining the concept of staking rewards. The second part explores policymaking and the crypto industry, and examines the problematic nature of regulation by enforcement, and lack of legal clarity. The third part explores the connection between ESG and the crypto industry standard setting, focusing particularly on the environmental aspects. The Fourth part dives into the challenges associated with regulating crypto-related taxation, and includes some analysis of behavioral economics-based tax nudges. Finally, the last part explores potential regulation. The Article concludes by arguing that if crypto is here to stay, for better or worse, ESG-goals in general and an agenda focused on sustainability in particular can and should be applied to taxation to ameliorate the impact of the crypto industry on society and the planet.

I. Blockchain Technology and Transactions’ Validation Mechanisms

A. PoW vs. PoS

At its core, distributed ledger technology (DLT) is a technology that no single entity, person, or computer node owns, controls, or otherwise maintains.39 DLT refers to distributed software, which runs on peer-to-peer networks40 that offers a transparent41 record management system in which transactions are cryptographically signed and validated with timestamps using a consensus mechanism.42 Cryptographic keys allow DLT systems’ users to securely transact with persons and entities that they do not know, without needing to rely on a trusted intermediary.43 Additionally, most DLTs verify entries pushed to the ledger by a cryptographic key pair via a transaction validation mechanism, also known as consensus mechanism.44 Alternative mechanisms for distributed consensus include proof-of-work (PoW) and proof-of-stake (PoS).45

Under the PoW consensus mechanism concept—the first one to be created—miners work out of special nodes of the blockchain network and use specialized computing equipment in order to solve complex computer problems that are called proof-of-work problems. Solving a PoW problem for a block of transactions requires many attempts and is dependent on tremendous computing power.46 Moreover, since under a PoW mechanism miners process the same transactions simultaneously, miners with more computing power have a higher likelihood of being the first to solve a PoW problem, add the new block, and be rewarded with a newly minted coin in addition to the corresponding fee.

Conversely, PoS was officially introduced a few years later, in 2012, with the publication of the essay PPCoin: Peer-to-Peer Crypto-Currency with Proof-of-Stake.47 Under the PoS concept, validators—which are the PoS’ version of miners—are elected based on their ownership stake to add the new block and be awarded a newly minted coin.48 Because there exists only one validator processing a given block of transactions, the PoS mechanism is not nearly as wasteful of energy as the PoW one, which has many processors competing over processing the same transactions at the same time.49 Considering this, it becomes apparent that consensus with a PoS mechanism presents some benefits over its PoW counterpart. In particular, PoS eliminates the need for the costly, specialized computing hardware, and consequently, it is more eco-friendly as it is energy efficient.50 Moreover, since validators with a larger and prolonged stake are more likely to be elected, and thus rewarded, incentives exist for such validators to remain loyal. Finally, PoS’ validation process and transaction times are arguably much faster than those of PoW.51 But PoS protocols also present disadvantages. For example, the PoS mechanism is much more susceptible to attacks,52 as it is possible for a small group of validators to get ownership of more than half of the blockchain's cryptocurrency, which could potentially enable them to reverse transactions.53 Following the Ethereum merge, at least in the immediate aftermath when lock-up periods were still almost universally in effect, this is exactly what happened, with two-thirds of staked ether controlled by Lido, Coinbase, Binance, and Kraken.54

Yet, some argue that a Delegated Proof-of-Stake (DPoS)—a version of the PoS mechanism used by several popular blockchains that ensures the integrity and security of transactions and puts emphasis on community governance through delegation mechanisms55—can be useful in introducing benefits that can help reduce the risks of whales,56 which are not specifically a PoS issue, as they can and do play with the value of the PoW-based Bitcoin, and increase protocol longevity, reputation, and efficiency.57 Finally, an additional disadvantage is the technological proficiency required of participants in PoS networks which presents certain barriers to inclusivity.58

B. Digital Assets and Cryptocurrencies—the ABCs

Digital asset is an umbrella term often used to describe the array of blockchain-based assets or instruments that have entered into the mainstream financial conversation following the adoption of Bitcoin beginning in 2016.59 When analyzing the crypto sector, however, it is important to first differentiate the types of cryptoassets from a technical perspective, as well as the implications that these differences pose for investing purposes, based, roughly, on the following categories of cryptoassets: (i) decentralized cryptocurrencies, (iii) centrally-issued cryptocurrencies (stablecoins), (iii) cryptoassets that include non-fungible tokens (NFTs), and (iv) block rewards earned from staking.60

First, decentralized cryptocurrencies include, but certainly are not limited to, cryptocurrencies such as Bitcoin and Ether, both of which represent the largest permissionless blockchains in the space of this Article.61 In addition to not constructing any real barriers to purchase rights or participation options, these decentralized cryptocurrencies are not tethered or connected to a singular issuing entity, which can make regulation a tricky issue.62

Second, and differently from decentralized cryptocurrencies, centralized or centrally managed cryptoassets, which include the fast-growing stablecoin industry, share some of the same features of decentralized cryptocurrencies with two main differences in the areas of volatility and energy consumption. On the volatility issue, stablecoins are designed to be directly linked, tethered, or pegged to some external asset, with estimates that approximately 90% of all stablecoin transactions use instruments linked to the U.S. dollar.63 This connection, at least ideally, provides various operational benefits in terms of lower price volatility and ease of use as a medium of exchange.64

With regards to energy consumption, stablecoins are generally based on a more environmentally aware consensus methodology. Notably—and since the majority of stablecoins are centrally issued and governed—this means that these cryptoassets will be able to use a PoS or other less energy-consuming consensus option.65 The potential environmental benefit, however, leads to a tax wrinkle in the PoW versus PoS context. Regardless of the developments of intended usage of cryptoassets, the tax treatment for both concepts is the same. In other words, every cryptoasset that has entered the marketplace to date is treated exactly the same from a tax perspective by the IRS.

Third, NFTs present a unique subset of cryptoassets, distinct from either decentralized cryptocurrencies or centrally issued stablecoins.66 NFTs are connected to or based on either an underlying digital or physical asset.67 These instruments are not designed, nor intended, to be used as a medium of exchange by either individual or institutional users, as opposed to both decentralized and centralized cryptocurrency options. As NFTs continue to evolve and develop, especially as the possibility for tokenizing and fractionalizing physical and tangible assets evolves, the legal and social implications of this asset class will continue to mature.68 Specifically, if the NFT in question is tethered or connected to an asset that meets certain ESG criteria, the question arises of whether this necessarily means that the token itself will also contain the ESG characteristics?69

Lastly, block rewards also represent a subset of cryptoassets that requires distinct analysis separate and apart from existing cryptoassets, since these instruments are a direct result of the integration of PoS consensus methodologies.70

C. Staking Rewards

One of the most controversial aspects of the debate on the PoW mechanism versus the PoS protocols is driven by the specifics around the staking activities of an underlying blockchain. At the simplest level, the concept of staking in connection with crypto assets can either be in a passive or active form, or via delegated crypto investing and asset allocation. Holders of certain cryptoassets can lend or deposit these cryptoassets either at a centralized organization, a decentralized platform, or a community of developers.71 Following this investment or deposit, the original tokenholder can either play an active role in the validation of transactions via the staking process, or play a passive role while earning a rate of return. This rate of return earned is where the debate around staking is most common—what exactly are these returns? Are they to be thought of as the equivalent of fiat-based interest payments, or are they more akin to newly issued ownership rights? This difference might seem like a minor technical issue, but it drives a substantial portion of the most intense debate around the PoS consensus protocol.72 As referenced above there are industry trade associations whose entire reason for existing is debating the tax and reporting treatment of block rewards.

It is important to distinguish that for the purposes of this Article, when discussing staking, the focus is on active staking versus simply passive staking. Differentiating these two very different subtypes of staking is primarily a function of how much user interaction or engagement is taking place with regards to the underlying blockchain protocol. Staking,73 in all its iterations, refers to the process by which an investor/holder of cryptoassets deposits said crypto either at a centralized organization or into the custody of a decentralized protocol. Passive staking usually constitutes an arrangement where, in return for depositing (lending) cryptoassets to either the organization or protocol, the lending party receives compensation in the form of interest payments or block rewards. Aside from this compensation there is no additional interaction between the two counterparties; such an arrangement is typical of retail staking, including the ETH2 staking available on a number of crypto exchanges.74

Active staking is not particularly different from an operational perspective, with stakers playing a role in the validation of transactions and blocks. Rather, a driving force that differentiates the classification revolves around how the taxpayer in question classifies these staking investments. Categorizing such activity as a trade or business75 leads to both different tax reporting and tax collection rates. In addition, active staking is normally also characterized by the staker in question having a larger stake and/or investment in the protocol, and seeking to exercise some level of control over the results of the blockchain validation process. Stated a different way, active staking tends to be associated with larger investments of capital, more sophisticated investors, and therefore increased opportunities for effective policy via tax changes. Flexibility and the appeal of the returns possible via these activities have led to the total-value-locked (TVL) for decentralized finance (DeFi)76—of which staking is a part of—reaching over $2 billion in 2022.77 With such rapid growth, and large sums invested, there have also been several trends developing linked to how these activities are treated in the legal and tax system.

Following the collapse of players such as leading crypto entities such as Celsius and FTX,78 a number of legal issues have arisen connected directly to the organizations themselves,79 as well as to the numerous counterparties involved,80 and to the potential impact on the financial industry in general.81 Specific to the tokenized asset space—including NFTs, 82 staking operations, and decentralized finance operations more generally—the following issues are currently being worked through the legal system. Intellectual property rights, securities classifications (or lack thereof), and opacity connected to ownership represent just a few of the legal issues currently being debated around staking as well as other crypto issues. Staking court cases will invariably follow, with concerns seeming to grow that Ethereum—and specifically staked Ethereum—possesses the potential to cause negative ripple effects across the crypto sector. Interestingly enough, private sector organizations such as Coinbase are also actively seeking to obtain greater clarity around certain specific issues through court cases and future rulings.83

The classification issue of whether staking rewards are the equivalent of interest payments or newly issued ownership rights was central to Jarrett’s lawsuit against the IRS.84 In the aforementioned case, the IRS taxed Jerrett’s staking rewards at the time of creation (receipt) rather than at the time of sale.85 Some scholars and commentators believe that this IRS stance represents the law and that there is no legal ambiguity on this issue,86 even if there is a disagreement as to what the best law should be.87 Others, believe that the issue is not as clear,88 stating market uncertainty and call for Treasury to issue “clarifying guidance,” attempting to get courts to issue advisory opinions on the matter.89 Even in the aftermath of Jerret being dismissed in October 2022, both the plaintiffs and POSA have indicated intentions to pursue appeals continuing to seek crypto-specific clarity from the IRS.90

II. Policy-Making and the Crypto Industry

A. Regulation by Enforcement

Regulation by enforcement is a practice that has long been criticized.91 Historically the criticism against regulation by enforcement was largely made in connection with the SEC, but other regulators have also relied on such rulemaking, often citing arguments such as the one made by the former Secretary of the Treasury Timothy Geithner, who stated that “it is imperative [in some situations to]. . . be able to adapt quickly to innovation and to changes.92

With regard to the crypto industry and markets specifically—which the SEC’s Chair Gary Gensler has famously referred to as the “Wild West” in 202193—regulation by enforcement has been an especially popular tool.94 In various speeches and conferences, Gensler explained this, stressing how enforcement is a “fundamental pillar in achieving the SEC’s mission” to safeguard investors.95 Under Chair Gensler, the SEC’s Enforcement Division was instructed to be looking at “the underlying economic realities” of crypto-based products and services with financial nature, and industry players were warned to “think about the spirit of the law” rather than be searching for “some ambiguity in the text or a footnote” that can conflict with the law’s purpose of investor protection.96 Focusing on crypto assets, Gensler has also specifically recommended that “legislative priority should center on crypto trading, lending, and DeFi platforms” in order to bring crypto within regulatory frameworks comparable to those already in place for conventional financial products and services.97 Enforcing these notions, in 2021-2022, crypto firms such as Celsius Network, Voyager Digital Ltd., Gemini Trust Co., along with others, faced SEC scrutiny, which focused on the products and services that they offer, and often rightfully so.98 Examining this scrutiny in retrospect, regulation by enforcement—in the absence of proper law—makes sense, as by the middle of 2022, many of these entities have faced financial difficulties and were dealing with major financial losses and bankruptcy situations.99 Therefore, it is clear that enforcing some financial regulation on these entities was a desirable course of action, but doing so based on clear, transparent laws would have been much more conducive to creating tangible industry boundaries. The fact that in September 2022 the SEC added a new industry office specifically to focus on the compliance, disclosure, and reporting of crypto organizations illustrates just how seriously the Commission is taking its regulatory duties.100

But the SEC is clearly not alone maintaining a regulation-by-enforcement approach when addressing crypto businesses’ and persons’ activities. For example, in September 2022, the CFTC has been accused of adopting inconsistent and arbitrary standards in deciding who is accountable for violations based on “an unsupported legal theory amounting to regulation by enforcement while federal and state policy is developing.”101 And while there was little dispute as to whether it was logical for the CFTC to view the decentralization aspect of a for-profit unincorporated association as something that should not make a legal difference, all else being equal, the dispute was mainly regarding the way the various members’ liability was determined.102 Likewise, Jerrett exemplifies the types of questions that the IRS has confronted with regard to crypto related issues.103 As argued in Jerret, as well as industry associations such as POSA, there are market participants looking for crypto-specific tax treatments and/or exemptions, even though such developments have been denied thus far. The importance that the IRS has placed, and will seemingly continue to place, on crypto tax enforcement and compliance is further evidenced by the previous cases published by the Criminal Investigation branch as successfully resolved matters. These include, but are not limited to, obtaining guilty pleas from multiple individuals involved in an unlicensed money transmission operation linked to the buying and selling of bitcoin, and a guilty plea connected to a fraudulent ICO that had raised $24 million that also involved a civil settlement with the SEC. Additionally, the IRS also recently announced the liquidation of $57 million in cryptocurrency that had been seized in connection with the BitConnect fraud conspiracy, and that the IRS CI had obtained a 36-month prison sentence connected to illegally exchanging $13 million in Bitcoin with drug traffickers. In 2021 alone, the IRS seized over $3.5 billion in cryptocurrencies related to illegal or fraudulent activities104—which seems to reflect the growing size of crypto sector, the increasing attention being paid to the space by regulators, and the ability of the IRS to trace, document, and address criminal activity.

Addressing the issue of regulation by enforcement in the context of crypto taxation, Avi-Yona and Salaimi have recently advocated for the taxation of tokens received as rewards to be deferred until the tokens are sold or exchanged. They indicated, however, that they “propose that Congress through enacting legislation, or Treasury and IRS through issuing definitive guidance, should set that Staking Rewards are to be taxed only upon sale or exchange, rather than taxing them in the date they are received.”105 Indeed, they too believe that clear legislation or definitive guidance is the better approach, which also increases certainty and clarity.

III. ESG and Crypto

A. ESG State of Mind

In recent years market forces have driven business entities, including financial institutions, to pay closer attention to corporate social responsibility and ESG-related campaigns.106 The ESG movement, which has proven itself to be a global one, has quickly gained much attention,107 and started dominating businesses, financial conversations and agendas.108 A great deal of evidence suggests that both institutional and retail investors, along with other various stakeholders, truly care about ESG policies, and feel committed to advancing these ESG-related goals.109 Moreover, via proxy advisory firms,110 and even unrelatedly, investors are increasingly bringing their interest in ESG to the attention of corporate boards and business leadership.111 This rise in ESG investor-activism is demonstrated in the trillions of dollars of invested capital, which has an increasing proportion of new investor funds that are being directed toward ESG investments. As investment and business-decisions take on an environmentally conscious approach, even in the financial sector,112 the continued popularity of green technology results in consumers’ demands for more sustainable products and services.113

With global events such as the Covid-19 pandemic, the war in Ukraine, and other supply chain issues taking place, it has become clear that geo-political forces also impact environmental and sustainability related matters—those of which have become front-burner issues across the globe. The public as well as the private sector and in the mainstream media have widely discussed climate change, and industries that contribute to its accelerated pace, in the last decade. Specifically, many have tried to understand how exactly technology fits into these conversations in a productive and proactive manner. Moreover, an entirely new innovative sub-industry known as Regenerative Finance,114 as well as established companies such as Tesla, have made it their business to show their awareness of climate-related issues, and have successfully leveraged carbon tax credits and other similarly designed incentive tools. Specifically, in Q1 2022 the sale of carbon credits from Tesla was double ($679 million) the level of sales from Q4 2021,115 and exceeded previous highs obtained from Q1 2021. Despite these sales, building on billions of previous such sales, and operating as an electric vehicle maker, in 2022, Tesla was removed from the S&P 500 index tracking ESG compliance organizations, leading CEO Elon Musk to lambast ESG metrics and adherents as misinformed, among other more colorful labels.116 Clearly the conversation around ESG is a complicated one, but crypto mining, and even the acceptance of crypto as a medium of payment, will certainly play a role in these conversations in the years to come. Compounding these pressures are the additional concerns that have been raised since the announcement that Musk was planning to acquire Twitter prior to taking the firm private. With a double-digit percentage drop (as high as a 35% drawdown) since this potential acquisition was announced,117 the pressure on Tesla and Musk looks set to only increase moving forward, driven by a combination of ESG concerns, crypto questions, and ramifications around the potential Twitter deal.118

B. Crypto and the Environment

Given the high consumption of energy and electricity that PoW mandates,119 the impact of the crypto industry on the environment is clear yet non-ideal, and has received a lot of coverage recently.120 For example, Swedish financial regulators and the European Commission have discussed the option of banning the PoW mechanism given its impact on the environment.121 Similarly, reports suggesting that Bitcoin mining is responsible for 0.5% of the world’s electricity consumption was a figure that shocked many.122

The negative environmental implications associated with PoW consensus has led Bitcoin mining to become an especially contentious source of blame.123 This is so because of the size of Bitcoin’s network and market share. But Bitcoin is not solely at blame for negative environmental impacts. Cryptoassets of all kinds have come under increasing scrutiny as of late; particularly with regards to their harmful consequences—specifically those associated with mining related activities—and to carbon footprints, emissions, and power consumption. In the United States, certain state regulators have actively examined and commented on the scale of the power consumed by these operators, with some advocating for regulation that would put a stop to the use of the PoW concept. For instance, in May 2022, the New York State Assembly passed a bill that blocks new crypto mining facilities using non-renewable energy sources from setting up shop in New York State.124 Assembly bill A7389C, which was sponsored by Democrat representative Anna Kelles, imposes a two-year moratorium on any new crypto mining businesses that use a carbon-based energy source.125 Similarly, in 2022, EU financial regulators and the European Commission have discussed the possibility of banning the PoW mechanism because of its impact on the environment.126 Likewise, somewhat relatedly, in September 2021, the People’s Bank of China (PBOC), China’s central bank, also banned all cryptocurrency transactions—citing concerns around the impact of cryptocurrencies on the environment and in facilitating financial crime in addition to posing a growing risk to China’s financial system owing their highly volatile and speculative characteristics.127

But global headlines and political commentary aside, the impact of crypto operations on the environment and environmental metrics is not something that can be easily overlooked or relegated to the proverbial back burner. Indeed, despite the great attention the media has given the issue, the conversation around the environmental impact of crypto thus far has mainly focused around the PoW protocol, but there is more to it than the scope of this mechanism.

Several specifics that should be part of any large policy conversation or debate around PoW or other consensus methodologies include the following. First, the majority of emerging blockchain or cryptoasset applications are not running on the Bitcoin blockchain, or other PoW-powered blockchain protocols.128 Rather, these emerging applications—including DeFi, DAOs, NFTs, staking protocols, and other higher profile use cases that are driving IRS tax conversations utilize other scalable blockchains which move away from PoW. Second, the Ethereum blockchain—the second largest permissionless blockchain—is currently in the midst of the aftermath of the September 2022 Ethereum merge, the network’s pivot to a PoS protocol,129 which by some estimates will reduce power usage (and environmental) impact by more than 90%. Lastly, it is also worth noting that the trading volume, market capitalization, and overall dominance of Bitcoin relative to the rest of the cryptoasset sector has continued to fade over the last several years, with current ratios below 50%.130 In other words, many of the issues connected with the crypto sector’s impact on the environment can be partially addressed via tax plans and nudges, but need not be left solely to IRS’ regulation by enforcement as a solution. Rather, these issues should impact the creation of ESG-based goals that should nudge newly created financial regulation.

Additionally, the PoW protocol’s impact on society is broader than mere electricity issue,131 and includes e-waste,132 environmental-related consequences,133 and even changes to the social structure of the communities living in areas where crypto mining has become popular that must be more carefully examined.134

IV. Taxing Crypto

The taxation conversation around cryptoassets is too complex to be properly analyzed in any singular article or piece of research. The focus of this Article, however, is on the current state of the crypto taxation regime in the United States at the federal level, as determined by the IRS, and in particular, how taxing active staking activities could help advance greener, ESG-based goals. The volatile cryptoasset space has achieved a trillions of dollars market capitalization in recent years,135 and the related tax amounts, which have grown significantly during that period, could be used as a source of profit for the government, as well as a tool to advance socially desired goals. Since the TVL in the cryptoasset sector continues to increase and interconnect with financial institutions across the globe, a focus on active staking makes sense from a time management and asset allocation perspective. In addition to the larger sums of capital that are involved in the active staking landscape, the fact that institutions are becoming more invested in the cryptoasset sector also might mean that it is a simpler process to enact change through policy directives and codification versus the longer and more uncertain path of judicial rulemaking. As the shift toward PoS consensus continues, following the Ethereum merge,136 and as institutional adoption of blockchain applications of all types—from traditional financial institutions to the biggest non-profit, global organizations—continuing to accelerate,137 this will have one profound effect in addition to all others. With the capital allocation shifting toward both institutions and PoS protocols—including staking—the potential for tax policies to drive behavior will continue to increase. In other words, with larger amounts of capital on the line, investors and organizations will likely be more open to complying with tax-oriented directives.

A. Challenges

In addition to often needing to resort to regulation by enforcement, the challenges surrounding the crypto tax conversation are numerous and oftentimes change, or are altered depending on the specific cryptoasset in question.138 One of the most prominent issues that can arise, especially as crypto investing continues to become an institutional trend, is that users and investors of cryptoassets may not necessarily understand the general tax implications of crypto transactions. As per current IRS guidance, coincidentally the only authoritative guidance issued by a U.S. regulator, cryptoassets are treated and classified as property. As discussed in this Article, this means that every time there is a transaction involving cryptoassets there is a tax reporting, and potential tax payment, obligation. Put differently, every time there is a transfer, payment, transformation, or any other transaction involving cryptoassets, there is most likely a tax bill due. The lack of awareness around these implications has led to retail investors facing painful tax consequences. Therefore, implications for institutional investors are likely to follow suit. The importance of these implications, as well as the ramifications of this tax treatment, is evident even at the highest levels of the U.S. federal government. Contained within the Bipartisan Infrastructure Bill, which was signed into law during Q4 2021, was a carve-out indicating that the IRS estimates collection of nearly $30 billion in tax revenues from crypto transactions on an annual basis forward. Including this source of revenue in such a large package is a clear indication.139

The following two hurdles represent major challenges for crypto taxes. First, there is a lack of transparent and crypto-specific tax regulation—both in the U.S., and internationally—which complicates the compliance and reporting procedures for users of all sizes.140 This enforcement of these tax laws can and has, led both to hesitancy on the side of market actors in terms of investments and tax liabilities that are either larger than expected, or come for various reasons as somewhat of a surprise to some investors, whether rightfully so or not. Second, and partly related to the lack of consistency and crypto-specific tax and financial regulation, there is also a lack of consistent reporting and disclosure from market participants.141 Even if existing tax guidance can, and is, applied on an “as-is” basis to crypto transactions, that does not mean that the debate is settled. On the contrary, as this Article has highlighted there are legal and tax arguments being made on a continuous basis to alter existing tax policy. Such a task may be a long time in coming, and may not ever occur, but it is worth acknowledging the arguments being put forward. This manifests itself periodically in the form of erroneous data being delivered to customers and investors, data being delivered in different formats from different organizations, and a general lack of confidence in the data that is produced.142

B. The Property Versus Income Distinction

Connecting back to an earlier point raised in this Article is the distinction and definition of cryptoassets as property under IRS guidelines—an issue which has created quite a robust debate over the impact of such a classification on tax treatment and reporting. On the one hand, the general consensus, reinforced via the IRS’ publications, revenue rulings, public commentary, and the recently dismissed Jarrett case, is that every transaction involving cryptoassets will create a taxable event. These events include transactions, payments, transfers, exchanges, or the earning of income denominated in cryptoassets. From that perspective the tax issue surrounding cryptoassets is a straightforward matter, but that would be an oversimplification of the core issues at hand. This tax treatment, that every transfer or earning of crypto generates a taxable event, is based on the classification of cryptoassets as property under current IRS guidance. A seemingly simplistic categorization, but one that quickly becomes complicated when different types of staking are integrated within the conversation.

Drilling down specifically, the very process of staking can result in multiple streams of income or earnings for the taxpayer, depending on the specifics of the staking protocol. Setting that aside, the key question at hand is the nature of the tokens or crypto denominated earnings; are these newly created cryptoassets or are these assets being released from previously created or reacquired assets? Again, the application of existing tax law, as-is, does not distinguish or create an allowance for crypto staking. This may work in the short term, but capital—and organizations—always flow to where they are treated best, and taxes remain a major issue of contention for investors, developers, and crypto organizations alike.

C. Behavioral Economics and Tax Nudges

Behavioral law and economics contribute concepts useful for exploring the legal and policy implications of persons’ decision-making and departure from rational choice behavior.143 Specifically, findings in behavioral economics and cognitive psychology demonstrate that persons can make decisions that are not necessarily the same ones they would have made if they had complete information, unlimited cognitive abilities, and no lack of willpower.144 However, since people are prone to incomplete knowledge, cognitive bias, and passiveness, behavioral law and economic analysis helps complete the picture drawn by rationality theories and provides additional, much needed explanations regarding decision-making.145 Realizing this, in recent decades scholars have advocated for lawmakers to use behavioral law and economics-based insights and incorporate them into legal frameworks. Specifically, terming it “choice architecture” because it assists persons to make the right choice, Professors Richard Thaler and Cass Sunstein used studies to show that regulators should create default rules that would help resolve problems and nudge market participants to do what is viewed as the right thing.146 In this case, tax law and policy could be used to nudge individuals to follow and promote certain desired goals, as either by intention or second-order effect—tax policies are either an inducement for certain activities or meant to discourage other certain activities.147 These goals could—and probably should—be ESG-based, and in particular, environmentally friendly and pro-consumer protection.

Moreover, since the linkage between tax policies and tax tweaks in the context of crypto is a clear one, focusing on a solid choice architecture in this context should be seen as an opportunity for lawmakers. Especially since tax codes and classifications have yet to evolve in any significant manner—be they in the U.S. or internationally—realigning the debate around PoW protocols versus PoS options, and its consequences on various ESG-based goals such as sustainability and climate change. Of course, arguments could be made against making a carve-out or exemption for crypto, but that potentially misses a broader point. Crypto continues to attract capital, and increasingly that capital is from institutions and nation-states. Simply ignoring these trends, applying tax laws not written with a broader, carefully tailored agenda in mind, does not seem like an approach that will lead to robust growth and development.

Much like how certain activities or industries have been subsidized and incentivized via the issuance of carbon credits, it would seem logical that a similar approach could be implemented in the blockchain space. One direct approach would be a modification of current tax classification and treatment that differentiates between types of consensus methodologies. For example, PoS can be delineated in modifications to the tax code or tax guidance that grants a preferential tax position for these activities versus PoW activities. This would not penalize organizations involved in PoW applications, maintaining the impartiality of the U.S. tax code, but allows for a lower tax burden on organizations operating in the space.

An additional tax nudge that could incentivize investment toward PoS endeavors would also mirror existing regulations on the books pertaining to the treatment of cash dividends versus equity repurchases.148 Under current guidance, dividend income is paid on an after-tax basis by the payee organization, and the recipient also pays income taxes on the dividends received, sometimes at the ordinary income tax rate. Conversely, when share prices increase as a result of share repurchases there is no tax liability for any holders of these shares until these shares are sold. A similar approach could be taken with the debate around block rewards and PoS income-generating activities.

V. Staking Creating Securities

One factor that needs to be assessed but remains generally under-analyzed in mass media, is the following possibility: as calls, from both policymakers and market participants alike, continue to encourage investment and a pivot toward PoS operations, there is a possibility that these cryptoassets might fall under the classification of securities according to The Securities Act of 1933 which contains a long list of instruments that count as securities.149 While most examples listed in the Act are particular ones and fairly obvious, including stocks and bonds, the list also includes terms that are much more generic and broad, such as “investment contracts.” These broader terms are meant to serve as a catch-all for “[n]ovel, uncommon, or irregular devices,” which can be securities.150 And indeed, given the novel nature of crypto assets, also often referred to as digital assets, courts and the SEC have been unsure if digital assets are investment contracts, or not. However, in the days following the Ethereum merge, SEC Chair Gensler hinted in a public statement that he might view staking as an additional indication that the cryptoassets should constitute a security.151

As mentioned above, the Howey Test152 provides the most useful way to determine whether or not there is an investment of money in a common enterprise with the reasonable expectation of profits, based on the efforts of others. 153 Active staking, which involves the placement of funds (tokens) with either a centralized entity or decentralized protocol, seemingly could trigger security recognition. After all, the expectation of staking entities is that this activity will generate economic benefits (profits, ownership, control), and is denominated by financial instruments known as tokens. Drilling deeper, an additional should be asked—how would security classification of PoS alter the tax incentive and the policy debate around this subset of crypto?

On the surface, the tax treatment of cryptoassets would not differ dramatically from the current treatment of securities. Equity securities are taxed when they are traded or exchanged, and depending on the holding period of the asset in question, taxes are levied at either the ordinary income rate of the taxpayer or at a capital gains rate. Where the difference would be felt, for individual and institutional taxpayers alike, is around the disclosure,154 reporting, and the wash sale treatment of crypto trades.155 Under current guidelines, disclosure standards for traders, investors, and exchanges remain murky in most jurisdictions, but classifying PoS tokens as securities will change that definitively. Without diving into the specifics, which are beyond the scope of this paper, classifying financial instruments as securities also initiates an array of broker-dealer reporting requirements, mandatory tax disclosure and reporting,156 and the elimination of the wash sale exemption cryptoassets currently enjoy.

Under current tax treatment, cryptoassets are not subject to wash sale rules,157 which in turn allows investors and traders to sell cryptoassets, harvest the tax losses, and immediately repurchase these cryptoassets. If and when some cryptoassets are treated as securities, the tax losses currently able to be harvested by investors would be disallowed. Given the fact that PoS tokens that are actively staked tend to also be locked up for a fixed period of time, this change would have a limited initial impact. Even though lockups tend to be measured in months versus years, the continued volatility in crypto markets means that even shorter lock-up periods can result in unrealized gains/losses that cannot be recognized by taxpayers until the lock up expires. Coupling this with the reality that, on a practical basis, tax loss harvesting is a strategy used by crypto investors of all sizes, the wash sale rule exemption is something worth taking into account if and when crypto tax policy changes. As the PoS continues to develop and advance, however, the increase in reporting requirements, greater scrutiny under both the IRS and the Securities and Exchange Commission (SEC), and elimination of current wash sales benefits are factors that developers, stakers, and investors need to be aware of going forward.

VI. Money (and Regulation) Time

The intersection of different mining protocols, types of crypto, and the implications around ESG initiatives, is a direct byproduct of the debates and conversations around the implications of PoW versus PoS. Putting it simply, the vast majority of debates around the power consumption and environmental impact of crypto from a carbon perspective has to do with the PoW crypto mining process.158 Without diving overly into the minutiae of the pros and cons of varying consensus methodologies, there is a connection that can and should be made between the tax incentives and opportunities available to operators and ESG factors driving market headlines.

Drilling down specifically into the issues around blockchain and cryptoassets, there is an opportunity presented to accomplish two goals simultaneously.159 First, the pivot and shift toward PoS consensus methodologies is well underway, and has been embraced by regulators and market actors alike. By requiring less power and technical complexity to operate as advertised, PoS has opened the door for increased scale, processing capacity, and the ability for more complex crypto applications.160 Secondly, the debate and conversation around the current tax and accounting treatment has intensified ever since bitcoin first burst into the mainstream financial conversation during 2016. Building on from the initial rulings on the treatment of virtual assets in 2014, albeit in fits and starts, the current staking debate has uncovered another layer to this conversation.

Block rewards and the ability for investors to generate income and other earnings using PoS methodologies also highlight the opportunity for policymakers to incentivize miners and organizations to allocate resources to this space.161 There are several specific steps that can be taken—even if only from a tax perspective—that can be leveraged to reallocate capital toward PoS applications.

First, in order to promote more ESG-based goals in general, and an environmentally-friendly agenda in particular, the IRS could borrow an approach from individual states and jurisdictions where it either exempts certain crypto transactions from taxes altogether, or taxes these activities at a lower rate.162 For example, these adjusted or lower rates can and should be applied to both the operators, managers, or organizers of the PoS protocols rather than PoW, as well as the rewards and income flows generated by the stakers of these protocols. Similar treatment already exists with the lower rates charged for capital gains and carried interest versus ordinary income so this approach is not without precedent.163

Second, the IRS could and should coordinate with other regulators in the financial services space to streamline applications to participate in sandbox initiatives, and make the entry into and proliferation of PoS activities, rather than PoW, more attractive to investors.164 While most crypto products and services are far from ideal in terms of their impact on the environment, the difference between PoW and PoS is a significant one. Therefore, if crypto products and services are to be used, it is better to use those that are more ESG-oriented and less harmful to the environment. Akin to how certain states have written and ratified specific laws around how blockchain and cryptoassets can be used or integrated into existing legal frameworks, it makes sense for a similar approach to be taken for PoS activities and operators.165 For example, clarity around the tax treatment of governance tokens, often issued as a result of staking contributions, would contribute significantly toward creating a more investable outlook for such protocols.

Lastly, and something that would not require a complete overhaul of tax law or treatment, would be a deferral of gain recognition on staking rewards until the time of sale. How this might play out would be as follows: following the initial deposit of tokens either at an institution or decentralized protocol, the staking entity would be entitled to earn certain types of rewards or income either on a passive or more active level. Under this proposal these rewards and/or income streams would not be subject to gain recognition or income taxes until these rewards are disposed of in an external transaction. The specifics of this would require additional clarification, as there would need to be clarity around which counterparty owns or has control over the gains or rewards as they are produced. Carve-outs and exemptions are always controversial, and creating one for staked tokens would be no exception, but it should at least be considered given the broad-based appeal and adoption of PoS protocols.

Without lawmakers’ attention to the type of legislation that would adopt and advance certain goals and courses of action, it would be hard to make a real change in the way the industry develops. Theoretically, however, a judicial interpretation that reads existing legal norms and standards in the income versus property debate could, pragmatically speaking, be an interpretative fix to taxing questions and business models.166 Or, put another way, courts can examine these questions and decide, without factoring in lawmakers’ agenda-based reasoning such as ESG-goals, to tax in a certain way that financially benefits those promoting the adoption of PoS versus of PoW protocols and staking activities. Indeed, if in Jarrett’s case the court can rule one way versus the other, which would result in consequences that could increase or decrease adoption and support for PoS protocols.


ESG goals in general, and the sustainability agenda in particular, can and should be applied to taxation to ameliorate the impact of the crypto industry on society and the planet. In making the case for a sustainability approach to taxation, in connection with crypto assets, it makes sense to especially focus on the difference that the PoS versus the PoW protocols have on the environment and suggest changes in financial regulation and particularly tax policy that can help promote a desired agenda, which others

have also advocated for.167

No comments here
Why not start the discussion?