Proof-of-work cryptocurrencies have come under fire in recent months amid rising environmental concerns. Bitcoin alone consumes more than one-half percent of global power, which is equivalent to countries like Malaysia or Sweden. These high energy costs, coupled with performance bottlenecks, have led to a new generation of cryptocurrencies.
Ethereum 2.0 is one such aforesaid cryptocurrency that solves energy and performance concerns. But before we elucidate on when Ethereum 2.0 will launch? Let’s delve deeper into what Ethereum 2.0 is and it's tax implications that investors should know before they buy.
What is Ethereum 2.0?
Ethereum 2.0, or ETH 2.0, is an upgrade to the Ethereum network that aims to improve:
- Security—the reduced possibility of 51 percent attack
- Scalability—higher number of transactions
- Sustainability—reduced environmental impact
How does it do it?
By swapping the conventional proof-of-work algorithm for a proof-of-stake algorithm that doesn’t require energy or computing resources but still penalizes network disruptions and thwarts malicious actors.
How Will Ethereum 2.0 Enhance Security?
As of now, Ethereum’s security against 51 percent attacks is dependent on the allocation of the computational power and can possibly be affected by a coordinated attack on the blockchain.
But, what is this 51 percent attack?
If more than 50 percent of the computational power is occupied by an individual or a group in PoW consensus protocol, there is a possibility that these groups might validate false transactions and breaks the users’ trust in the validation process of the blockchain.
In Ethereum 2.0’s PoS model, an attacker cannot purchase the blockchain’s hash power. Additionally, if the attacker wants to attack the network, they would need to acquire above 50 percent of the entire staked ETH, which is a quite intricate task and decreases the likelihood of a 51 percent attack.
How Will Ethereum 2.0 Enhance Sustainability?
Understanding how PoW is negatively impacting the environment is the underlying tenet of how Ethereum 2.0 is going to enhance sustainability.
PoW based blockchains need thousands of computers for performing billions of calculations—also known as hash power—per second. These calculations need huge amounts of electricity produced by power plants, which causes pollution. The PoS model of the upgrade replaces a billion calculations with rewards for validating transactions. This model requires substantially less electricity and enhances Ethereum’s sustainability.
Moreover, proof-of-stake algorithms involve employing a network of validators that stake their own cryptocurrency in exchange for a chance at validating new transactions, updating the blockchain and earning a reward. The winner is based on the amount of crypto each validator has in the pool and the length of time they’ve had it there.
How Will Ethereum 2.0 Enhance Scalability?
Ethereum’s current transactions per second are quite less and this capacity cannot help the blockchain grow and be cost-effective at the same time. Therefore, Ethereum will enhance its scalability issue with shard chains.
What are shard chains?
Shard chains will split transaction data across 64 blockchains on the Ethereum blockchain. These chains will have a limited capacity on their own but collectively they will tremendously increase Ethereum’s output.
What Are the Ethereum 2.0 Tax Implications?
The switch to Ethereum 2.0 is considered a soft fork since the Ethereum 1.0 blockchain will cease to exist when the transfer is complete. While hard forks followed by an airdrop of a new coin are taxable transactions, as was the case with Bitcoin Cash, the Ethereum soft fork is not a taxable event since one cannot own both ETH and ETH2 in the end.
When ETH is replaced with ETH2, the cost basis for the new ETH2 will carry forward from the original ETH. Traders and investors should maintain a record of the original cost basis in order to ensure that their taxes are accurate and up to date. Depending on the wallet or exchange, the original cost basis may not be available following the migration.
A thornier tax question is: Do you owe taxes on staking rewards from ETH when it’s still locked up? Tax professionals are still debating the answer to that question, but the most likely precedent would be the Original Issue Discount rule, which requires that taxpayers make payments on accrued interest before it’s received (e.g., with a certificate of deposit).
Ethereum 2.0 Gas Fees and Taxes
Many actions on the Ethereum blockchain require the payment of gas fees, including yield farming, transfers, approvals and staking rewards. With the rise in decentralized finance, or DeFi, the Ethereum network has started to reach its performance limits, which is one of the reasons that Ethereum 2.0 was developed to dramatically improve via shards.
Gas fees will likely experience a significant drop from their current levels with the rise of ETH2 by both eliminating the need for costly computational resources and dramatically improving underlying performance. Many experts believe that gas fees could drop to cents rather than dollars, enabling the DeFi ecosystem to continue its robust expansion.
From a tax standpoint, gas fees are often added to the cost basis of an asset, which reduces capital gains or increases capital losses when it’s sold. Transfers and other transactions are treated differently since there was no asset acquisition. Most experts simply remove gas fees from holdings without recognizing a capital gain or loss.
Now that we know about Ethereum taxes and Gas fees, let’s talk about the most anticipated questions, when will Ethereum 2.0 launch?
When Will Ethereum 2.0 Launch?
Ethereum 2.0 launch is initiated in multiple phases. As per phase 1, Beacon Chain was launched on December 1, 2020, and is currently live on the Ethereum network. In phase 2, the existing Ethereum blockchain is expected to merge with the Beacon Chain in the second quarter of 2022.
With the launch of the Beacon Chain last December, Ethereum holders can stake their ETH to help secure the upgraded network in exchange for rewards. These rewards change based on how much ETH is staked at any given point in time, but as of June 2021, investors can earn upwards of 7% APR in exchange for staking ETH and may even be covered from losses.
Later this year, the Mainnet Ethereum is expected to merge with the Beacon Chain to enable staking for the entire network and signal the end of energy-intensive mining. In 2023, shard chains will expand Ethereum’s capacity to process transactions and store data while gaining more features over time as it’s rolled out in multiple phases.
How to Get Started with ETH2
MyEtherWallet is one of the most popular software wallets that enables ETH tokens to be staked into the ETH2 Beacon Chain. In order to qualify, MyEtherWallet users need at least 32 ETH while a partnership with Staked will run a validator node for them, eliminating the need for in-depth technical knowledge in order to participate.
Coinbase is the largest crypto exchange that supports ETH2 staking. Any users that hold ETH in their account, living in an eligible country, complete verifications and agree to terms and conditions can stake ETH. Customers in the U.S. that earn over $600 in staking rewards will receive a 1099-MISC from Coinbase and the rewards will appear under Lifetime Rewards.
Before staking ETH, it’s important to keep in mind that there’s a possibility of loss if validator duties are not met or if the Ethereum network upgrade is unsuccessful. Investors should also keep in mind the tax implications of staking rewards, including the fact that they may be taxed on the rewards before they are able to fully withdraw them.
Proof-of-Stake Cryptocurrencies Checklist
Use the following checklist to identify the different proof-of-stake cryptocurrencies.
- BNB: BNB is a cryptocurrency coin that powers the Binance ecosystem. As one of the world's most popular utility tokens, not only can you buy or sell BNB like any other cryptocurrency, but BNB comes with a wide range of applications and benefits.
- Flow: Flow is a new blockchain built for the next generation of apps, games, and the digital assets that power them. The development team behind Flow originally hails from the CryptoKitties project.
- AKT: AKT is the utility token powering the world’s first open-source cloud. It’s used as the primary means to govern, secure the blockchain, incentivize participants, and provide a default mechanism to store and exchange value.
- Raydium: Raydium offers DeFi and AMM projects a clear path for bridging platforms and liquidity with the evolved capabilities of Solana and Serum. It provides on-chain liquidity to a central limit order book.
- Tezos: Tezos is an open-source platform for assets and applications backed by a global community of validators, researchers, and builders.
- NOW: NOW is the first native digital asset introduced by an instant exchange platform to serve as an internal currency accepted within the NOW product system
The Bottom Line
The migration to Ethereum 2.0 addresses critical shortcomings in the performance and sustainability of conventional proof-of-work cryptocurrencies. While investors have flocked to an opportunity to stake ETH and earn an attractive yield, they should keep in mind the risks associated with staking as well as the potential tax implications.
If you have a complex crypto tax situation, try ZenLedger to simplify your taxes and ensure that you’re not overpaying each year. ZenLedger aggregates transactions across hundreds of different wallets and exchanges and computes the cost basis and capital gain or loss for each transaction, including complex DeFi transactions.
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