Before we understand the Income Tax Implications for Staking & Yield Farming in India, lets clear some basic fundamentals.
What is crypto staking?
Crypto staking is the act of holding a specific number of supported tokens for a period of time in the hope of earning rewards, and at the same time, contributing to the tokens’ governance. As the term implies, it only applies to tokens that employ the PoS consensus algorithm, such as EOS, Tezos, Cosmos and VSYS.
A simpler analogy would be a Fixed Deposit with a Private Limited company wherein you earn interest on your deposit and your money is Locked-in for a fixed period. Risks are high as there is no assurance but that's where your due-diligence and reasearch comes into play. Rewards could be huge as some networks pay 10-18% returns.
What is Yield Farming?
Yield farming is the practice of staking or lending crypto assets in order to generate high returns or rewards in the form of additional cryptocurrency. This innovative yet risky and volatile application of decentralized finance (DeFi) has skyrocketed in popularity recently thanks to further innovations like liquidity mining. Yield farming is currently the biggest growth driver of the still-nascent DeFi sector, helping it to balloon from a market cap of $500 million to $10 billion in 2020.
In short, yield farming protocols incentivize liquidity providers (LP) to stake or lock up their crypto assets in a smart contract-based liquidity pool. These incentives can be a percentage of transaction fees, interest from lenders or a governance token (see liquidity mining below). These returns are expressed as an annual percentage yield (APY). As more investors add funds to the related liquidity pool, the value of the issued returns rise in value.
A simpler analogy would go something like this - A private limited company is offering a Fixed Deposit scheme with high interest rate but there is a minimum capital requirement with lock-in period among other conditions. A group of investors pool their funds together to meet the minimum capital requirement and reduce their overall risk to one company.
One of the most common questions that I encounter Is Staking the Same as Yield Farming?
It’s a similar concept. But it’s different from one another. Staking involves validators to lock up their coins based on the PoS consensus algorithm. While yield farming boasts of the lending pool that allows the token holders to generate passive income in exchange for the interest rate.
Why Crypto Staking is beneficial?
Staking cryptocurrency is one of the many avenues to increase one’s crypto holdings. However, the most appealing thing about it is probably the fact that it allows you to passively grow your holdings (after you’ve decided where to stake to manage your slashing risk).
What’s more, crypto staking has many other benefits to offer, such as:
1 - No special machines required
2 - Environmental-friendly
3 - No trading required
Despite the sophisticated technology and concept that underlie cryptocurrency staking, in practice, it is pretty straightforward.
Here’s How to Stake in few simple steps:
1 - Do your research
Each PoS token has its own staking rewards scheme, terms and conditions, as well as the staking service provider has its fee structure, reputation and rules. Some ill-intentioned tokens, however, sometimes offer staking to incentivize users to buy up their coin as they dump on the markets. So, make sure you are well informed before making any decisions.
2 - Choose the service provider
There are several options as to where you can keep your staked tokens and get rewarded. From digital wallet, crypto exchanges to crypto staking pools. Whichever crypto staking services you choose, make sure that you follow the given instructions and understand how it works clearly since each staking provider has its own set of features and offers.
3 - Pick the tokens of your choice
Now that you’ve done your research, you can pick the PoS tokens of your choice and start staking. You can purchase them first or use your existing tokens.
If interested, we offer Crypto consulting services wherein we can guide you right way to invest in Staking & Yield Farming opportunities in a low risk fashion.
What would be the Income Tax Implications for Staking & Yield Farming in India?
From the above discussions, it is clear that income earned from staking & yield farming is nature of Interest on Deposits though there is no clarity of regulations from Government of India on this. As you know, neither the Income Tax Act, 1961, nor the Central Board of Direct Taxes stipulates any specific tax treatment for income earned from investments in cryptocurrencies. In the absence of regulations, one may declare Income earned from staking & yield farming as Income from other sources and provide detailed description by each coin.