Welcome to our July edition of all things blockchain. This month, we overboard on NFTs, ponder on how safe our crypto is and get overly excited…
UPDATE – Some of the information contained in this article has been superseded by our latest blog
What is a node?
In simplest terms, a node is a computer that connects to a blockchain network in order to support the network, and they come in a number of different forms. If we look at the bitcoin blockchain, mining nodes were originally the only way to get into Bitcoin and generated new blocks on the chain whereas full nodes held and distributed copies of the ledger. Super Nodes operate around the clock to connect full nodes and spread the blockchain throughout the network, essentially acting as redistribution relays.
But can’t I buy a node?
You absolutely can. As mentioned before nodes come in completely different shapes and sizes, hardware or cloud based.
These are seemingly becoming more relevant due to the new offerings in the marketplace around cloud based nodes operating as a Node as a Service (NaaS), offering a passive income stream to investors.
For the purposes of explaining this in further detail, we will consider such a service – $STRONG nodes on StrongBlock in more detail.
What is Strong?
StrongBlock automated the process of purchasing nodes, removing a lot of the complexities and barriers to entry to getting involved in blockchain. Strong nodes support the Ethereum network, require no hardware, and reward STRONG tokens (an ERC-20 token).
The current reward for operating a Strong node is 0.1 STRONG per 7,000 blocks, roughly equating to around 0.092 STRONG per day. At current time of writing (when the markets are not at their best), that equates to roughly £30 per day.
To purchase a STRONG node, you would need to cough up 10 STRONG, current around £3,500 at time of writing. From that point you start accruing rewards which accrue onchain and can be claimed to your wallet when convenient. It is important to note that up until claiming, the rewards are recognised as accruing to the wallet used to purchase the node, until a time the rewards are actively claimed by the wallet owner.
There is a monthly maintenance fee of around £10 (plus gas fees) to StrongBlock in order to maintain the node, and where this is not met the node is sacrificed and unrecoverable. These are all rules written into the protocol for node owners to abide by.
Owners have a choice as to whether they let rewards accrue to draw down as assets to sell or trade for other assets or convert to fiat, or to reinvest in the network and purchase further nodes, thus compounding the rewards received.
A similar project is THOR on the Avalanche network which advertises similar rewards based on the type of node purchased, however these rewards come from returns in protocol-owned liquidity and DeFi protocols and not the creation of new blocks. THOR has a range of nodes available for purchase, all named after characters in Norse mythology. If users claim tokens before the set return-on-investment period, then some of that claim is sacrificed as a ‘tax’ (to the network). Unlike STRONG, this encourages the owners of a node to leave their rewards unclaimed for longer periods of time helping the sustainability of the token.
There is much speculation around the legitimacy of some of these projects, which we are unable to comment on, and the prices of the tokens rewarded are subject to high volatility.
How are these rewards taxed?
Rewards from node ownership is taxed as income in the UK at a rate dependant on the recipients marginal rate of tax (20%/40%/45%). If a recipient is trading, then income accrues at the point this can be claimed, however for some an argument exists that their point of income is when the rewards are claimed and taken to their wallet, based on the risk of the underlying protocol (e.g. a rug pull, loss of value etc).
Record keeping is therefore essential to determine any tax liability, as it is based on the spot price of the tokens received. Any movement between when tokens are received and recognised as income and eventual disposal will likely be treated as a capital gain or loss accordingly.
Can I treat this as a trade?
In order to establish whether a trade exists, it is common to refer to case law, and what is considered the “badges of trade”. There are a number of factors that may mean somebody is undertaking a trade, as activities may fall into some (and there is no requirement to meet all) of the badges of trade:
- Profit-seeking motive
- Frequency and number of similar transactions
- Modification of the asset to make it more saleable
- Nature of the asset
- Connection with an existing trade
- Financing arrangements
- Length of ownership.
To date, we have not seen any legal precedence with regards to cryptocurrency activity being regarded as a trade, but HMRC’s manual states that ‘only in exception circumstances’ would they consider activity to form that of a trade. Given the rewards are often referred to as ‘passive income’, it may be unlikely that the purchase of these nodes is sufficient to give rise to a trade.
Costs and allowable deductions
If owning nodes is not considered to be a trade (despite the purchase of a node, which could be considered to be a piece of software), then relief from expenses incurred are limited.
Maintenance costs can therefore not be offset. Likewise, gas fees are considered transactional costs and therefore cannot be offset against income but would form part of the cost of asset acquisition for capital gains tax.
Are the original costs of nodes deductible?
When you buy a node you are investing in an intangible asset, which from an accountancy perspective is capital in nature. It may be possible to claim relief for this capital expenditure in certain cases.
Let’s consider this in the case of compounding tokens received into nodes. Tokens are rewarded, and there is a charge to income tax based on the spot price of these nodes. Instead of converting these into fiat to eventually settle my tax bill, the tokens are compounded into another node. Often the cost of a node is unrecoverable as they are not assets that can be sold, and no secondary market exists for them. Without any consideration of off-ramping my receipt of tokens, not only is the activity compounding the number of nodes, but it is not allowing for any settlement of a future tax position from the income received.
Would a company structure be beneficial?
A company structure would mean that rewards received are subject to corporation tax instead of income tax, which is currently at a rate of 19%. Assets received could either be distributed from the company or off-ramped so that the owners of the company receive a dividend from the company to plan their remuneration effectively.
If you are planning to compound your reward income into further nodes and you are at or near the higher rate of tax of 40%, this structure could certainly provide some planning opportunities.
If you have any questions about nodes or would like to explore the planning opportunities available this is something we would be more than happy to discuss with you.