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The most well-known consensus system is Proof of Work, which is used by Bitcoin (amongst others). Here, the right to add a new entry to the distributed ledger is only available to the first person to solve a randomly generated complex cryptographic puzzle. That person then creates the new entry and it is shared with all holders of the distributed ledger. The time and energy required to solve the puzzle is the proof of work, the right to add the entry is the primary reward. The person with that right will be entitled to any fees available for including transactions in that entry and they will be allocated with a quantity of new tokens that are released into circulation. This process is known as ‘mining’ and serves to maintain the network of a given cryptoasset.
Whether you mine as a hobby or as part of a business, crypto received as a result of mining activities is treated as income. If you are mining as a hobby, you need to declare the proceeds as income on schedule C of your tax return.
If you've incorporated a business set up as a sole proprietorship you should report your income on form 1040, schedule C. You may be able to claim certain deductions if the mining is part of a business. These include
- Equipment expenses
- Office space
- Any losses
Please consult a tax professional to help assess if your mining activity would be considered a business. Not all mining is a business.
Mining activity reported in Recap