Preparing Your Organization for the Rise in Cryptocurrency Donors
The movement of cryptocurrency and digital assets to the mainstream has changed how we exchange value. The value of cryptocurrencies such as Bitcoin and Ether has seen a significant increase over the last year. Donors are crypto-rich and looking for ways to deploy their gains for good. There are new nontraditional donor opportunities coming from the cryptocurrency universe. The points below are just the beginning; to learn more, contact your BKD Trusted Advisor™.
What Is Cryptocurrency?
Let’s set a baseline for what cryptocurrency is and how it is accounted for:
Cryptocurrency (crypto or coins) is a type of digital asset that uses cryptography as a tool to secure transaction data. The data exchanged related to cryptocurrency transactions is distributed by means of its own protocol or program code. In the case of Bitcoin (one of the more mainstream cryptocurrencies), the Bitcoin blockchain uses proof of work to verify transaction data. Miners participating in the blockchain use significant computing power and hardware to work through the complex mathematical combinations/calculations and solve the cryptographic hash. This hashing process confirms transaction data and attaches this data to the blockchain.
Each crypto has its own protocol and genesis. In approximately 2008 when Bitcoin surfaced as a peer-to-peer decentralized medium of exchange, it was alone and considered revolutionary. Today, there are an estimated 4,000 different cryptocurrencies worldwide, with many more in production. Everyone has their favorite digital asset. Cryptocurrencies have created interesting and challenging discussions around the world, inspiring movements that bring fintech and decentralized finance into our everyday systems of exchange.
Cryptocurrencies are used as a medium of exchange, meaning they move value from one market participant to another. However, it is important to remember that cryptocurrencies are not backed by the U.S. (and most foreign) governments or other system of collateral (unless specifically designed as such). The value of crypto is generally based on market demand. The supply of the coin can be managed in creation through establishing a finite number of coins available or establishing burning mechanisms to reduce supply as the coin ages or demand grows. This mechanism varies from the dollar and other fiat currencies and acts as a significant consideration for cryptocurrency investors.
Bitcoin and Ether are considered mainstream cryptocurrencies in today’s market. These coins have a liquid market and are commonly traded through many public exchanges. We have talked a bit (no pun intended) about Bitcoin; however, Ether also is valuable in this conversation, as it performs as not only a payments system coin but also a functional coin. The protocols used in the Ether blockchain allow for programmable contracts commonly referred to as smart contracts. Although the world of smart contracts is in its adolescence, this brings a futuristic capability to determine when and how contractual obligations are fulfilled.
As with any movement, it is always interesting to understand the “why.” Why are we seeing this movement to cryptocurrency, and what has created the path to mainstream? There are many psychological considerations related to cryptocurrency and decentralized finance, such as having direct access to your own personal finance, removing the idea of an intermediary, and watching a truly free market generate value for those who otherwise felt excluded from wealth. These considerations are combined with a vocal movement demanding transparency in financial markets, attention for underserved/underbanked populations, and a worldwide need for value storage to create space for cryptocurrency. Outside of these intangible catalysts, the search for investor yield and protection against inflation has created a tangible shift in market investment. Below is a graph showing the change in Bitcoin value in the most recent 12 months:
The summary above illustrates volatility for cryptocurrency (Bitcoin as a benchmark cryptocurrency). In the third quarter of 2021, Bitcoin and Ether values decreased by approximately 32 percent and 45 percent, respectively. This volatility speaks for itself, and organizations that hold cryptocurrency should be prepared for the uncertainty.
Accounting & Tax Guidance
- Generally accepted accounting principles do not currently provide specific guidance on accounting for cryptocurrency. The American Institute of CPAs has acknowledged the need for guidance and established a Digital Assets Working Group. This group has produced a practice aid that addresses the complexities experienced in accounting for digital assets. This practice aid is a valuable resource for all who are considering receiving or investing in cryptocurrency or other digital assets.
- A contribution of cryptocurrency would be considered a noncash contribution (gift in kind) of intangible property. The contribution would be recorded at fair value in conformity with Accounting Standards Codification (ASC) 820.
- For organizations that are not reporting as investment companies under ASC 946, Financial Services, the current consensus is that cryptocurrency should be accounted for as an indefinite-lived intangible asset under ASC 350-30.1 If purchased, the asset is recorded at cost and subsequently tested for impairment annually or more frequently if events or changes in circumstances indicate that it is more likely than not the asset is impaired. Impairment should be recorded through the income statement.
- Derecognition of cryptocurrency should be accounted for under ASC 610-20, Other Income – Gains and Losses from the Derecognition of Nonfinancial Assets, or ASC 845, Nonmonetary Transactions, depending on the nature of the transfer. Net gain or loss is determined by subtracting cost from consideration transferred and should be presented outside of contribution revenue.
- For federal tax purposes, individuals who are not engaged in the trade or business of selling cryptocurrency hold cryptocurrency as a capital asset and therefore recognize capital gain or loss when sold, which can be either short term or long term depending on the holding period. As cryptocurrency is treated as a capital asset, a donor may be eligible for a charitable deduction equal to fair market value of the cryptocurrency at the time of the donation, as long as it has been held for more than one year. Donating appreciated property held for more than one year is a good strategy for reducing a taxpayer’s tax liability because the taxpayer can take a charitable contribution deduction for the property’s fair market value while also avoiding tax on the unrealized gain. If held for one year or less, the deduction is limited to the lesser of the donor’s basis or fair market value. Individual donors claiming a charitable deduction equal to or in excess of $5,000 will need to obtain donor acknowledgment and a signed Form 8283 from the organization. For individuals or businesses engaged in the trade or business of selling cryptocurrency, ordinary income will be incurred.
Guidance for Nonprofit Organizations
New decisions and risks will emerge as your organization enters the world of cryptocurrency. In preparing to accept cryptocurrency donations, organizations should consider if they will “receive and hold,” “receive and sell,” or use third-party liquidity services.
- When an organization determines it will “receive and hold,” the organization will need to establish a wallet. A wallet is used to digitally store cryptocurrency value. “Receive and hold” requires the organization to provide the donor with its wallet address.
- Wallets can be maintained as an account on an exchange (such as Coinbase, Gemini, or Bitstamp) whereby the exchange maintains the public and private keys.
- Software wallets are another option. Several software wallets allow the wallet holder to maintain their own keys without needing to purchase an additional piece of hardware.
- A hard wallet also is an option. A hard wallet allows the wallet holder to maintain their own keys.
- The organization also can choose to engage a third-party custodian (an exchange is not a custodian) who can maintain “hosted wallet” services and maintain cryptocurrency in a secure environment. See the Accounting & Tax Guidance section above for other considerations when holding cryptocurrency.
- “Receive and sell” also requires the organization to provide the donor with its wallet address. The organization then uses an exchange to liquidate the cryptocurrency. In this case, the organization takes possession of the cryptocurrency and is responsible for maintaining a record of transactions and reporting gains and losses.
- A third-party cryptocurrency payment application or gateway will act as an intermediary to receive and convert the cryptocurrency to cash. A payment application and payment gateway are very similar in execution. A payment application will use the established wallet of the organization, while a gateway will require donors to submit the donation through the portal. The organization can review the transaction data and approve the donation. The portal liquidates the cryptocurrency and sends cash to the organization, and the organization is not required to have a wallet (in most gateway transactions, the organization does not take possession of the cryptocurrency). In each case, a fee is charged that can approximate 1 percent. Coinbase, PayPal, and BitPay are examples of third-party payment applications and gateways. Platforms like The Giving Block generate tax reporting documents for donors and facilitate a gateway donation structure for organizations.
It can be key to know your options and determine policies and procedures ahead of time. Consider a review of your donor acceptance policies to determine if your organization will accept cryptocurrency, and if so, how.
Internal policies also should be updated to consider “know your donor” and “know your transaction” requirements. The fraud and anti-money laundering regulations proposed (in comment period) by the Financial Crimes Enforcement Network (FinCEN) are applicable to unhosted wallets. If a donor uses a custodian, they are likely operating under a hosted wallet. If the donor wallet is a hard wallet or held directly by the individual, the wallet is unhosted and has likely not been subject to FinCEN regulations. For some types of cryptocurrency, it may be difficult to establish the source of a cryptocurrency gift. Policies should emphasize the quality of donor records, acceptable cryptocurrency donations, and transparency in transactions.
Be cautious of cryptocurrencies that are not mainstream. Bitcoin and Ether are actively traded and provide liquidity. The value is therefore easily determined and transferable. More obscure cryptocurrencies can lack liquidity or encourage anonymity and therefore come with additional holding risk. When approached with a donation, consider using a set of criteria such as:
- Is there a liquid market for the cryptocurrency?
- How did the donor obtain the cryptocurrency?
- What are the anonymity practices of the cryptocurrency?
- Is there a collateral base for the cryptocurrency, or is the cryptocurrency backed by a central bank or value system?
- Has the cryptocurrency issuer filed the appropriate registration with the SEC and/or the Commodity Futures Trading Commission?
As the world of giving evolves to include cryptocurrency donors, educate your organization and board about cryptocurrency, update policies and procedures, and vet the necessary parties. For additional information about cryptocurrency and digital assets, reach out to your BKD Trusted Advisor or submit the Contact Us form below.
1 This discussion does not include matters specific to stablecoin. The accounting guidance for stablecoin can vary based on the relevant facts and circumstances. To learn more about accounting for stablecoin, see questions 22 and 23 of the Association of International Certified Professional Accountants™ practice aid related to accounting for and auditing of digital assets. ↩