If you think the embrace of crypto from retail investors over the last 10 years was a whirlwind, wait for the tsunami coming over the horizon: Enterprise and institutional adoption of digital assets.
But just as enormous tailwinds have brought us to this point, a balanced set of regulatory, tax and compliance headwinds holds many enterprises at bay.
Let’s dig into the state of enterprise crypto adoption and explore three common tax and compliance challenges new enterprise blockchain adopters must address.
Progress is incremental until it isn’t
In 20 years, when we look back, the tail end of 2022 will go down as the most pivotal period for enterprise adoption of digital assets.
First, Ethereum’s switch from proof-of-work to proof-of-stake made the network less energy intensive and, thus, friendlier to corporate environment and social governance (ESG) goals. Then, in a series of events, the Financial Accounting Standards Board (FASB) proposed accounting rules that would lower the financial stigma associated with companies holding crypto, which was promptly followed by preliminary tax guidance from the Internal Revenue Service.
Read more: How to Benefit From Tax-Loss Harvesting in Crypto | Opinion
For chief financial officers at publicly traded companies or others who have to consider the financial, product-level and board-level impacts of digital asset adoption, these changes alleviate the blood-red hole in their profit and loss statements (P&L), further the board’s ESG goals and allow the product team to finally benefit from this transformative technology.
If anything, it’s already happening. Organizations including BNY Mellon, Nike, Roofstock, Gucci, Chipotle and Telefónica are using digital assets to:
- Increase brand recognition and customer loyalty and reach tech-forward demographics
- Improve internal business operations with practical use cases of blockchain
- Accept or make payments
- Access alternative investments not available through centralized finance (CeFi)
In the coming years we’ll see the blockchain applied to supply chain management, finance (asset tokenization) and energy (carbon tracking/credits). Despite these advancements, organizations will still need to address common tax and compliance challenges, regardless of where they fall in the digital asset maturity curve, including:
- Getting transaction data
- Understanding the data for accounting and tax purposes
- Tracking holdings, which is more complex than organizations realize
The tax and compliance challenges every new adopter must address
The importance of accessing data cannot be understated. After all, it’s hard to account for transaction activity without hard data. And even though a lot of the accounting data needed for tax and compliance is on-chain, that doesn't mean it’s easy to work with. Of course, that’s ignoring the gigabytes of off-chain data sitting in exchanges, custodians and internal databases. Let’s just say a lot of data is required to get a complete picture of an organization's finances, and it doesn’t organize itself.
This brings us to the second area many organizations struggle with: understanding data.
One of the most significant issues in crypto accounting is the fallacy of network data. Many people assume that the blockchain is an all-seeing, all-documenting technology, and in some ways it is. But block explorers aren’t bank statements and can only get you so far. Copying and pasting data from Etherscan to a spreadsheet isn’t sufficient to understand what is happening from an accounting and tax perspective. You need to keep lookup tables of addresses for your customers and vendors, internal wallets and the smart contracts deployed.
See also: Why NFT Tax-Loss Harvesting Remains a Challenge for Investors | Opinion
There are also instances where the data collected is opaque. For example, interacting with a decentralized finance (DeFi) liquidity pool can pose challenges to even the most seasoned accountant, if for no other reason than no one in the industry can agree on how these transactions should be treated.
This brings us to the last challenge: tracking holdings.
Many organizations think you can track digital assets like forex using the average cost basis as the answer. Sadly, nothing could be further from the truth. At Bitwave, we like to say crypto is an unholy alliance of forex and inventory – it’s like a foreign currency you have to track at a lot level, or like inventory that you sometimes just decide to pay your employees and suppliers with.
That is to say, in order to complete a picture of the cost basis for tax purposes, you must track tokens lot by lot. This makes sense because ether (ETH) purchased in 2022 sure has a different value than ETH purchased in 2020.
Getting a headache reading this? I get it. Fortunately, many software programs can automate these processes for your organization. And while these kinds of things aren’t one-size-fits-all, there are a couple of best practices I recommend to help navigate tax season.
1. Maintain good wallet hygiene.
Good wallet hygiene is essential as organizations scale because it helps accountants understand transactions from a workflow perspective as they process them. Always keep transaction-specific wallets (e.g., investments, DeFi transactions, revenue, etc.), and use a consistent naming system. For example, if your client is a non-fungible token (NFT) creator, ensure it keeps a separate wallet for primary vs. secondary royalty payments.
2. Get help from a degen CPA.
In the normal fiat world you just need to find a knowledgeable certified public accountant (CPA). In crypto, everyone needs to be an expert in their field and the industry itself.
Get yourself a CPA who understands the complexities of accounting and knows the pain of paying 2 ETH in gas fees for a failed transaction during an NFT drop. It’s crucial that your CPA can play both sides, because even though regulators are finally starting to update guidance for crypto assets there is a lot of uncertainty.
And on this note, talk to your CPA early and often. We work with a lot of CPAs and I promise, they’re great people! But that’s not exactly why we recommend this – digital asset accounting isn’t something you can chuck over the fence once a month; your CPA is going to need your help. Trust me – it’ll save you from headaches and, it is hoped, an audit.
This wave of crypto adoption has created a new wave of tax and compliance challenges, so it's up to the crypto-natives to help Fortune 500s bridge the chasm to adoption. Fortunately for them, there’s an amazing group of builders laying the foundation for an open, transparent and equitable financial system.
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