The Risks and Rewards of Cryptocurrencies

The accounting profession must mull the future as more consumers and businesses turn their cash into cryptocurrencies. By LISA WILDER | Spring 2018



As markets gyrate, the business world debates, and consumers muse about the wisdom of wading into the wild world of alternative, digital currencies, the accounting profession mulls the future.

No matter what day — or what hour — you Google “cryptocurrency,” you’ll get colorful results. One moment, your top listing could be the day’s trading results for bitcoin futures at the Chicago Board Options Exchange (CBOE) and Chicago Mercantile Exchange (CME). Next, you could be reading about the fallout from a major cryptocurrency hack. And at any moment of the day or night, there’s diverse and divisive coverage of whether you should buy, sell, spend, or avoid cryptocurrencies.

Indeed, a lot has happened since the shadowy beginnings of the cryptocurrency movement some nine years ago. Bitcoin, arguably the first “peer-to-peer electronic cash system” to gain traction, was launched in 2009 by a person or persons bearing the pseudonym Satoshi Nakamoto.

That’s right, “person or persons.” We still don’t know the exact identity of the individual or individuals involved in creating the world’s No. 1 brand in cryptocurrency, which notably peaked at nearly $20,000 per BTC this past December before plunging below $6,000 in February. At press time, BTC was struggling to renew its advance, bouncing around $7,000.

Bitcoin’s founding isn’t the only “shadowy” tale that’s evolved with the accelerating cryptocurrency movement. Now, more than 1,500 different cryptocurrencies trade worldwide, with seemingly new ones being created daily for highly specialized audiences and uses. The takeaway, however, is that since the start, the semi-secretive, decentralized nature of the blockchain technology behind bitcoin and its peers has made using cryptocurrencies a fast, cheap, and convenient way to move money, both legally and illicitly, around the globe.

Then came the headlines.

"Celebrity risk-takers the Winklevoss twins rode the bitcoin wave up to become bitcoin billionaires."

"The CBOE and CME launched bitcoin futures trading on their exchanges, a big step forward in legitimizing the investment potential of digital currency."

"JPMorgan Chase CEO Jamie Dimon called bitcoin a 'fraud' last fall, and then said blockchain was the real value proposition of the digital currency movement."

"The Oracle of Omaha Warren Buffet said of bitcoin: 'Stay away from it. It’s a mirage, basically.'"

"Major credit card issuers Chase, Bank of America, and Citigroup all banned cryptocurrency purchases on credit cards."

"Wall Street giant Goldman Sachs labeled most top digital currencies as 'too primitive' to survive."

2017 seemed to be the year of the close-up for cryptocurrencies, and interest and uncertainty — and trading — in them only seems to be increasing in 2018. So, where does that leave accounting and finance professionals? Understand now how cryptocurrency use and trading affects your clients and focus on the bigger issue of blockchain and how it evolves.

Taxable or Taxing?

As early as 2015, the U.S. Commodity Futures Trading Commission defined cryptocurrencies as commodities to help guide the agency’s regulatory and enforcement practices, a decision recently upheld this year by U.S. District Judge Jack Weinstein, but there’s been a notable absence of federal level rules governing cryptocurrencies in other areas. Tax treatment of cryptocurrencies has been a relatively gray area, even with the IRS’ 2014 guidance that stated virtual currencies should be treated like real property. Meaning that:

• Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2, and are subject to federal income tax withholding and payroll taxes.

• Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply. Normally, payers must issue Form 1099.

• The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.

• A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.

However, many experts believe the consumer-use issues are so… well, 2014. In fact, there’s a shortage of information on how taxpayers should go about tracking and reporting their cryptocurrency transactions, particularly for those who’ve earned them through cryptocurrency mining activities, which carry hardware and utility costs and other expenses.

Meanwhile, the IRS is scrambling through legal suits with U.S.-based cryptocurrency exchange Coinbase to gain access to customer data that will allow it to track down taxpayers who haven’t been reporting their cryptocurrency transactions — aka evading taxes on the gains realized during bitcoin’s meteoric moves in recent years.

On the commercial front, cryptocurrencies are also gaining a foothold. To put it kindly, broad commercial acceptance is still far from universal, but more companies, small and large, seem to be accepting cryptocurrencies each day. There’s also a growing number of big-name businesses accepting bitcoin and other cryptocurrencies for payments for goods and services. Overstock.com was the first big online retailer to start accepting bitcoin in January 2014. Expedia users can pay for travel arrangements with bitcoin. Electronic retailer Newegg accepts bitcoin, and so does Microsoft and Intuit. And even the Big Four accounting firms are becoming bitcoin-friendly; PwC and EY were early adopters of bitcoin as a payment method for advisory services, and Deloitte and KPMG too are increasingly investing in the evolving cryptocurrency and blockchain ecosystems.

What this all means for future IRS guidance on cryptocurrencies, and for individual and corporate taxpayers, remains to be seen. The wild swings in cryptocurrency values certainly aren’t doing any favors for businesses accounting for them in their transactions.

However, as a recent Bloomberg headline claims, “You’d Be Crazy to Actually Spend Bitcoin,” indicating the top cryptocurrency and its leading competitors, including Ripple (“The world’s only enterprise blockchain solution for global payments”) and Litecoin (“The cryptocurrency for payments), are trying to differentiate themselves, which is creating further confusion in the early goings of this currency evolution.

Over time, the purpose and structure of cryptocurrencies will change, according to Lamont Black, assistant professor of finance at DePaul University - Chicago. “The definition of ‘money’ is typically three-fold: a medium of exchange, a store of value, and a unit of account. The volatility of cryptocurrencies has led many people to define them as an asset or commodity rather than money,” Black explains. However, a maturing cryptocurrency could eventually satisfy these criteria for money, he says, which would be “relevant for distinguishing its treatment for legal, tax, and regulatory purposes. It is likely that different cryptocurrencies will fall into different categories.”

And of course, that’s just about the evolutionary path for virtual currency. Others are focusing on the evolutionary path for the technology behind cryptocurrencies. Which brings us to blockchain, which might be the bigger issue in 2018 for accounting and finance professionals.

Connecting the Blocks

Blockchain has the potential to blow up and revolutionize many of the traditional business and finance processes that accountants and auditors perform and support.

Sometimes you’ll hear blockchain technology referred to as a “digital ledger” or “distributed database.” Let’s stick with the ledger example. A digital ledger is a software platform or app that enables transactions or other forms of electronic, time-stamped information to be verified and recorded instantaneously without a centralized mediator or ability to change or alter a single input. These inputs, or records, are called blocks. And as these blocks add up with each entry from all authorized participants, a chain forms in real time — that’s where blockchain gets its name.

Experts see plenty of revolutionary promise in blockchain’s ability to record information in a secure form that can’t be altered, which goes far beyond the exchange of monetary value and traditional bookkeeping. “What if there was a protocol — call it the trust protocol — that enabled us to do transactions, to do commerce, to exchange money, without a powerful third party?” Tapscott Group CEO Don Tapscott asks in a recent interview with McKinsey. “This would be amazing.”

This is blockchain. So, what will blockchain mean for the accounting and finance profession?

Some think it could eliminate the traditional audit function, which means a potential redefinition of what many accounting and audit professionals do. Others think it will spur innovation in the profession.

“I see our jobs shifting. I see fewer invoices being reviewed. I see many accounting professionals becoming subject-matter experts on ‘smart contracts.’ I see audit procedures changing drastically,” says Joel Waterfield, tax leader of Grant Thornton’s Blockchain Technology Services Group. The evolution of smart contracts — a blockchain feature that essentially automates the creation, review, and approval of transactions of any kind — is a big element of the discussion, he thinks, which will ultimately require input from regulators around the world.

“Gone, too, will be the days of inventory counts as blockchain technology combined with the Internet of Things (IoT) will provide for far fewer manhours to accomplish the same tasks,” Waterfield adds.

Retail heavyweight Walmart Inc. is proof of concept. Using propriety blockchain technology developed with IBM for supply chain management, Walmart can precisely track produce from farm to shelf. In a simulated recall, Walmart’s head of food safety reported to the Wall Street Journal that his team traced the origin of a bag of sliced mangoes in just 2.2 seconds in the blockchain versus the nearly seven days it took using traditional systems.

“The key to blockchain technology and cryptocurrency is proving that its use will materially reduce the costs to transact business. This should be accomplished by smaller transaction fees, single-source information retainage eliminating the need for multiple parties to maintain redundant information, reduced administrative networks, and other efficiencies that are still being identified,” Waterfield explains, noting that the accounting industry needs to embrace the potential impact of peer-to-peer transactions in business and government and what that will mean for the future of tax and advisory services.

“Companies and governments will use this technology as the fees become far more affordable in a peer-to-peer network than they are currently through the financial services industry. Additionally, many government agencies, both domestically and internationally, are exploring the possibility of real-time taxation. Cryptocurrency and blockchain technology will serve to improve cash flow and reduce the expense required by both the government and private industry to collect, file, and remit taxes.”

In other words, “Given the relation between cryptocurrency and blockchain, the distributed ledger system where transactions are validated and recorded, cryptocurrency is here to stay,” says W. Brooke Elliott, EY Distinguished Professor and head of the accounting department at the University of Illinois at Urbana-Champaign. “The accounting industry needs to position itself to serve as an expert and trust-verifier of cryptocurrencies.”

A Cryptic Future

So, what comes next? In short, a lot more experimentation, uncertainty, and study. “In the end, blockchain and cryptocurrencies still need to earn their place in the future, but the opportunity is there, and many early adopters are focused on building an increasing number of use cases,” Waterfield says.

“This innovation landscape represents just 10 years of work by an elite group of computer scientists, cryptographers, and mathematicians. As the full potential of these breakthroughs hits society, things are sure to get a little weird,” writes Harvard Business Review’s Vinay Gupta.

He puts “weird” this way: “Self-driving cars and drones will use blockchains to pay for services like charging stations and landing pads. International currency transfers will go from taking days to an hour, and then to a few minutes, with a higher degree of reliability than the current system has been able to manage.”

That means, in Gupta’s view, crumbling transaction costs and “sudden, dramatic, hard-to-predict aggregations and disaggregations of existing business models.”

Or as Elliott puts it, “a new assurance market for the accounting profession, new areas of specialization, and new demand for unique services.”