by Mark Li and Dmitri Alexeev of BPM
The continuing explosion of blockchain technologies and the acceleration of the adoption of digital assets, especially cryptocurrencies, is one of the most exciting technology trends that we’ve seen in decades. It first entered the public consciousness as a tool for some fairly unsavory activities, but it has matured into a technology used by banks, governments, healthcare systems and other organizations where security is essential. Today, it is best known as the backbone of cryptocurrencies and digital collectibles called non-fungible tokens, or NFTs.
While blockchain technology can bring new opportunities, efficiencies and other benefits to commerce, it also brings with it certain challenges, such as privacy, security, and regulatory and compliance concerns. Currently, digital assets are the most widely used application of blockchain technology.
What might 2022 hold for the blockchain and cryptocurrency spaces? This article will look at a few notable trends for this year and beyond.
1. A Common Marketplace.
2021 was a fantastic year for NFTs, and the current hype around the ecosystem is unprecedented. Based on a research report performed by Cointelegraph Research, NFT sales in 2021 were worth approximately $17.7 billion — and sales next year will almost surely eclipse that total.
The consequences of this should not be understated: What NFTs have done is successfully utilize blockchain technologies to create art that can never be forged because its ledger is maintained by thousands of independent computers around the world. Not surprisingly, NFTs are inspiring other trailblazers to seek out numerous other new uses for blockchain technology to build a more transparent, secure and sustainable world.
2. Environmental, Social and Governance (ESG).
U.S. regulators, including the Securities and Exchanges Commission (SEC) and Commodity Futures Trading Commission (CFTC), are realizing that cryptocurrencies cannot continue to exist in their legally ambiguous state and need new or better-defined regulations. In fact, SEC Chairman Gary Gensler has explicitly called for more investor protection in crypto markets, meaning future regulatory guidance should be expected.
Environmental, social and governance (ESG) standards are the metrics by which many investors have begun evaluating companies’ operations to:
- Screen out potential investments that may have adverse effects on people or the environment
- Modify the criteria for making new investments in a manner harmonious with the ESG guidelines
Environmental considerations typically include a company’s energy use and its contribution to pollution. Social criteria often examine how a business manages its relationships with partners and stakeholders, including employees, vendors, clients and communities. Governance concerns generally relate to how transparent a company is, the composition of its board, and how boards are held accountable for the promises that they make to their shareholders.
3. Cryptocurrency “Savings” Accounts.
2022 is the year in savings accounts in cryptocurrencies will finally go mainstream. With a robust system of services and currencies such as Celo, Cardano, Bitcoin, Ankr, Flow, Solano, Ethereum and stablecoins, individuals can now deposit cryptocurrencies into crypto savings accounts to generate passive income. With the emerging blockchain trends of decentralized finance (DeFi) ecosystems, attention is starting to shift away from the legacy ecosystem of traditional financial products and toward the rise of trustless and transparent protocols such as staking, yield farming and liquidity mining that run without intermediaries.
4. Adoption of Cryptocurrencies in Financial Systems.
In September 2021, El Salvador became the first country to adopt Bitcoin as legal tender. As we move into 2022, we believe more countries will integrate cryptocurrencies into their financial systems as well as their monetary policies. Which other countries could follow?
In likelihood, the countries that might consider adopting Bitcoin or other cryptocurrencies as legal tender will be those that are less geopolitically stable, such as Panama, Ukraine, Cuba, Paraguay, Brazil, Mexico and Argentina. That said, with El Salvador taking the lead, there may result a domino effect that will compel other governments to also begin embedding the emerging crypto ecosystem into their own financial system and economy.
5. Reporting Obligations Will Expand.
On Nov. 15, 2021, President Joe Biden signed into law the $1.2 trillion Infrastructure Investment and Jobs Act. The act includes $550 billion in new funding to rebuild roads and bridges, water infrastructure, resilience, internet, etc. But the act also includes important tax provisions that will significantly impact digital assets reporting requirements. Specifically, the act expands broker and barter exchange transactions reporting requirements, including the definition of a “broker.” Many tax professionals believe that the act (and subsequent Treasury guidance) will significantly expand the broker/barter exchange requirements, impacting many businesses in the ecosystem in the process, including decentralized finance and non-fungible token issuers and platforms.
It is likely that many states will follow federal law with respect to filing and reporting requirements, consistent with the existing 1099 or other tax filing requirements. Some states are also looking at taxing all or some digital asset transactions. These taxes may include sales and use, transfer or stamp duty, franchise, gross receipts, minimum, consumption, or digital services taxes.
6. Federal and State Scrutiny of Crypto Transactions Will Increase.
The Biden administration has proposed to raise nearly $2 trillion in revenue over the next decade through eight policies aimed at increasing taxes and closing loopholes for the wealthiest Americans and large corporate taxpayers under the Build Back Better reconciliation framework. The Administration is hoping to invest approximately $80 billion in the Internal Revenue Service (IRS) over the next decade to aid in the increased compliance and enforcement.
In recent years, various congressional watchdogs and members of U.S. Congress have been critical of the IRS compliance and enforcement efforts with respect to digital assets. For instance, the Government Accountability Office’s 2nd Virtual Currency Report, issued in February 2020, was very critical of the IRS’s and Financial Crimes Enforcement Network’s (FinCEN) compliance efforts. There is a general expectation that the Treasury and the Internal Revenue Service will continue to expand the general guidance and issue regulations addressing specific types of transactions, including but not limited to basis reporting, accounting methods, aggregation and segregation rules, transfers, and matters related to compensation and benefits.
7. NFT Taxation Controversies Will Arise.
NFTs are complex and require significant tax technical analysis. Though many of the most recent case studies tend to stay in the realm of collectibles, some NFTs are more complex and require significant tax technical and regulatory analysis. Questions that buyers and sellers of NFTs need to ask from a taxation perspective include:
- What are the rights and obligations with respect to an NFT?
- Is the first transaction (sale of the NFT) the same as a secondary transaction? That is, are the rights and obligations with respect to the NFT in a subsequent transaction the same as they are in the first or previous transactions?
- Is the NFT a collectible, intangible, or a combination of a product or service?
- Does creation of the NFT create a partnership or a joint venture for U.S. income tax purposes?
- Is the transaction subject to sales or use tax or other indirect taxes?
- Is the transaction (or series of transactions) subject to withholding obligations (federal, state or foreign)?
- Are NFTs being issued contemporaneously with other tokens or securities, including, but not limited to, warrants, equity or debt?
8. International Taxation of Crypto Will Continue to Evolve.
There are currently more than 30 jurisdictions that have some general tax guidance with respect to taxation of digital asset transactions and that number is expected to grow significantly over the next few years. Each jurisdiction is expected to have different treatment of transactions, including reporting and compliance obligations and tax recognition and realization rules.
Entities with global operations will have to be nimble and flexible in adjusting to new realities. Without proactive tax planning, some entities may encounter significant tax obligations or reporting requirements arising from cross-border transactions, transfer pricing, intellectual property utilization or migration, employee mobility, independent contractor relationships, or other activities. These obligations may include both below the line (income taxes) and above the line (non-income tax) implications, including significant withholding obligations or employment taxes.
As 2022 continues, we are bound to see numerous changes affecting the blockchain and digital assets, headlined by regulatory guidance from the U.S. government. Cryptocurrencies and NFTs are still in their infancy, and while it may be a stretch for all these predictions to come true by the end of Dec. 2022, we know how quickly things can change.
Mark Li is a Partner of BPM’s Assurance Practice. He has 20 years of experience in public accounting and private industry, 16 of which were with a Big 4 accounting firm in the Bay Area. Mark is experienced in serving pre-IPO early-stage, venture-backed technology companies as well as public technology companies and has expertise in all aspects of the SEC registration process from IPOs to follow-on offerings to public company reporting.
Dmitri Alexeev is a Partner in BPM’s Corporate Tax Practice. He has over 20 years of public accounting experience with regional and national accounting firms, with extensive experience serving clients in financial services, life sciences, mobile gaming, services and technology industries.