General Accounting and Custodianship Trends

From an accounting perspective, Token Companies are tackling how best to structure their wallets, determine their capital gains and losses, and label their chart of accounts and their use in classifying transfers.

Wallet Structuring

Typically, Token Companies align with accounting firms’ standard processes by organizing separate wallets into either token sale, cold storage, or hot wallets.

A designated token sale smart contract will accept funds from the participants and transfer them to a cold storage wallet. Usually, the cold storage wallet is a multisig wallet that contains the bulk of the raised funds and requires multiple signatures to move funds. To increase liquidity, the company sends funds from the cold storage wallet to a hot wallet in order to cover company expenses, including payroll, legal, and marketing.

In some cases, multiple hot wallets are used to separate and categorize payments based on the expense, i.e. a hot wallet solely for payroll expenses. Exceptions to this process include scrambling transfers from the token sale contract to increase the difficulty of discovering the cold storage wallet as well as keeping large amounts of funds on centralized exchanges such as Kraken, GDAX, and Poloniex.

Capital Gains and Losses

Many Token Companies are registered in countries that treat cryptocurrencies as assets or property, including the US, UK, Canada, Israel, Singapore, and Australia. These countries levy taxes depending on a variety of factors, including holding periods. Those Token Companies registered in these areas must take into consideration how to track their “inventory” and the resulting capital gains or losses, which could be spread across multiple cryptoassets, blockchains, and wallets. There are numerous inventory methods to calculate gains or losses on the disposition of cryptocurrencies; the most common one has been coined “FIFO by Address.” This is a similar concept as FIFO, or First-In-First-Out, in which the most recently sold cryptocurrencies use the historical price of the oldest incoming cryptocurrencies.

Two primary qualities differ FIFO from FIFO by Address. First, FIFO by Address does not coincide with a realized event when cryptocurrencies are transferred between addresses that are owned/controlled by the company. Second, with FIFO by Address, it is a choice out of which wallet to record the sale. These two qualities allow Token Companies to track the cost basis only as far back is it goes within their internal wallets and choose from which wallet to sell. As an example, a Token Company that has theoretically created thousands of wallets, each with its own unique purpose, could strategically pick the wallets with the highest cost basis when they choose to sell.

Chart of Accounts Created and Used

Crypto-assets and crypto wallets have given rise to a new taxonomy of transactions and their purposes. As a result, new names for the Chart of Accounts have emerged as Token Companies respond to accounting challenges. The most commonly used Chart of Accounts on the Ethereum network is “Gas Fee Expenses” to refer to associated fees on the blockchain. Consensus does not exist around how to approach token sales. However, Token Companies have classified funds raised through ICOs as “Sales Revenue,” “Deferred Revenue,” or “ICO Revenue,”as a sub-account of “Revenue.”

Sales Revenue accounts create income taxes against immediately-recognized funds raised upon receipt. Deferred revenue, on the other hand, can defer the recognition of taxable income for about a year while expenses accrue to offset taxable income. The classification of funds raised through ICOs have been determined on a case-by-case basis, often on accounting advice from professionals. Other Charts of Accounts commonly used in digital asset accounting classify newly-created wallets undergoing testing, which are classified to the receiving wallet as “Test Revenue” and from the sending wallet as “Testing Expense.”