While fiat-based firms struggled through the Coronavirus crisis, the crypto space has flourished throughout the pandemic, according to Zac McClure and Barrett Strickland
For anyone looking to start their own private equity fund, do business with crypto firms, or even start their own crypto fund, many crypto companies showed profits through the stock market collapse, and crypto firms frequently have global mobile workforces that are resilient to geographically-correlated shutdowns.
It is increasingly important for fiat-based firms to be able to conduct business with or invest in crypto firms. In 2020, the potential Coinbase cryptocurrency exchange Initial Public Offering (IPO) and discussions about creations of digital national currencies by various political figures around the world brought cryptocurrencies into mainstream economic and finance conversations.
Bitcoin also survived its first recession stress test in 2020 after the bull run of 2017. Additionally, multinational investment bank JP Morgan took on Gemini exchange as a client in 2020.
Similarly, a plethora of private equity firms have invested in various cryptocurrency startups and funds, with many receiving multiple rounds of funding.
Increase in crypto business activity
In the US, the Office of the Comptroller of the Currency (OCC) allowed national banks and federal savings associations to take custody of cryptocurrencies in 2020. All of these developments highlight the increase in crypto business activity and the need for crypto accounting partners to facilitate conducting day-to-day business between fiat and crypto-based firms.
In order to successfully conduct business with crypto firms, you need a crypto-first accounting partner. The main challenges to bridge when conducting business between crypto-based and fiat-based firms are understanding their business models and associated industry trends, having the tools to create comparable financial statements in the local fiat currency, and understanding the national taxes associated with crypto transactions.
One of the most important factors in doing business with or investing in crypto firms is understanding their business models. There are so many arbitrage opportunities, hybrid business models and profitable trends that you really need a crypto-first adviser to analyse the business. Simply stating the financials in terms of US dollars is not enough because it does not adequately allow you to understand the strengths and risks associated with the business in an ever-changing crypto landscape.
Investment opportunities
When investing in a nascent industry, there are incredibly lucrative investment opportunities, but you need to be ahead of trends, such as the Initial Exchange Offerings (IEOs) of 2019 or the yield farmers of 2020. Businesses taking advantage of arbitrage opportunities are highly profitable until the market is flooded with many firms doing the same thing. Therefore, the commentary about the business strategy, combined with its restated financial statements in local fiat currency is imperative for facilitating business between crypto and fiat-based firms.
Financial statements naturally need to be restated in the fiat currency of the relevant country in which you are conducting business. Therefore, the first thing you need in an accounting partner is a full crypto pricing database. Another key element is separating the profits from crypto investments apart from the other corporate revenue streams.
For example, our firm TokenTax worked with a crypto lending institution which also strategically invested its profits in crypto assets. From a credit risk perspective, you need an accounting team that can analyse the different income streams so that you can correctly explain the different strengths and risks. In the hybrid lending and investment firm example, the analysis of the crypto lending portion of the institution will be all about stressing and forecasting the cash flows. On top of that, the risk framework for their crypto investments will be a completely different analysis. In order to correctly analyse the business, the crypto firm needs an accounting partner that can showcase the strength of their risk framework for investments as well as how resilient their lending platform is to economic and industry shocks unique to the crypto space.
Understanding the lending landscape
Similarly, any fiat-based firms that want to do business with crypto firms will equally need an accounting partner that understands the crypto lending landscape and investment approaches. A traditional accounting institution is not sufficient because their risk teams are siloed across geographic regions, industries and product lines.
To analyse crypto firms, they need to bring together an international group of analysts from different departments and specialties, which is prohibitively difficult, expensive and time consuming for them. On top of that, they also are unlikely to have deep knowledge of the crypto space. For all of these reasons, a crypto-first accounting partner is necessary. They have all of these resources on hand in one team with deep industry knowledge.
Lastly, remember that each segment of crypto firms involves crypto taxes, which are different from fiat taxes because cryptocurrencies are considered property by most international tax authorities — investments, payroll and all transactions are often subject to taxes. Crypto taxes are complicated in many countries because many tax agencies require reporting of all crypto transactions. If your firm plans on receiving payment from a crypto firm in Bitcoin or another cryptocurrency, remember that in many countries you will be taxed on the capital gain or loss at the time of the disposition (sale or trade) of the assets you hold.
Unless you are making very few transactions, you will likely need a crypto tax partner with a full price database and software that can track your receipts, purchases, trades and sales of cryptocurrency in a centralised dashboard. On the crypto firm side, most crypto companies already have tax partners to handle their year-end accounting. It is highly recommended that you consult a crypto tax software firm if you plan on starting a crypto firm or investing in a startup crypto firm because it will save you immensely on taxes.
Managing your tax liability
For example, hedge funds have historically used a practice called tax loss harvesting before the tax year-end to minimise the tax bill on their equity profits for the year. Onboarding a crypto tax software firm from day one will allow your firm to essentially do the same thing for your crypto taxes. Additionally, even within the crypto space, individuals and startup funds do not always realise that decentralised finance (DeFi) transactions are subject to taxes. A small amount of planning and consulting with a crypto tax expert in the beginning will allow you to track your crypto holdings from the start and manage your tax liability for future years.
Overall, we see an increase in highly profitable crypto firms looking to do business with traditional fiat-based firms and vice versa. The challenge in bridging the gap between these institutions is not only in converting financial statements into local currency — it is also translating business models and features unique to the crypto space into terms that can be easily understood by any finance team.
Just as Amazon and other tech startups were criticised early on for not having real assets and subsequently bought them, crypto firms are securing lines of credit from traditional underwriters and buying assets from traditional fiat-based companies. It will become increasingly important to understand the crypto space and be able to conduct business with crypto firms in the next decade.
Zac McClure, TokenTax CEO, co-founded TokenTax after his career as an international financial accountant at JPMorgan, Imprint Capital, and Bain. He has worked in over a half-dozen countries and received his MBA from the UPenn Wharton School.
Barrett Strickland, Head of Analytics and Research at TokenTax, built her career as a lead analyst modeling structured finance deals and portfolios at Moody’s and in investment banking. As an MIT-trained economist, she began her career in research at MIT and Yale.
