This article was updated February 18, 2022
Technology is advancing at a rapid pace—most recently in the form of a quickly growing blockchain movement, which has resulted in the proliferation of cryptocurrency. There are currently more than 1,000 types of cryptocurrency—Bitcoin is a popular example—and not-for-profit organizations are more likely to accept cryptocurrency contributions due to its growing popularity.
To understand how a not-for-profit organization can benefit from these technological advancements, it’s important to first understand how blockchain technology works.
How Does Blockchain Technology Work?
Blockchain is an encrypted database similar to a general ledger that’s promoted as being transparent, tamperproof, and secure and also has sets of consensus rules.
If a transaction violates those rules, the transaction is rejected; once a transaction is completed, it can’t be modified.
In more detail, blockchain technology is a distributed database where the data is stored on nodes or digital ledgers. These nodes are basically computers connected to the blockchain, which create a peer-to-peer network. When a new transaction or information is added to the blockchain, each node simultaneously downloads the information and then validates and verifies it before it’s added to the shared ledger. The benefit is data that’s continuously reconciled and verified.
Once a new block is added to the blockchain structure, the previous block is locked and can’t be altered or changed. Because the data is held in an interlinked network of computers, the information is owned by the users—although only the intended recipient can view and process the data.
- It’s a decentralized technology, which means a clearinghouse or manager isn’t needed to process, clear, or complete transactions
- Transactions are processed in a secure manner
- It’s more efficient to process information, enter contracts, and analyze or follow data
For a not-for-profit organization, blockchain technology can be used to integrate operating and accounting functions. It also means organizations will no longer be bound by geographic regions or traditional intermediaries, such as banks or investment managers, to conduct business.
Cryptocurrency is a digital asset, also known as digital currency. It acts similarly to traditional currencies in that it allows an individual to purchase goods or services. Unlike traditional currencies, such as the US dollar or euro, cryptocurrency doesn’t need a bank, investment house, or central banking system to transmit funds or complete transactions.
Cryptocurrency is instead dependent on blockchain technology to transmit the currency between individuals or organizations.
How to Hold Cryptocurrency
To receive, transfer, and hold cryptocurrency, an organization needs to set up a digital wallet. To access the wallet, an organization needs a private key, which is a secured digital code.
It’s important to note the only identifier needed to access cryptocurrency is that digital code, which means anyone with the code potentially has access to the wallet. As such, if the wallet is ever compromised and the cryptocurrency stolen, the organization would be unable to recover its digital currency.
There are two primary types of wallets:
- Cold. This is an offline wallet stored on a platform that isn’t connected to the internet, protecting it from cyber hacks and other risks associated with online wallets.
- Hot. This is a wallet that’s stored online. The benefit of a hot wallet is that transactions can be completed more efficiently than with a cold wallet.
Investing in Cryptocurrency: What to Know
- Cryptocurrencies don’t generate income in the form of dividends, but selling can generate earnings, and would be subject to typical taxes on gains or losses
- Demand for the currency relative to its supply solely determines the return from investing in cryptocurrency, resulting in price changes
- Investor speculation has driven recent price changes
Read more about benefits, risks, and best practices of investing in cryptocurrency.
What Are Potential Benefits of Cryptocurrency?
Cryptocurrency offers users a few benefits that traditional forms of currency can’t provide.
Some of cryptocurrency’s benefits include the following, though the currency’s uncertain future and the likelihood of changes may ultimately affect its benefits.
- Potential insulation from geopolitical risk. When factors such as war, internal politics, or natural disasters shake nations, currencies generally dip for an undetermined amount of time. Because cryptocurrency runs on a decentralized, peer-to-peer, censorship-resistant network, these geopolitical risks may not be able to derail its value.
- Potential insulation from traditional monetary regulations. Unlike the dollar, which has been the risk-free rated asset for a long time, monetary inflation, seizure, or confiscation hasn’t subjected Bitcoin to the same rigors.
- Potential access to new demographic groups and regions
- Provide resources to impacted geographic regions without going through the central banking system.
What Are the Three Major Types of Cryptocurrencies?
Cryptocurrency types include:
- Stablecoin or Digital Fiat. A stablecoin is a type of cryptocurrency whose value is attached to that of a separate asset, such as currencies or commodities like gold. A digital fiat represents a government-backed currency on the blockchain. Tether, one of the most popular examples of a digital fiat cryptocurrency, pegs its value to the US dollar.
- Memcoins. These have little to no value and no discernable value proposition.
- Non-fungible Token (NFT). An NFT basically stores data or accounts for it in a digital ledger, and that data represents something specific.
What Are Uncompensated Risks of Cryptocurrency?
A few of these risks, significant for long-term investors, include the following:
- Regulatory risk. Several countries have banned or plan to ban cryptocurrency, or put heavy regulation over its trades. If this trend continues and is enforced, it could have a significant impact on the currency and its continued use.
- Low barrier to entry, difficult exit. A low barrier to purchase allows investors to rush in and causes inflation in price, but limited counterparties can bar exits.
- Theft. With the rise of cryptocurrency value, hackers’ attempts to steal large amounts of the currency have also increased.
- Market manipulation. Cryptocurrencies are particularly prone to social engineering and misinformation risks. For example, a tweet from a celebrity can significantly impact the valuation of the asset
What Should Organizations Consider Before Investing in Cryptocurrency?
Key questions to ask before utilizing cryptocurrency include:
- Will your organization hold the asset for a short or long term? Do you have the ability to hold for long term?
- What is the risk tolerance of the organization, and is it worth holding cryptocurrency within that tolerance?
- Will the organization directly invest and hold cryptocurrency or will the organization invest in cryptocurrency indirectly, as through an investment fund?
- Have you considered management and board’s knowledge level regarding cryptocurrency and the technology behind it?
- If the organization plans to receive cryptocurrency, does the organization's gift acceptance and investment policies reflect that, including how to value the gift?
Other considerations to keep front of mind include:
- Set up systems, accounts, policies, and procedures to accept and secure this class of asset
- Understand and implement systems for gathering necessary information to comply with all reporting requirements associated with accepting this class of asset
- Consider the internal controls of the organization to ensure appropriateness of segregation of duty, recordkeeping, and asset custody
Financial Statement Disclosures
An organization needs to consider how the financial statements, including the statement of financial position and footnotes, reflect the asset.
Because of this, an organization should revisit and update any significant accounting policies and valuation-technique disclosures.
While accepting cryptocurrency can present many opportunities for not-for-profit organizations, it also surfaces complex challenges that require an evaluation of the following:
- Internal controls
- Valuation process
- Financial statement disclosures
The IRS stated that virtual currency is property for tax purposes. However, because no valid charitable deduction exists without a contemporaneous written acknowledgement, the major issue is likely to be valuation, determined, for example, through an appraisal.
Under Internal Revenue Code Section 170(f)(11)(E)(ii)(I), criteria for a valid deduction require that the individual conducting the appraisal have verifiable education and experience in valuing the type of property for which the appraisal is performed.
The American Institute of Certified Public Accountants (AICPA) and the Chartered Institute of Management Accountants (CIMA) has released a practice aid that contains nonauthoritative guidance developed by the Digital Assets Working Group
The objective of this aid is to offer guidance on how to account for an audit of digital assets under the US generally accepted accounting principles (GAAP) for nongovernmental entities and generally accepted auditing standards (GAAS), respectively.
We’re Here to Help
For more information on the challenges of holding cryptocurrency and how accepting such assets can impact your organization—as well as determining the internal controls that protect such assets—contact your Moss Adams professional.
You can also learn more about our Not-for-Profit Practice and additional topics affecting investors.