A payroll professionals' guide to crypto-accounting

As 2017 rolled into 2018, many cryptocurrency enthusiasts looked at their investments with an understandable sense of accomplishment. By December last year, the market had hit an all time high and they were sitting on windfalls that were barely conceivable only a few months before.

Against this backdrop, it is hardly surprising that Google searches for the term ‘cryptocurrency accounting’ hit an all time high in January of this year. With tax day approaching that April in both the US and UK, people wanted to understand what their tax obligations would be based on their gains.

Ten months on though and many are still searching for the answer. But this lack of clarity is not a new issue facing the industry. For example, during the 2015 tax year, a mere 802 individuals reported any gains to the US Internal Revenue Service (IRS) - and the numbers remain much the same today.

The truth is that, just as the cryptocurrency space is still an emerging one, so is the process of crypto-accounting for these kind of assets and events.

But the situation has also not been helped by the near breakneck speed at which the industry has seemed to change. Even more significant is the fact that so few regional regulators have made clear statements about how to assess these assets from an accounting standpoint.

For payroll professionals trying to understand how crypto-accounting affects them, there is no one definite answer. Which is why, right now, the best approach you can take is simply to understand the basics, which will enable you to monitor and adapt to any regulatory changes in future.

What is crypto-accounting?

In its simplest terms, crypto-accounting is the process of accounting for cryptocurrencies and related digital assets within a traditional regulatory environment. While working out the tax obligations of individuals who have seen their investments increase in value is one element here, the number of businesses operating in this area is also growing in significance.

Successful crypto-accounting requires an understanding of cryptocurrency fundamentals, such as distributed ledger technology and public/private key cryptography. While they can seem like alien ideas at first, such concepts are crucial to getting to grips with how digital assets are created, stored and transferred.

Why does crypto-accounting matter to payroll professionals? 

At the moment, crypto-accounting only really matters to payroll professionals who work in a business that interacts with cryptocurrencies or digital assets. But even if the business does not fit into this category right now, there is a good chance it will do so in future. In fact, payroll professionals would be advised to familiarise themselves with this area sooner rather than later as the function is likely to be one of the first to embrace such financial innovation.

This is because one of the main benefits of cryptocurrencies is their ability to make global financial payments quickly and cheaply. More specifically, by cutting out the traditional banking and payment services middlemen and transferring digital assets directly from one party to another, it is possible to move huge amounts of ‘money’ without paying large fees for the privilege. 

To illustrate the point, a large, cross-jurisdictional payment was made earlier this year in the shape of a US$99 million transfer of Litecoin. The trade took less than three minutes to clear and was subject to fees of less than US$1. In other words, hefty bank fees on settlements that take days to happen could become a thing of the past.

By the same token though, it would be wrong to suggest that there are no challenges to consider if going down this route: 

What challenges are payroll professionals likely to face with crypto-accounting?

Regulatory uncertainty

The rules put in place by different authorities around the world to regulate cryptocurrencies are varied and inconsistent. This means, unsurprisingly, that their guidance on how to undertake crypto-accounting is equally unclear.

In the US, for example, the IRS has provided no strong direction on the correct accounting method to use. Not only that, but it classes cryptocurrencies as property, which means a sale incurs a taxable gain or loss.

This means that for payroll professionals with accounting responsibilities, it is crucial to understand how assets are classed locally.

Understanding cryptocurrencies

Digital assets on a blockchain do not behave like traditional financial assets. For instance, holders of cryptocurrencies do not own their assets in the same way that they do fiat currency

While individuals think of their dollars, euros or yen as being held at their bank - even if, in reality, the situation involves nothing more than just storing data in an institution’s central database - cryptocurrency holders know that they only possess private keys that enable them interact with their cryptocurrency, which is stored on a blockchain.

Therefore, a necessary first step is for payroll professionals to understand how wallets, public and private keys and blockchains interact in order to transfer value effectively.

Technology integration

Even the most ardent supporter of cryptocurrencies would admit that many user experiences leave a lot to be desired. Few vendors support the technology, which means it is difficult to integrate crypto-processes with third party business software. 

For example, two of the most popular accounting software products, Quickbooks and Xero, do not handle crypto-trades. To make matters worse, common crypto-wallets and exchanges do not necessarily make it easy to extract reports or visualise audit trails. As a result, payroll professionals will currently find themselves limited to using spreadsheets or trying to find an innovative, new application to meet their own particular needs.

 Sean Ryan Perry Woodin

Sean Ryan and Perry Woodin co-founded NODE40, whose Balance cryptocurrency reporting software integrates directly with major cryptocurrency exchanges. The aim is to help blockchain users, who are transacting, trading in, or mining digital currency and could have triggered a taxable event, to properly disclose these transactions to the authorities.