So I was leaving a meetup in New York on Monday, one that was focused on the crypto space. I’ve developed a few opening lines for these sorts of events, one being the generic “what are you working on?”; and the more specific, slightly cynical, “so, are you doing and ICO?”.
I’d had a couple of Makers and was on my way out. There was only one other person on the elevator down, so I sprung the “are you doing an ICO?” question. Turned out no, the poor soul replied, but the conversation quickly – to my delight – turned to accounting. “token sale proceeds, debt or equity?”, I posed, which, to my surprise she replied, “equity”. My feeling is that cash received should be classified as a sort of prepaid revenue (liability), but her response got me thinking. Other parts of the conversation had convinced me that I was intellectually inferior to my elevator mate, so I mumbled something and slunk off into the evening.
The next morning, with a clearer head, I sat down to sort through the issue. Now, I’m a CPA, and have a firm belief that most accounting treatments are common sense, or can at least be explained in a reasonable manner. So the following discussion will go easy on the citing of accounting standards (ASC or IFRS) and reason in a way that most can understand.NOTE: This is not a discussion of whether a token is a security. That’s a Howey Test debate, and I can’t shine any further light on it. Securities, from a US perspective, can be either debt or equity, depending on their characteristics. So ignore the security classification; we’re having an accounting discussion.
Setting the Stage. Let’s start with a crash course in accounting. Relax, it will be so quick you will barely feel it:
Assets = Liabilities + Equity
See, that wasn’t so bad. It’s the balance sheet equation. Every accounting entry has to balance. Simplistically, equity represents the value of the company held by the owners. Or, logically, the difference between the assets and liabilities of the business.
That said, let’s paint a scenario. You’ve noticed a problem, and have decided to solve it. And a blockchain is the technology that will allow you to accomplish this. Fortunately, a token is required for the use of your blockchain-enabled platform, so you decide to sell some ahead of time to fund platform development. Great! Let’s do an ICO! $100M later, flush with cash, you’re immediately confronted with a puzzling dilemma – how do I account for this? Debt or equity?
The Case for Debt. Really, all you have done is sold rights to use your platform, correct? If someone wants to use it, they would have to buy a token and “spend” it on the platform, at which point you can count the value of the token as revenue. Pretty simple. So, if you sell a bunch of these tokens ahead of time, then it should be really thought of as pre-paid revenue, and sit on your balance sheet, awaiting conversion into revenue once you deliver the service. So, you have cash coming in as an asset, and a prepaid revenue liability offsetting it. Common sense, huh? Done.
Hold On Though…. But. Until a platform is operational, the token is useless (except for speculation – wait I didn’t say that). Plus, since the company has no legal obligation to token holders to actually develop the platform, in effect there is no immediate liability. So, how to classify the proceeds from a token sale prior to full operation of the platform? Not pre-paid revenue, but not equity, as the token holders are not owners of the company – they have no legal claim on the company’s assets.But it has to show up on the balance sheet somewhere. So, at this point, all I can call it is “other liability”. If the platform launches, then it becomes deferred revenue. If it doesn’t, then the company will have a group of angry (worthless) tokenholders, and a host of other issues…..Real Blockchain CFOs – what have you done?
I Know It’s Not That Simple. My example is very simple. There are many factors I have not considered. Accounting for tokens that have been generated but not sold. Token-based compensation plans. Taxability of token sales and related tax liabilities. All topics for future blog posts…..