Navigating Cost Basis for Crypto by Adam Efrima
When introducing people to the world of crypto cost basis, it is important to define it in its current state.
“Cost basis” is a term that simply refers to the original cost of an asset. If we know how much we paid for something, say a share of stock in a company, it’s straightforward to calculate our profit or loss on it. But cost basis calculation is more challenging for crypto assets than traditional finances. There are no clear guidelines or best practices for helping companies calculate their cost basis, asset performance, and tax liabilities if they use crypto. This leads to inaccurate tax and P&L reports, which can create unnecessary liabilities and negatively affect business decisions.
In order to identify the solution, we must first zoom in on the problem:
Missing data: Companies with lots of operational time behind them might find parts of their transaction data missing or inaccessible. Some exchanges furthermore only provide partial transaction records.
Classification: Unlike bank statements, blockchain records don’t provide any information about the nature of the transaction or the people involved. If we didn’t mark it at the time, we probably forgot about it.
Excel spreadsheets: These are a favorite tool for many companies, but they are prone to human error and manual maintenance. Today’s users expect automation.
Scale and complexity: Many companies store assets across multiple wallets and exchanges. The more assets and accounts a company operates, the more complexity it adds to their operations.
This is only a partial list of concerns. It doesn’t mention the lack of clear rules on crypto taxation, or the lack of standardized reports available from wallets, custodians, and exchanges.
Most companies react by improving their bookkeeping practices or consulting CPAs with crypto experts. If you’re doing the same, then you’re already on the right path.
The common cost basis calculation method for crypto assets uses the FIFO method (first-in, first-out). To make it as simple as possible, let’s take the following example; Two years ago you bought one bitcoin when it was trading for $500. Two months latter, you bought one more Bitcoin for $1,000. Your balance now shows the you own 2 Bitcoins which cost you different amounts of money to obtain ($500, $1000). After holding your Bitcoin for 2 years, you finally decided to sell 1 BTC for a whopping $15,000. Under FIFO calculation method, your cost basis is derived from the Bitcoin which was earliest in your possession, in our case $500 — selling it for $15,000 generated you $14,500 in profit.
Since every crypto transaction is a tax event, it is valuable to monitor profits or losses that were triggered following a transaction for tax reporting purposes and for accurate measurement of your crypto activity.
This example is relatively simple, but the calculations get complex for companies operating in this space with a high-volume of transactions. Companies all have many different uses for cryptocurrencies, like airdrops, coin offerings, forks, bounties,revenue, and even paying salaries. Furthermore, most companies don’t have proper records of their crypto transaction. Sometimes, what appears as a “sale” might actually be a transfer to a new wallet or exchange account. With tens of different assets used in thousands of transactions, the end result is a maze of financial activity that makes it almost impossible to calculate your crypto profit or loss.
Companies have a few options to address the issue. The easiest and most effective is to improve crypto bookkeeping practices, and well as hire a specialized crypto accountant. Some companies may also make use of online crypto tax calculator, but these aren’t especially useful to most.
The golden rule of cost basis starts with internal practices. If there’s one piece of advice relevant to every company in the space, it’s to “be more deliberate.” Some companies invest in ICOs, buy back their own tokens or engage in an airdrop campaign. In the “Wild West” days of crypto, this sort of activity largely went overlooked. But legitimate companies today must think twice before transacting with crypto assets — every action is taxable, every decision must be carefully executed, and transactions need to be accurately recorded.
Seeking the advice of an expert crypto accountant is usually the next step, and these people will definitely help you organize your books. Make sure you choose an experienced firm, and test their knowledge by discussing your next airdrop or an impending Bitcoin fork. If that conversation confuses them, then keep searching.
The less reliable solution is to use online services that purport to calculate your tax liabilities and save you money in just a few minutes. Calculating cost basis and the related tax implications is no simple task. Professional general ledgerL systems like QuickbooksXero, and TurboxTax took years of development in order to reliably perform suck complex tasks. Today’s solutions for crypto assets don’t offer the same level of depth and control, leaving your company to submit incorrect reports or making financial decisions based on incorrect calculations.
Until legal framework is solidified, the most important decisions a company can make is to continuously be deliberate and seek third party guidance.
Improving your crypto bookkeeping practices
It’s finally time to start getting your cryptos in order. We listed a few tips and hacks that might help:
Try automation for a change, there are many tools which allow you to automatically pull data from any number of wallets and exchange accounts. Replace the outdated practice of using blockchain explorers and data extracts in order to stay on top of your transactions. Use automation, ‘set it and forget in’.
Structure your wallets the right way; a chart of accounts allows us to assign financial transactions to specific accounts for accounting purposes. Savvy crypto users apply this idea to their wallet set up and try to open as many wallets as possible for the different crypto uses they have. For example; ‘Petty cash wallet’, ‘Income wallet’, ‘General expenses wallet’. Having this kind of segregation directly on the blockchain is one benefit we can enjoy in the chaos of trying to keep our crypto assets in check.
Permissions and governance; as most companies are their own custodians, in many cases the people who hold the majority of crypto assets will be the company founders. The tech background and sometimes ‘cyberpunk’ attitude is not a welcome attribute in areas where laws and compliance are so material. Make sure corporate governance and permissions are structured similarly to your fiat transaction approval process and be assertive when such restrictions are not executed rigorously.
Mistakes might be harder to correct; crypto assets and blockchain is unforgiving at times. We are granted with an absolute freedom yet in many cases we find ourselves making irreversible mistakes; Losing a private key, sending the wrong amount or the wrong wallet etc. Remember that every action you take is irreversible, if you are transacting without proper log keeping and caution it will be extremely hard to retrace your steps moving forward.
To summarize and conclude, every introduction of new technology into a business might be challenging at the beginning but extremely rewarding over time. Most of us are working in the blockchain space because of the notion that something bigger than us is taking place Some call it a revolution, the next internet while some think its a fraud. No matter the case, there were only a number of instances in which technology has the potential of dramatically disrupting financial recordkeeping and accounting practices. Today, each and every one of us should lift our head from the endless clutter of our crypto finances and feel a little lucky for the opportunity to be working at the bleeding edge of financial technology.
I can’t remember a time in which the big four and other prominent accounting firms were ever excited to invest in a new, risky and experiential technology. The potential of blockchain has the world curious and desiring to innovative. Sometimes it’s worth it to just stop to enjoy everything that’s happening around you, we all have a front row seat.