Burkland - Start Smart, Scale Fast
The Smarter Startup

Six Key Things Crypto Startups Should Know About Finance

Crypto founders need to think differently about several key aspects of running a business and bridging it to the traditional financial world.

The last two years have seen explosive growth in the number and size of crypto startups. The startup ecosystem experiences the normal ebbs and flows of mood and macroeconomics over time. For venture-backed startups in particular, these cycles are also driven by advances in, and adoption of, technology that disrupts or dismantles legacy incumbents. Recently, few such advancements have captured the popular imagination as quickly as crypto.

Burkland’s role as a finance and accounting specialist for crypto companies and NFT marketplaces has also grown rapidly. Accordingly, we have a front-row view into the evolution and growth of this industry. This vantage point has allowed us to observe several distinct differences between “traditional” and crypto startups:

1. Not all crypto wallets are created equal.

Crypto wallets have a variety of pros and cons. Some provide detailed transaction information, while others only barely maintain balance amounts. Our fractional CFOs and controllers work with founders to determine the best “wallet fit” for their organization depending upon risk profile, location, volumes and needs. Getting the financials in order for crypto companies can present many challenges, not the least of which is finding, interpreting, and recording what happened to what funds and when. This is often a major puzzle because 1) the company and/or its founders have dozens, if not hundreds, of different wallets, 2) the founders are using private wallets to pay employees and contractors for work they’re doing for the company, 3) some of the wallets are “hot”, i.e., online, and some are “cold” and offline, 4) no one has collected the information required by the IRS and state tax authorities such as name, legal address, tax ID numbers, etc. While we know transaction details are immutably memorialized forever on the blockchain, you still need to keep track of who you paid, when they were paid, what was paid for, and how, if you’re going to prepare a proper P&L and meet tax compliance requirements.

2. Everything about payments is different for crypto startups.

Sending ETH to that developer in South America is only a few clicks away. It is deceptively simple to send it along without worrying about creating the proper policies and procedures for your startup to pay employees and vendors. But some missteps here can be costly down the road and take significant resources to rectify right as you’re trying to scale. Each country has its own tax and regulatory requirements for payments to individuals and companies. Failure to do so can result in costly fines and delays.

Think carefully about what type of payments your company intends to make and how it intends to make them. Determine how, or if, you will mesh your company’s payments in fiat currency with those in crypto, and what infrastructure you will need to make those payments AND keep good records to meet compliance, regulatory and tax requirements. Remember, crypto companies are just as obligated to follow the rules as any other.

3. Everything about banking is different for crypto startups.

Please read that again. Related to point #2, crypto companies simply do not interact with the fiat banking industry the same way as other startups. Generally, most larger commercial banks are still reluctant to deal with any company that touches the crypto ecosystem in any way. Traditional banks have been known to unceremoniously dump the accounts of companies and those of their owners upon learning of any exposure to the industry.

While there is no easy solution, we work with clients to ensure all companies which receive and transfer fiat currency have at least TWO operating accounts at separate banking institutions. While this may sound redundant, the regulatory landscape continues to remain uncertain. If your bank sends you a 30-day close notice, the lead times to finding and opening a new account can easily exceed the close period. Indeed, wait times at some of the most popular crypto-friendly institutions – Mercury, Silvergate, Signature, RHO, and Evolve, among others – continue to stretch as demand explodes at record rates. It pays to have these accounts opened BEFORE you need them.

4. Getting funds first, THEN worrying about the business can be worse than the other way around.

While startups of any kind can be chaotic and disorganized, crypto startups risk being even more so if they don’t take a moment to work through at least rudimentary business questions and strategies before the money starts rolling in. Many venture-backed clients we’ve worked with over the past 15+ years followed a typical progression – someone has a great idea, forms a company around that great idea, bootstraps or patches together funding from friends/family/angels, develops a prototype or minimum viable product. THEN the company raises institutional capital from VCs.

However, for most crypto startups, this progression is exactly the opposite. In fact, rarely are equity fundraising activities necessary. Sales of utility tokens, drops of popular NFT collections and royalties from secondaries mean many crypto startups have banked tens of millions of dollars without selling a share of the business, providing them with liquidity and profitability from early on. However, in many cases, this liquidity and profitability come long before any corporate, founder or tax structure has been contemplated. We work closely with our clients in advance to ensure these costly mistakes are avoided.

5. *Mostly* everything about taxes is different for crypto startups.

This is especially true if your customers or users are paying you in tokens, or you’re receiving crypto as part of mining, minting NFTs or participation in a token drop. There are two key differences from traditional startups, at least as far as your financial statements are concerned:

a) Your crypto is considered an intangible asset by the IRS, which means it’s essentially treated like a patent or other intellectual property.

By those same rules, intangible assets can only be impaired, not improved, in value, i.e., your wallet full of ETH can only be marked down in value, not up, regardless of what the price does. This does not reflect the economic value of the asset, and we fully expect this rule to be modified to eventually better track true market value. However, public companies must carry the value of crypto accounts on their balance sheets at the lowest market value during a prescribed period of time (i.e., month, quarter, year). The asset can never be written up, only written down.

Non-public companies typically mark their crypto assets to market at the end of a period. The company will keep track of the lowest value, while its balance sheet will maintain an asset at market value with an offsetting unrealized gain or loss.

b) Crypto is considered and taxed as property, similar to a house sale or shares of stock.

However, few companies are paid in houses – crypto is the only such property with the liquidity, volatility and use cases of a currency.

As you’d expect, this means when crypto is used to buy things or pay expenditures, its value at the time you spend it versus the value at the time it was acquired generates a realized gain or loss. Confused yet? Taxing crypto similar to property is a square peg in a round hole – each receipt of a crypto asset must be carefully recorded in tax lots such that a capital gain or loss can be recognized at disposition.

An example: You receive $1,000 worth of ETH from a customer for your services. Three months later, the value of your ETH has risen to $1,300, and you use it to buy a new computer for your business. Taxwise, $1,000 comes to you as revenue and is taxed as income, and $300 is taxed as a short-term capital gain – the difference between the value of ETH when you received it and when you exchanged it for the computer.

This is another crypto-related rule we believe will change (See our Open Letter to the FASB), but for now, the rules are the rules, despite how complicated this becomes for companies with tens of thousands of transactions per month. Our advice – bring in an accounting specialist for crypto and be sure they’re adept at one of the several software programs to help keep track of acquisition vs. disposition value.

6. Regulatory, jurisdictional and compliance issues loom larger in crypto.

One of the most dramatic differences between traditional startups and crypto startups is the regulatory environment in which they operate. Dramatic and significant differences between the United States and other Nations regarding legality and treatment of the crypto ecosystem remain, meaning startups in the space MUST have competent and experienced legal advisors alongside them to help choose the most advantageous corporate, tax and operating jurisdictions for their activities. This is one of those things that is much better done before the funds start to roll in, crypto or otherwise, not afterward.

In our work as fractional CFOs and accounting specialists for several very well-known crypto companies, we are often asked if the sector is overheated, in a bubble, or just in its infancy. It’s a debate that goes well beyond the scope of this post, although volatility, regulatory change and uncertainty are going to characterize the financial and legal aspects of the crypto space for the foreseeable future. Nonetheless, crypto founders need to think differently about several key financial and operational aspects of running a business and bridging it, as needed, to the traditional financial world.

Proper financials, accounting policies, strong cap table management, corporate structure planning, etc., are valuable best practices at any startup, regardless of how innovative the underlying activity may be. If you’re a crypto entrepreneur, do yourself (and your company) a favor – bring crypto-savvy finance and accounting professionals alongside you in the infancy of your organization, so you don’t have to worry about costly mistakes and headaches down the line. Starting a company is hard enough – it will be one less chainsaw you’ll need to juggle.