A decision to begin or expand the use of blockchain technologies and digital assets can represent a commitment to innovate how the company operates. As such, it requires a broad rethinking of fundamental strategic questions and how the company intends to manage operational complexities and risks.
Blockchain technologies have matured greatly in the past few years and, while still evolving, now have a track record of solving significant business challenges while producing material returns on investment. Digital assets—including cryptocurrencies, stablecoins, tokens, and non-fungible tokens (NFTs)—are based on blockchain technology and continue to increase in popularity. It may be a natural reaction for board members to see this innovative technology as on the fringe and only suitable for companies with a high-risk appetite, but that mindset may lead to significant opportunities being missed.
Just as board members have a responsibility to understand this new market to grasp the broad opportunities blockchain and digital assets portend, they should also understand the scope of risks. Strong leadership and governance over risk and controls is critical for both management and the board.
Management has the responsibility to lead on decisions of key risks and controls on digital assets, including:
- Technology and talent.?Blockchain and digital assets can be complicated to manage, so it’s important for companies to have the necessary skills and resources as well as the investment in technology to support such a movement.
- Cybersecurity.?Key risk areas to consider include novel security risks presented by distributed systems and smart contracts, how the digital assets are custodied, the process for approving distributions, phishing attacks designed to target digital assets, and vulnerabilities in the protocol code underpinning digital assets.
- Regulation.?The regulatory landscape is evolving, but not as rapidly as the crypto ecosystem. The Securities and Exchange Commission (SEC) released Staff Accounting Bulletin 121 on March 31, calling for enhancements in the disclosure and accounting of crypto-assets held by platform companies on behalf of third parties. In addition, several bills are under discussion in Congress regarding the regulation of stablecoins and the role of key regulators such as the Commodity Futures Trading Commission and the SEC.
- Accounting and finance.?Investments in certain cryptocurrencies, for example, are often accounted for under guidance related to indefinite-lived intangible assets, assuming industry-specific guidance does not apply. Under this area of Generally Accepted Accounting Principles (GAAP), companies are required to book acquired assets at cost and evaluate them periodically for impairment, or markdown, when values diminish. However, GAAP does not provide for such assets to recover value, making it virtually impossible for digital assets held as investments to realize any return on value until they are sold.
- Tax.?The Internal Revenue Service regards digital asset transactions as taxable, although treatment may vary depending on whether transactions are for purposes of investment or business transactions. If companies wish to establish cost basis for tax purposes between separate purchases of digital assets, they should segregate each purchase into separate digital wallets rather than store the purchases in an omnibus custodial account. Companies may also need to consider whether they have examined each of the business cycles that will use crypto to layer on tax treatment. Examples include using crypto to pay employees and vendors or taking it from customers. This draws unique considerations in payroll tax withholding, indirect taxes, revenue recognition, and basis tracking.
- Fraud risk.?The disintermediation of activity occurring in a blockchain makes it important for companies to understand who their counterparties are in business transactions and the provenance of each digital asset they encounter. Compliance with anti-money laundering, know-your-customer, and anti-corruption requirements now apply to digital assets. To the extent companies rely on third parties such as exchanges or custodians to execute transactions, companies are still responsible for compliance with all relevant laws and regulations.
- Internal controls.?Companies need due diligence with respect to how various platforms operate, their vulnerabilities and volatilities, and the terms and conditions of doing business in the space. They need to understand the blockchain supporting each asset and how the related governance system operates.
Questions to Weigh Opportunities and Risks
In the board’s role to oversee and govern decisions over digital assets, boards should consider engaging with management on the following questions:
- What is (or what should be) the company’s involvement with digital assets and blockchain? How does our involvement compare with that of our customers, vendors, competitors, and peers in the marketplace?
- How does our position on cryptocurrency fit with our risk appetite and growth strategy? What is the business case for expanding our consideration for integrating crypto into our strategy??
- What about our position on blockchain? Are there opportunities to engage with the technology that we’re overlooking, such as the use of smart contracts to elevate commercial activities? Have we considered re-platforming on blockchain to take advantage of new methods of digital rights management?
- What financial risks do we need to consider with respect to cryptocurrencies and blockchain technology? Are our treasury and finance leaders monitoring the marketplace for emerging risks and opportunities?
- What controls, processes, policies, and procedures do we have in place currently with respect to cryptocurrency? Should we revisit them?
- What operational risks do we need to consider? Do we have the talent and technology necessary? Does our investment strategy support a consideration for engaging in cryptocurrencies and the underlying technology?
- What are the regulatory and tax implications of engaging with cryptocurrencies and blockchain technology?
- How can we continue to educate ourselves on digital assets and the underlying technology to understand how they may transform the way we engage in the marketplace of the future?
An incremental movement into blockchain or digital assets can help a company learn and develop a road map for broader adoptions that support the company’s strategy and growth objectives. This early stage experimentation is key, allowing an enterprise to form their own views, build competency within teams, and establish a baseline reference for future engagement. Adoption will require new processes and controls that span departments. A collaborative effort of the board and its committees with management leaders across the enterprise is critical to help each company prepare for the journey.
—by?Tim Davis, principal, Deloitte & Touche LLP;?Rob Massey, partner, Deloitte Tax LLP; and?Carey Oven, national managing partner, Deloitte & Touche LLP
