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Sunday, September 4, 2022

Challenges of Defining Virtual Currency - Recent Observations from FASB

At its August 31, 2022 meeting, the FASB discussed the scope of its digital asset project (see meeting handout here). This FASB project was adopted in May 2022 with the objective "to improve the accounting for and disclosure of certain digital assets." Well a good question is - what are digital assets and which should be addressed in the FASB project.

One part of the handout aims to identify characteristics that can help distinguish among various digital assets. It notes that specifying that the assets are "created or reside on blockchains and are secured through cryptography" will distinguish cryptocurrencies or crypto assets form other digital intangible assets such as software and data.

FASB also notes that terms such as "store of value" and "medium of exchange" are often used but "may not be helpful in defining" the scope of the FASB digital assets project because:

"(a) Other assets share these characteristics (real estate may be viewed as a store of value and money is a medium of exchange).

(b) A medium of exchange may depend on the perspective of the holder.

(c) A digital asset may not be considered a medium of exchange by some in practice because of limitations of networks.

(d) Evaluating whether an asset is a medium of exchange or store of value is subjective. For example, relative volatility may lead some stakeholders to conclude that a digital asset is a poor store of value."

There is more analysis in the handout.

I think the observations are interesting because in Revenue Ruling 2019-24, the IRS defines virtual currency as "a digital representation of value that functions as a medium of exchange, a unit of account, and a store of value other than a representation of the United states dollar or a foreign currency."

It does not define the terms "medium of exchange," "unit of account" or "store of value."

The instructions to the 2021 Form 1040 virtual currency questions also used the three traits above only it used OR rather than AND as used in Rev. Rul. 2019-24 (for more on that, see this 8/29/22 letter submitted to the IRS by the AICPA with suggestions to improve the ability of taxpayers to understand the question).

So, if FASB wasn't able to reach a clear understanding of cryptocurrencies per the terms "medium of exchange" and "store of value", how are individual taxpayers to do so?

When the word "or" is used for the three terms, non-fungible tokens (NFTs) seems to be a virtual currency for the Form 1040 question in 2021, but since they are non-fungible, they likely are not a virtual currency (not a unit of account perhaps) for the definition in Rev. Rul. 2019-24.

And the IRS definition makes no reference to a blockchain or distributed ledger for tracking the currency.

So, how should virtual currency be defined?

What do you think?

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