Accounting Archives

Lukka Announces Partnership with Space and Time for On-chain Data Collaboration

Rafal Janik on May 10, 2023

This joint partnership will allow institutions to consume high quality blockchain transactional data across multiple protocols

NEW YORK (May 10th, 2023) – Lukka, the leading institutional crypto data and data management provider, has announced a partnership with Space and Time, a leader in decentralized data warehousing.

Through this partnership, Lukka and Space and Time will deliver institutional-quality blockchain transaction data to businesses requiring higher quality on-chain data than is available in the public domain. This collaboration aims to offer institutions mature analytical and reporting benefits derived from accurate and tamperproof on-chain blockchain data, covering a continuously growing number of protocols. Furthermore, it strengthens both companies’ commitment to providing the blockchain industry participants with innovative solutions that build trust and transparency in blockchain data.

Lukka is the only institutional-grade digital asset data and data management provider and was the first crypto asset business to obtain the rigorous technical control standards of an AICPA SOC 1 Type II and SOC 2 Type II Service Organization Controls Audits. Lukka additionally has received an ISO 27001 ISO/IEC 27001 certification and utilizes a number of other frameworks in order to build trust and a commitment to ensuring trust and financial transparency for its institutional customers as they participate in the crypto ecosystem.

“The technical acumen that the Space and Time team offers to a partnership with Lukka was immediately obvious.”, says Brandon Sang, Chief Solutions Officer of Lukka. “The appreciation for clean and reliable data is often overlooked, however, is paramount for the institutional adoption of blockchain. We are thrilled to begin this collaboration with Space and Time”

Space and Time is a decentralized data warehouse that powers low-latency transactional queries and scalable analytics in a single cluster. Space and Time has developed a novel zero-knowledge proof called Proof of SQL℠, which cryptographically proves that each query computation was done accurately and that both the query and the data are verifiably tamperproof.

“Lukka is leading the industry with accurate and transparent blockchain data, and we’re thrilled to support them in their initiatives to expand access to more chains, provide deeper analytic insights, and establish more verifiability for Web3,” said Space and Time CTO and Co-Founder Scott Dykstra. “Space and Time is providing essential data infrastructure for developers and enterprises building on the blockchain, and our partnership with Lukka emphasizes our commitment to that.”

Space and Time allows users to store, manage, and analyze data in a verifiable way. Space and Time’s decentralized data warehouse provides a powerful suite of data tools for developers in the blockchain ecosystem, now enhanced by Lukka’s risk-mature approach and data solutions.

About Space and Time
Space and Time is the first Web3-native decentralized data warehouse that joins tamperproof on-chain and off-chain data to deliver enterprise use cases to smart contracts. Space and Time has developed a novel cryptography called Proof of SQL℠ that allows developers to connect analytics directly to smart contracts, opening up a wealth of powerful new use cases and business logic on blockchain technology. Space and Time is built from the ground up as a multichain data platform for developers in financial services, gaming, DeFi, or any project requiring verifiable data across enterprise, blockchain and AI.

For media inquiries, please contact: Spencer Reeves, [email protected]

Lukka Announces IOSCO Statement of Adherence for Lukka Prime Following Big 4 Accounting Firm Review

Rafal Janik on May 3, 2023

Leading global institutional crypto data and data management provider, Lukka, further demonstrates commitment to operational risk management through adherence to IOSCO’s Principles for Financial Benchmarks.

NAPLES, FL (May 3, 2023) – Lukka, the leading institutional crypto data and data management provider, has published its IOSCO Statement of Adherence, for Lukka Prime, which is supported by a review performed by an independent Big 4 accounting firm. Lukka’s IOSCO Statement of Adherence describes the governance, quality, and accountability policies, procedures, and controls implemented for Lukka Prime (the “Benchmark”).

The International Organization of Securities Commissions (IOSCO) brings together the world’s securities regulators and is recognized as the global standard-setter for the securities sector. The IOSCO Principles for Financial Benchmarks was created to increase market confidence over Benchmarks by providing recommended practices to help ensure governance and accountability, including quality and transparency, for Benchmark Administrators.

“The completion of Lukka’s independent audit of Lukka Prime against the IOSCO Principles by a Big 4 Accounting Firm is just another example of our continued commitment to build trust with our partners and provide institutional-grade product offerings that our customers can rely upon with confidence.” – Dan Huscher, Chief Data Products Officer at Lukka.

Lukka was the first service provider in the crypto ecosystem to complete AICPA SOC 1 Type II and SOC 2 Type II audits in 2018 and 2019, respectively. Lukka also received its ISO/IEC 27001 Certification in November 2022. With the addition of IOSCO, Lukka further emphasizes its commitment to ensuring customer trust to establish financial transparency for their customers. Lukka is, and will continue to be, adherent to the IOSCO Principles to support and accelerate innovation in building the infrastructure for the future of global commerce.

About Lukka

Founded in 2014, Lukka serves the most risk-mature businesses in the world with institutional data and software solutions. Lukka bridges the gap between the complexities of blockchain data and traditional business needs. Its customers include both Traditional and Crypto Asset Exchanges and Trading desks, CPA & Accounting Firms, Fund and Financial Auditors, Fund Administrators, Miners, Protocols, individuals, and any other businesses interacting with crypto assets. All of Lukka’s products are created with institutional standards, including AICPA SOC Controls and ISO standards, which focus on accuracy and completeness. Lukka is a global company headquartered in the United States.

For information about Lukka, visit https://lukka.tech/

Lukka Inc.

Lukka Completes ISO/IEC 27001 Certification to Build Trust with Global Customers

[email protected] on January 26, 2023

Leading global institutional crypto data and software provider, Lukka, further demonstrates commitment to risk management with ISO Certification.

NAPLES, FL (January 26, 2022) – Lukka, the leading institutional crypto data and software provider, has completed its ISO/IEC 27001 Certification, furthering its long-standing commitment to putting risk management first in order to serve the most risk-mature businesses in the crypto ecosystem. This international standard is used to certify that organizations establish, implement, and maintain continually improving Information Security Management Systems.

The ISO/IEC 27001 is the world’s best-known standard for information security management systems (ISMS) and is often required as part of vendor selection processes. Certifications are conducted by independent accredited certification bodies following a comprehensive audit of the requirements outlined within its framework. Lukka’s ISO/IEC 27001 Certification was issued by the British Standards Institution (BSI), an independent certifying organization. BSI is one of the world’s first National Standards Body, was an integral part in forming the ISO/IEC 27001 framework, and is globally recognized as a leader in certifying ISO standards.

“Participating in the crypto ecosystem requires partnership and interaction with many different entities across a complex value chain. Receiving the ISO 27001 ISO/IEC 27001 certification shows our customers that they can rely on Lukka to deliver innovative software and data solutions with a commitment to the highest standards of security risk management and data protection.” – Michael Quilatan, Head of Risk at Lukka.

Lukka was the first service provider in the crypto ecosystem to complete AICPA SOC 1 Type II and SOC 2 Type II audits in 2018 and 2019 respectively. With the addition of this ISO/IEC 27001 Certification, Lukka further emphasizes its commitment to ensuring customer trust to establish financial transparency for their businesses.

About Lukka

Founded in 2014, Lukka serves the most risk mature businesses in the world with institutional data and software solutions. Lukka bridges the gap between the complexities of blockchain data and traditional business needs. Its customers include both Traditional and Crypto Asset Exchanges and Trading desks, CPA & Accounting Firms, Fund and Financial Auditors, Fund Administrators, Miners, Protocols, individuals, and any other businesses interacting with crypto assets. All of Lukka’s products are created with institutional standards, such as AICPA SOC Controls, which focus on accuracy and completeness. Lukka is a global company headquartered in the United States. | For information about Lukka, visit lukka.tech

Measuring Fair Value for Crypto Assets in Markets that Never Close

[email protected] on January 19, 2023

It’s always midnight somewhere.

By Suzanne Morsfield, Global Head of Accounting Solutions

Upcoming changes in requirements make this more relevant than ever:

The notion of measuring crypto assets at fair value has gained increased interest because of the FASB’s recent vote to require fair value for a larger subset of crypto assets. The final version of the new requirements and the effective dates have not yet been released, but it’s crucial to begin discussing and planning to estimate fair value for the assets within the decision’s scope. One key practicality that is unique to crypto assets is that reporting entities currently have an element of choice in the time of day at which they price their end-of-day holdings. And, because of the global nature of crypto markets, the most informative fair value for accounting purposes is in that part of the world where the most reliable measures of volume and exit price are, regardless of the time zone–i.e., it’s always midnight somewhere.

Some key differences between equities and crypto markets:

This table is not intended to be comprehensive, but it draws attention to those areas of difference that matter for financial reporting definitions of fair value–e.g., how crypto asset markets function, their quality, and the tools needed to identify a principal market within this ecosystem. It is important to note, that despite there being unique challenges related to the characteristics of crypto markets, this does not make determining FMV unsolvable. In many ways, crypto markets and the underlying technology offers more transparency into prices than is typical in traditional markets.

Principles for estimating fair value – a reminder:

Fair value guidance for accounting purposes is derived from specific accounting standards that focus solely on the accounting concept of fair value–ASC 820 and IFRS 13 (for US GAAP and IFRS, respectively). These standards were developed at a time when both the FASB and the IASB were working together to develop joint requirements on a series of topics. Therefore, the key approaches are very similar, if not identical, in most cases. Notably, both standards lay out the principles for fair value, but do not give a precise recipe for calculating it. To be fair, there are some prescriptive elements, but they are fewer than one would think. Both standards are also consistent in the idea that fair value should be informative.

Below are some of the main ingredients in the US GAAP and IFRS standards for establishing fair value for actively traded assets (and liabilities):

Apply a market-based, orderly transaction approach;
Identify the Principal Market as the market with the “greatest volume and level of activity”;
Rely on quoted and observable prices; and
Use the exit price of a market participant in the Principal Market.

The reporting entity has to choose a time of day to apply all of these principles and find fair value. In traditional equity markets, this task is relatively straightforward because end of day pricing typically occurs when the market closes. Because an exit price is required for accounting purposes, this then implies that fair value is most often based on the price of the final trade just prior to the close. So, how should such a final trade be identified for markets that never close?

Choosing a time of day for fair value.

The 24/7 global aspect of crypto trading and transfers is an amazing development that traditional financial markets have aspired to for decades. While it is a key feature and attraction for crypto investors, it also creates a practical challenge. At what time of day should a reporting entity measure the value of their crypto? Does it matter?

Currently, most regulators and standard-setters have not prescribed a particular time of day for establishing fair value. Each entity can choose their own time of day, with a special caveat for impairment testing. To conduct this test, the SEC has weighed in, for example, that the lowest fair value within the test period should be used. Lukka does not provide accounting or tax advice, but one important principle to invoke here is it’s advisable to maintain well-documented policies about the time of day chosen. Auditors likely will also want to see that this defined policy is applied consistently.

Some policy options include: the time at which the equity markets close for the majority of the entity’s equity holdings, 00:00 UTC, or other local norms for striking net asset value (NAV). In addition to documenting a particular time, management may also wish to document its reasons for the time of day chosen. Those reasons can be as simple as wishing to keep the pricing mechanics of their equity investments and their crypto investments aligned. Alternatively, an entity may wish to examine in more detail the price formation data for the particular crypto assets they trade or hold.

Volume and trade frequency of some assets may be stable across an entire 24-hour period, or it may decrease or increase substantially after the equity markets close. Assessing the price formation process is more than simply examining price variation because the definition of a Principal Market for fair value purposes relies on reliable and sufficient trade volume and frequency information. As a result, analysis requires access to robust data that can in turn be used to examine volume and frequency across millions of trades, across times of day, across time zones, across many exchanges, and even across years. All of this analysis can then be used to substantiate the time of day chosen for the entity’s particular circumstances.

Conclusion

The punchline is that when it comes to choosing a time of day to estimate the fair value of crypto assets variation is permitted, and good documentation and analysis are recommended best practices. Lukka provides advanced tools and data by which to analyze and select an informed time of day for the set of crypto assets that any firm is holding or trading. This enables our customers to execute on that chosen time automatically so that companies do not need to intervene or make manual decisions. In addition, full transparency and reports are provided so that an independent, 3rd-party, AICPA SOC 1 and 2, Type 1 and 2 attested fair value time of day and methodology are applied.

Lukka’s proprietary Lukka Prime methodology provides FMV of actively traded crypto assets, fully compatible with GAAP, IFRS, as well as IRS rules, and today is used by audit firms, some of the biggest banks, exchanges, fund administrators, funds, trading firms, and so on. This methodology has proven to solve use cases beyond just accounting. Underneath the hood of the Lukka Prime fair value methodology is a foundation of high-quality data and a classification system that permits users to further understand the types of crypto assets they are considering or are already holding– further, this data classification system allows you to help assess whether a particular crypto asset is likely to be within scope for the new fair value requirement. And, for any crypto assets that are not within scope, Lukka’s impairment product facilitates daily, monthly, quarterly, or annual impairment testing and calculation at the push of a button.

The Principles of Risk Management for Crypto

[email protected] on November 15, 2022

Authors:

Suzanne Morsfield, Lukka’s Global Head of Accounting Solutions

Brian Whitehurst, Lukka’s Head of Regulatory Affairs

Background

Recent developments within the crypto industry have captured the attention of crypto market participants and observers. Due to the plunge of the market earlier this summer, highlighted by the collapse of the TerraUSD (UST) stablecoin, and the insolvency of crypto hedge fund Three Arrows Capital, and CeFi platforms Celsius and Voyager, regulators are paying more attention than ever.

These bankruptcies and significant losses shine a light on a key, even basic financial principle–the risk-return relationship. This relationship derives from finance theory and simply put, implies that to take on higher risk, investors typically require a higher return for their investments. To illustrate, numerous entities in the crypto environment offered APYs north of 20%, rates unheard of in traditional finance where yields typically top out at single-digit percentages. And while high yields are nice, investors would be wise to ensure they understand the risk they are taking on, because higher risk does not guarantee sustained higher returns–whether in crypto or in traditional assets.

One of the virtues of crypto and decentralized finance is that the individual has complete control over their finances. No longer are traditional finance middle-men able to reap the majority of the reward. But at what point does that control start to become risk-return negative? As the past few months have shown, too much risk can lead to a collapse of the system because the continuous, long term returns associated with the undisclosed risk becomes untenable over time.

This naturally leads to the observation that a risk management mindset, coupled with risk management methods and tools, are a necessity within the world of crypto finance. Control of your own holdings does not mean subjecting yourself to a system that puts your life’s savings at risk of disappearing one day. While some things are new, losing everything due to poor risk management is not.

Realities dictate that regulators worldwide are going to have a say, and while proportional regulation that doesn’t stifle innovation should be a part of the conversation, it doesn’t need to be the entire story or only solution. Even with all of its advances and improvements over traditional finance, the crypto industry can still learn from traditional finance when it comes to the guardrails that both create and maintain safer innovation and profit-taking.

Can we learn from traditional finance?

Crypto finance has a decentralized approach by design, meaning it operates differently than traditional markets. However, as noted above, it’s still exposed to risk, some of which is the same as traditional finance.

The key is to identify, understand, communicate, and manage all the risks present in crypto transactions. The exact steps to that identification will vary, depending on which side of the transaction one is on. Risk identification and communication are important for those originating crypto finance transactions for investors, lenders, borrowers, and others. Risk understanding and management are crucial for those engaging in the transactions offered to potential investors, borrowers, lenders, etc.

How can Risk Management Improve Crypto Finance?

Traditional finance, while sometimes viewed as the antithesis of crypto, utilizes core principles and tools which the crypto industry can begin to institute to a higher degree in order to protect the market as a whole. Developing the principles below will allow the crypto industry to take a step towards maturity:

Focus on substance over form
- Many crypto transactions and products call themselves one thing, but when the lawyers and auditors look in, it is shown that the substance is not clear, or does not match the naming or description.
- In simple terms, experts should weigh in before the product goes to market. The form and substance should both match, and be made crystal clear. Classifications that look beyond marketing to the underlying characteristics and components of the products are important.

Enable and use liquidity analysis and audited financials
- This principle is closely tied to a complete set of audited financial statements and their accompanying notes; with the potential implementation of regulation those involved with the crypto community should aim to produce these traditional financial reports in order to stay ahead of the market.
- If institutional investors involved with crypto conducted thorough pre-investment analysis, and required audited financials, this would require their crypto counterparties to comply with normalized best practices without waiting for regulators to step in.

Conduct ongoing performance monitoring of the transactions and the counterparty(ies)
- The entity who made the investment or loan should be responsible for conducting its own ongoing, substantive performance monitoring of the crypto product and counterparty, e.g., financial trend, variance analysis, and smart contract audit, where relevant.
- As a routine matter, the contracts should provide for regular statements that mirror those of similar traditional transactions, and for a legally enshrined right to inspect the books.
- Reliable fair value assessments of the crypto held, pledged as collateral, or otherwise used will be a key part of this analysis.

Clarify collateral, custody, and segregation of assets
- Collateral is a key component of traditional financial arrangements, and applying its processes could be transformative for the maturation of the crypto finance ecosystem i.e., custody should be clear, the pledged assets should not be commingled with corporate assets, and the security interest should be carefully documented and crafted so that the lenders are adequately protected.

Enhance disclosure and Terms and Conditions (T&Cs)
- The control of one’s finances should not end at the point of transfer to a third-party platform; therefore, how crypto businesses handle customer assets should not be trade secret. By sufficiently disclosing risks and basic practices, providers will not only protect their customers, but also themselves.
- As the crypto industry grows, so too should transparency through disclosures. Clear, predictable, accurate disclosures and terms of service are a must have.
- Promoting mature and easy to understand terms and conditions with fulsome disclosures provides customers a better understanding of the risk they are taking on.

Conclusion

Crypto has ushered in a lot of new features and opportunities in financial services, but it has opened the door to issues in risk management. Institutional quality solutions to these issues are critical for businesses engaging in the crypto ecosystem. Lukka has built best-in-class data and software offerings to aid businesses in managing their risk when they interact with crypto finance.

About Lukka:

Bloomberg Adds Lukka Prime, The First Institutional Fair Market Value Crypto Data Provider, On The Bloomberg Terminal And B-Pipe

[email protected] on September 20, 2022

Lukka Prime data available under wire code ‘LUKK’

New York, NY| (September 20, 2022) – Lukka, the leading institutional crypto software and data provider, announced today that it will now be available through Bloomberg, in Terminals and through Bloomberg’s enterprise redistribution platform, B-Pipe.

The Bloomberg Terminal has chosen Lukka as the first institutional provider of Fair Market Value (FMV) crypto asset data to offer to its global customer base. In an increasingly scrutinized industry where standards and rules are still developing, topics such as price manipulation and data quality are in the spotlight. Lukka’s proprietary methodology provides FMV of actively-traded crypto assets, fully compatible with GAAP, IFRS, as well as IRS rules, and today is used by audit firms, some of the biggest banks, exchanges, fund administrators, funds, trading firms and so on. This methodology has proven to solve use cases beyond just accounting – Lukka Prime mitigates manipulation through the application of a very transparent methodology while preserving the core characteristics and principles of FMV, such as using executed prices instead of any form of an average or model-based price.

Both Terminal (wire code LUKK) and B-Pipe Bloomberg users now have access to Lukka Prime pricing data for 50 crypto assets. Lukka Prime is designed to align with GAAP and IFRS guidelines. It allows businesses trading in crypto access to a reliable FMV even in the absence of a primary market, closing day, and other traditionally necessary factors. Terminal users can now bring institutional level consistency and reliability to their crypto data analysis by using Lukka Prime. You can read more about the Lukka Prime methodology on the Lukka website: https://lukka.tech/enterprise-data/.

“Recently, we have seen risk management practices across the crypto ecosystem stress tested more and more every day.” says Robert Materazzi, CEO at Lukka. “This has forced businesses to increase their focus on operational risk management which has highlighted the importance of data quality. Lukka Prime’s unique institutional focus on data quality is precisely why it is being used by most of the risk mature companies in the crypto world.”

“Our mission is to help the global institutional investor community to seamlessly incorporate digital assets into their workflows in a trusted and familiar way, on the Bloomberg Terminal,” says Alex Wenham, product manager for cryptocurrencies at Bloomberg. “As this market develops, we will continue to evolve our data-driven offerings to help our clients define and develop their strategies in this space.”

For more information on how to find Lukka products in Bloomberg, please contact your Bloomberg representative.

About Lukka

FASB Confirms Initial Scope of its Crypto Assets Accounting Project.

[email protected] on August 31, 2022

Author: Suzanne Morsfield, Global Head of Accounting Solution

In May, 2022, the FASB voted unanimously to add a standard-setting project to its technical agenda on accounting for crypto assets, with a decision about the exact scope of the project to be decided at a later meeting. The Board was not in favor at that stage of a “fair value option”, but instead the majority advocated for a fuller set of deliberations and decisions that would establish a valuation approach applicable to all the crypto assets ultimately decided to be within the scope of the project.

The next step in this process occurred today. The Board meeting addressed decisions about the exact scope of the standard-setting project. The Board voted unanimously again to establish the scope for the crypto assets covered, and the initial framework appears to be as follows (all of the following must be true):

The item voted on by FASB:

(a) is created or resides on a distributed ledger or blockchain;

(b) is secured through cryptography;

(d) does not represent a contract as defined in the Master Glossary; and

(e) is fungible.

(the Board meeting handout is linked here)

Some select observations from today’s meeting are:

Today’s vote was solely to establish the scope of the project, and was not intended to speak to future recognition, measurement, or presentation outcomes of the project;

The scope:
- meets requests during outreach to begin with a narrowly-defined project;
- excludes NFTs, as well as any crypto assets that may already be addressable within the existing Codification topics that cover items classified as financial assets or securities, for example;
- is expected to apply to all types of reporting entities;

There were questions about possibly later refining or clarifying the criterion to exclude crypto assets that meet the definition of a contract;
- Some asked whether it would be better to focus more clearly on excluding crypto assets that grant claims to underlying assets, or to goods or services;

One Board member noted that the scope includes those crypto assets for which the accounting does not equal the underlying economics, and excludes those crypto assets for which the current accounting is not problematic (in their view); and

There was support for renaming the project from digital assets to crypto assets, now that the scope clearly focuses on a set of crypto assets.

In May, Lukka welcomed the Board’s decision to add this project to their agenda. We also continue to support the importance of high quality, authoritative standards that do not stifle innovation. Today, we reiterate that capital market participants ultimately will benefit from relatively more relevant and decision-useful information than is often provided under current interpretations of the now applicable authoritative standards. It is never a question of whether we like or don’t like a given set of standards or proposals, but rather the quality of the information provided to users of financial statements to best assess the amount, timing and uncertainty of future cash flows is paramount.

Lukka is committed to authoritative standards and regulations that do not inadvertently stifle innovation, and will readily support our customers’ compliance with US GAAP and SEC reporting requirements, regardless of the direction and timing of standard-setting that follows from the Board’s decisions. We also applaud the quality of FASB staff’s work and the Board’s discussions.

We will always support standard-setters and the standard-setting process in whatever ways we can. As a practical matter, Lukka’s Reference Data and LDACS will allow users of our data to filter on the above scope characteristics to better understand the exact set of crypto assets that will likely fall within the newly-defined scope of the project.

About Lukka

Lukka is a firm that helps solve some of the greatest financial challenges in crypto and has the intellectual resources, along with the data and processing capabilities, to test hypothetical scenarios like the one here. For more information on how Lukka puts data to work across multiple finance sectors, traditional and decentralized, supporting industries from insurance to Formula E, go to our website at Lukka.tech

FASB Adds Digital Assets Accounting To Its Technical Agenda

Suzanne Morsfield on May 11, 2022

Author: Suzanne Morsfield, Global Head of Accounting Solutions in Academics

Today, the FASB voted unanimously to add a standard-setting project to their technical agenda on accounting for specific digital assets. They also voted not to include commodities in the project, but the Chair will keep it on the research agenda in a paused status at this time.

The next step will include establishing the exact scope of the standard-setting project, including which digital assets will be included. However, the project does not appear to only be focused on improving disclosures, but instead will likely cover recognition, measurement, presentation and disclosure. The Board was not in favor at this stage of a fair value option, but instead advocated for a fuller set of deliberations and decisions that would establish a valuation approach applicable to all the digital assets within the scope of the project.

Lukka welcomes the Board’s decision to add this project to their agenda. We support the thoughts shared by Chair Rich Jones May 4th at the Baruch College 20th Annual Financial Reporting Conference that convey the importance of authoritative standards that do not stifle innovation. In his words, “our standards benefit from a robust, thorough, and transparent process that results in high-quality standards that provide crucial decision-useful information to investors and other allocators of capital. Our standards are developed in full sunlight with the active participation of our stakeholders.” A formal project on digital assets will benefit from all of these attributes. Capital market participants ultimately will benefit from relatively more relevant and decision-useful information than is often provided under current interpretations of the applicable authoritative standards.

Some select observations made by Board members as part of their vote included:

The outreach and research by the staff added to the Board’s understanding of the digital assets, markets and exchanges, such that the members had greater assurance that the project was both needed and feasible.

The standard of pervasiveness was met, as one member noted, by the pervasiveness of digital assets in the economy at large, even if not in the number of public company Balance Sheets at present.

Most FASB members preferred a recognition, measurement, presentation and disclosure project, as opposed to a disclosure only or disclosure first project.

While there is current authoritative guidance to rely upon, many members felt the current accounting did not accurately reflect the economics.

The ongoing role of ASC 820 was acknowledged, but there was some diversity of opinion on how or whether it might need to be modified for digital assets.

Defining the scope of the project would be a very important step and would need to be done carefully.

The FASB Chair closed with a comment on the importance of providing unbiased and transparent information through the accounting, and not only through disclosure. Lukka is committed to high-quality standard-setting and will readily support our customers’ compliance with US GAAP and SEC reporting requirements, regardless of the direction and timing of standard-setting that follows from this decision. We also will support standard-setters and the standard-setting process in whatever ways we can.

About Lukka

Crypto Actions, Part 1: Blockchain Migration and Hard Forks

Suzanne Morsfield on March 22, 2022

Author: Adam Katt and Olya Veramchuk

The term “corporate actions” is well known in traditional finance as an event by a public company that may affect the company’s securities and, consequently, its shareholders and bondholders. Examples include making a change to a company’s name, issuing a dividend, or even restructuring through a merger or bankruptcy. These transactions are familiar, have an established framework, and can be categorized and analyzed for different purposes, including taxation.

However, the crypto ecosystem has introduced completely novel event structures to this framework that are highly focused on decentralized technology itself and can occur faster or more unpredictably. It is difficult to fathom a publicly-traded company splintering off into over 100 distinct entities with competing goals, but we know in the digital world, Bitcoin birthed more than 100 hard-forked assets in the 2010s. The dynamic and unprecedented ways in which digital assets can change and transform have brought a huge challenge to market participants: how does one categorize, analyze and prioritize events like hard and soft forks, migrations, airdrops, burns… and the list goes on.

In addition, without a source of standardization, events as simple as ticker symbol changes may potentially create certain reporting issues for users. The lack of consistency in how changes are tracked can lead to materially inaccurate tax lot matching, where such lots are created across entities using different ticker symbols to represent the same asset or, alternatively, the same ticker symbol is utilized to represent different assets. This can make something as simple as applying a lot relief methodology challenging or not possible without first applying reference mapping data. Bitcoin fork history illustrates the nearly impossible task of tracking newly formed assets and their respective naming conventions.

Just as in traditional finance, some “crypto action” events (as we call them at Lukka) are more impactful than others. When looking specifically at assets – rather than entities in the crypto ecosystem – crypto actions can broadly be categorized as either a complete change to an asset’s structure or as a change to its characteristics. Understanding the type and degree of change is important in facilitating analysis of the relevant tax, accounting, and legal implications. Here is a look at some crypto actions and the tax consequences they prompt.

Asset and Blockchain Migrations

Overview

Migrations are a constant occurrence in the digital asset space and can have a variety of effects on the structure of an asset. Assets can migrate from contract to contract on the same protocol and also from one blockchain platform to another, or both. Migrations can occur for multiple reasons, including bringing new assets into an existing product ecosystem, expanding support to new protocols, upgrading asset functionality, or movement of an asset from testing environments to production.

An example that encompasses several of these scenarios is the migration that Project Hydro initiated last year. In this case, the project was looking to expand its reach and avoid high Ethereum gas fees by migrating HYDRO, its native token, to the BNB Chain. They also intended to respond to community feedback that the total supply was too large by reducing the supply and adding burn functionality to the asset smart contract. This was accomplished in two phases:

Old HYDRO ERC20 tokens in personal wallets were migrated directly for new HYDRO BEP20 tokens at a 100:1 ratio (a migration between two blockchains).
The remaining old ERC20 HYDRO tokens were swapped for new ERC20 HYDRO tokens at a 100:1 ratio on a per exchange basis (a migration between two contracts on Ethereum).

As a result, there were two new versions of the HYDRO asset on different blockchains, and users who had previously held 100 old tokens now only held 1. The Hydro Project stated that the old HYDRO tokens were now obsolete.

What this means from a tax perspective

Generally, under the US tax principles, a realization event would occur when two conditions are met: there is a sale or exchange of assets, and the asset received is materially different in kind or extent from the asset given up¹. Every instance should be reviewed on a standalone basis to determine whether there is a taxable event or not because the difference in the fact pattern may result in different tax treatments.

Consider moving an asset from the testing environment to production. It is unlikely that any assets are exchanged or there are any new features added. Consequently, it probably shouldn’t be treated as a taxable transaction. Similarly, enhancing existing assets with some new capabilities or improvements but not exchanging the original token iterations for the new and improved ones should not give rise to tax.

However, an asset swap with a migration to a new blockchain would likely yield a different result. The HYDRO migration example outlined above clearly shows that the original tokens were exchanged for the new tokens at the 100:1 ratio. Further, because the new tokens had new capabilities as compared to the original tokens, it is reasonable to suggest that they were materially different from the original tokens. Thus, both realization requirements were met, resulting in a taxable exchange for the token holders.

There are many other examples that are much grayer than the ones discussed. For instance, certain exchanges offer swapping ERC-20 versions of digital assets for the native ecosystem tokens (consider KuCoin facilitating the KAI swap). Note that this is slightly different from the so-called backdoor bridging offered by some centralized exchanges. There, the investors could deposit or buy tokens on one blockchain but withdraw them on a different blockchain. The key differentiator between a migration and a backdoor bridge is that a migration is an infrastructural change and not a permanent pathway designed to facilitate financial trading.

The views on taxation of such ERC-20/native tokens swap vary. Some tax practitioners believe it is unreasonable to treat such swaps as taxable trades because the investor retains the benefits and burdens of owning the asset, and thus there is no exchange for tax purposes. We have discussed this issue in detail in our earlier blog.

Other tax experts take a more literal view of the transaction and consider it an asset-for-asset exchange. Further, they look to the like-kind exchange guidance issued by the IRS last summer², where the IRS maintained that every blockchain was “fundamentally different from each other.” Consequently, if an asset migrates from one blockchain to another, then it would likely gain new capabilities and therefore be materially different, resulting in a taxable transaction. There is no formal guidance on the matter. Thus, taxpayers are encouraged to discuss any points of contention with their tax advisors.

Hard Forks

Overview

Hard forks are arguably the most (in)famous events in the blockchain ecosystem. There are many ways in which hard forks can be implemented. They generally involve a change to a single blockchain protocol that makes previous versions incompatible with that protocol going forward. Whether this revision is to implement new features or create an entirely new asset based on an old one, this new branch or “fork” of the blockchain protocol stems from the previous one.

Although it is often the case, both branches do not need to be “adopted” for an event to qualify as a hard fork. While many hard forks are the result of divergent views on protocol management in which the community must choose which branch to support, many are part of planned upgrades in a blockchain’s development.

Two very different examples of forking are the London hard fork on Ethereum and the Bitcoin Cash fork from Bitcoin.

In the case of the London fork, Ethereum was implementing a network functionality upgrade that resulted in a new set of rules for transaction validators going forward. While a new branch of the protocol was created from a technical point of view, the old branch was deprecated, and only one Ethereum persisted in the market.

The Bitcoin Cash fork from Bitcoin resulted from a disagreement between market participants on how the protocol should operate, thus giving birth to two completely separate assets. In 2017, holders of Bitcoin were credited with Bitcoin Cash when the fork occurred. Users of these crypto assets should consider these differences when analyzing their tax implications.

What this means from a tax perspective

Unlike many other issues in the digital asset space, tax treatment of hard forks was addressed by the IRS in the Revenue Ruling 2019-24, with some subsequent clarifications in the ILM 202114020 and FAQs on Virtual Currency Transactions.

The IRS defines a hard fork as an event that “occurs when a cryptocurrency on a distributed ledger undergoes a protocol change resulting in a permanent diversion from the legacy or existing distributed ledger” and which “may result in the creation of a new cryptocurrency on a new distributed ledger in addition to the legacy cryptocurrency on the legacy distributed ledger³.”

Consequently, it is important to distinguish between the events resulting in an airdrop of a new digital currency and those that do not.

Generally, when a hard fork is not followed by an airdrop of a new cryptocurrency, no taxable income should be recognized, and no reporting is needed. The Ethereum London hard fork discussed above is a great example of a non-contentious hard fork.

In contrast, contentious hard forks followed by an airdrop of the new cryptocurrency result in ordinary income recognition under the current guidance. The assets received should be reported at the fair market value, provided the recipients have dominion and control over such assets, i.e., can, exchange or otherwise transfer them. This is illustrated by the Bitcoin Cash hard fork discussed above.

To summarize, tax consequences and reporting requirements can vary quite significantly depending on the blockchain event. Therefore, taxpayers should always do the due diligence to understand what, if any, implications would apply.

Treas. Reg. Sec. 1.1001-1(a)
CCA 202124008
Revene Ruling 2019-24

About Lukka

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