While tax, appraisal, and legal considerations are all important for making effective and compliant contributions of Bitcoin (and other cryptocurrencies), the practical question remains – how does a donor move virtual currency from their ownership to a charity they support?
Many charities do not have the expertise on staff, which is understandable considering that cryptocurrency is still a new type of asset. Further, most charities have many questions: Can charities even own Bitcoin? What is the donation process? How does the charity convert the virtual currency to cash? What are the acknowledgement, compliance and substantiation requirements? Does the charity require the donor to provide personal information (name, address, Social Security Number, etc.) or other similar Know Your Customer protocols to guard against criminal or fraudulent activity?
To answer all these questions, let’s take a look at a hypothetical donation of virtual currency from the donor’s planning to the charity’s liquidation.
Step 1: “Philanthropic Phil” has decided to donate $50,000 of Bitcoin to a charity (recall substantiation thresholds of $5,000 in value). The charity may choose to collect donor personal information at this stage. Some virtual currency donors have shown a reluctance or simply refused to share this information.
Step 2: Phil consults with tax/legal advisor to determine the tax characterization of the holding—i.e., a short-term capital asset, a long-term capital asset, or an ordinary income asset. This classification will determine the charitable income tax deduction implications.
Step 3: “Philanthropic Phil” proceeds with donating Bitcoin to the charity through a processor, like BitPay to immediately convert the donation to cash, or to a “wallet” if they wish to hold the Bitcoin and sell it through an online exchange such as Bitstamp.
A virtual currency wallet allows access, by use of a privately held key, to virtual currency either through an online platform, a software program (a “hot” wallet), or even offline hardware (a “cold” wallet). The potential problem is that anyone who has the private key to the wallet can access the wallet – and the Bitcoin it holds.
A processor, on the other hand, handles virtual currency transactions for businesses and charities, and will also convert virtual currency to legal tender. This is likely the best and most cost-effective option for charities that wish to accept virtual currencies. Alternatively, the charity could refer its donor to a donor advised fund that accepts virtual currencies. The DAF would then sell the cryptocurrency, and then the donor could recommend a grant of cash to the charity.
If the donor prefers to transfer from a personal wallet to the charity’s wallet, it would be wise to have the donor complete a test transfer first. Since cryptocurrency can be transferred in very small fractions, a test transfer is a low risk way to verify that all information is correct. The donor can collect the public address (via secure communication), make the transfer, and have the charity confirm receipt. Then, the main donation can be completed.
Convert it Quickly
Similar to receiving publicly traded securities, most Bitcoin gift acceptance policies should encourage automatic conversion because of price volatility. At its highest in early December 2017, the market value of Bitcoin approached $20,000. By comparison, January 2015, the market priced it at only $220, and in April 2016 was around $420. Since that late 2017 peak, it has even gone as low as $3,400. Many payment processors can provide immediate liquidation automatically, and will directly deposit the value of the Bitcoin in the charity’s bank account.
If the charity cannot use a processor, it will have to go through a virtual currency exchange (essentially an online trading platform that works similar to an online stock brokerage platform) to sell the donated Bitcoin in exchange for legal tender, which can be a complicated process. Many exchanges have extensive signup and verification requirements in order to trade and withdraw meaningful amounts of cash, if they allow nonprofits to create accounts at all. If the charity is receiving cryptocurrency other than Bitcoin, it should verify that it will be able to quickly liquidate that specific currency using the exchange. This can be a major impediment to accepting these so-called “altcoins.” If the coins do not have a significant trading volume, it could take days, weeks, or even months to liquidate. An over-the-counter desk (which many exchanges offer) may be of use. Additionally, the longer the charity holds the virtual currency, the greater the risk of losing the coins. As discussed below, lost or stolen cryptocurrency is rarely retrieved.
Nonprofits may receive proposals for donations more frequently, or donations of larger amounts, or even proposed gifts of virtual currencies other than Bitcoin. Charities should discuss exchanges, wallets, and security measures in light of their organization’s expertise, capacity and risk tolerance.
Virtual Currency Exchange Issues to Take into Consideration:
- What is the process, information requirements and timeline to open an account?
- Does the exchange allow charities to trade on their platforms?
- Does the exchange trade the virtual currencies the charity will receive as donations?
- Does the exchange allow US-based customers and withdrawals of USD (many large Asia-based exchanges do not)?
- Can the charity quickly sell through the donated cryptocurrency and withdraw the USD received in exchange or are there limits?
- If the virtual currency will take more than a short period of time to sell, is the charity comfortable keeping it in the charity’s account on the exchange?
The last question is important for security purposes. The charity may not want to keep the donated virtual currency on the exchange, given that exchanges are frequently the target of hackers. In that case, the charity will need to keep the virtual currency in a wallet. Prior to accepting gifts of virtual currency, nonprofits should carefully research which solution, if any, will meet their needs. Unfortunately, there have been reports of virtual currency fraud, both phishing and hacking, where the charity was a victim.
Securing unsold virtual currency is extremely important, since theft or other loss cannot be undone, due to the nature of blockchain transactions. Two factor authentication, complex passwords, and separation of duties all merit consideration. Nonprofits would be wise to investigate whether a cold wallet is a good solution to securely hold the virtual currency. Due diligence and research are essential advance tasks if a nonprofit is considering accepting gifts of Bitcoin or other virtual currency.
Processing Questions to Ponder:
Each charity, of course, must weigh the convenience (nonprofits can accept Bitcoin from any source worldwide), set-up process, and the legal and tax considerations to determine whether it wishes to receive virtual currency directly or whether they wish to use a third-party charity like a donor advised fund. If properly planned, a donation of Bitcoin or other cryptocurrency can be extremely easy and worthwhile for the donor and charity alike.