The evolving cryptocurrency token landscape presents challenges for financial professionals

The Securities and Exchange Commission considers some cryptocurrencies as securities and broadly regulates them, while the IRS categorizes cryptocurrency as property.

The evolving cryptocurrency token landscape presents challenges for financial professionals, tax advisers, and lawyers, as they may not be fully aware of how to analyze and report the value of private tokens.

The Securities and Exchange Commission considers some cryptocurrencies as securities and broadly regulates them, while the Internal Revenue Service categorizes cryptocurrency as property. So it’s crucial to understand the drivers behind cryptocurrencies to accurately report private tokens on the tax returns of individuals and companies. It also can benefit token-issuing companies to understand these valuation drivers to report token values on their books and tax returns.

Cryptocurrency regulations are changing, and new rules might be forthcoming. For instance, SEC Acting Chair Mark T. Uyeda launched a crypto task force dedicated to developing a comprehensive and clear regulatory framework for crypto assets. The drivers affecting token valuation remain broadly the same, and understanding them can help companies and individuals comply with and navigate the changing regulations.

Private tokens aren’t listed and don’t have a readily available price on exchanges. Companies can use these tokens to raise capital, pay for services, or compensate employees. Companies often issue tokens through crowdfunding on their website or through direct private sales to investors. Eventually, companies can opt for an initial coin offering to collect funds.

Valuing tokens is challenging compared with stocks because tokens mostly don’t generate revenue, profits, or cash flows akin to company shares. However, the principles of private company valuations can apply to token valuations, considering their limitations and differences from stock.

Here are some key drivers that can be useful in valuing private tokens:

* **Underlying asset.** Tokens might be backed by real-world assets such as gold (for instance, PAX Gold). In such cases, the factors that affect the underlying asset might affect the token as well. If future cash flows to the token holder can be estimated, the value of the token can be determined as the sum of present value of these cash flows. The risk and volatility of these cash flows can affect the value of the token.

* **Market price of other similar listed tokens.** Tokens issued either in the same period or for the same purpose can indicate value. These market prices might need adjustments due to the marketability of listed and private tokens. This difference can be quantified as a marketability discount. Tokens with higher trading volume and less price volatility might be more reliable compared with tokens with less trading volume and high volatility.

* **Price paid by investors for the token in a private sale.** Companies often issue tokens through crowdfunding, and these prices might be available on the issuing company’s website. Both the price paid for the token being valued and its comparable tokens can be a value driver. The volume of these tokens in a private sale is a key factor along with the price. Higher volume can indicate that the selling price of the token is in line with investor expectations.

* **Cost to create, develop, market, and launch the token.** The actual cost incurred from ideation to selling these tokens might indicate value. If these costs are higher, they can form a barrier for other companies to launch similar tokens.

* **Outlook of the tokens.** Companies might have additional funding requirements, in the absence of which, the company might shut down and the token can be worthless. The tokens’ value might be affected by this additional risk of raising future capital.

Broader macroeconomic factors such as economic growth, political environment, overall market sentiments about cryptocurrencies, cryptocurrency trends, technological innovations, policies, and taxes can further drive token values.

Recognizing these key drivers of tokens might help in estimating token value. As the regulatory environment changes, many more companies can join the bandwagon and issue tokens, making understanding of token valuation more critical.

While not an exhaustive list, the presence of a token’s underlying asset and its value, the market price of similar tokens, the selling price of the token in a private sale and the volume sold, and the developing and marketing costs of tokens are all factors companies should keep in mind when determining valuation.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Meenal Aggarwal is founder of Groots Valuation in New Jersey. She specializes in providing valuation services for financial reporting, tax reporting, and litigation matters.