Introduction

The popularity of digital assets has grown exponentially over the last decade. Unsurprisingly, the value of many cryptocurrencies has followed suit, gaining enormous market capitalization over a relatively short period of time. What was once a fringe asset owned by relatively few tech-savvy investors has quickly become a commonplace investment, particularly for a new generation of taxpayers.

Part I of this series discussed the history and IRS tax treatment of cryptocurrency. Part II covered the various planned giving methods that may be well-suited to donations of digital assets. This article, Part III, will discuss the practical considerations for nonprofits considering receiving digital assets.

Practical Considerations

There are important considerations for nonprofits to take into account when determining whether to accept cryptocurrency donations. One is the gift's risk to the nonprofit. Another is the organization's ability and willingness to take on the asset. Any nonprofit organization considering accepting gifts of cryptocurrency must do its due diligence to determine whether it can handle the risks involved. The organization should implement a thorough gift acceptance policy that covers the types of digital assets that it will accept and place boundaries around which types of planned gifts involving cryptocurrency are acceptable.

Gift Acceptance Policies

Charitable organizations may accept donations of a variety of assets. Oftentimes, however, the question that needs to be asked is not whether a nonprofit may accept a certain type of asset, but whether it should accept the asset. Gift acceptance policies help protect organizations from receiving assets that may cause trouble down the road. Nonprofits commonly have policies in place stating which types of gifts may or may not be accepted, addressing who must approve certain types of gifts and setting the parameters for acceptance of certain types of gifts.

The way digital assets are included in the gift acceptance policy will look different across a variety of nonprofits. One organization might choose to accept any and all types of digital assets while another might choose not to accept any. The likely more common result is that many organizations will choose to accept digital assets under very specific conditions.

Regardless of whether the organization chooses to accept donations of digital assets, it is important to include that decision in the organization's written gift acceptance policy. The gift acceptance policy helps to ensure that everyone involved in fundraising at the organization is on the same page when it comes to accepting these types of property. Without a written policy, there is a much greater likelihood of confusion and miscommunication among fundraisers. To avoid surprises related to acceptance of extremely volatile or hard to dispose of digital assets, it is essential to write out the organization's policy regarding what types of assets will be accepted, what conditions need to be met in order to accept the asset and whether special approval is required prior to accepting the asset.

As discussed in Part I of this series, there are a variety of digital assets that rely on the blockchain. Cryptocurrency is the main player here, but nonfungible tokens (NFTs) have gained traction among investors as well. As technology continues to develop, it is likely that new assets will emerge and new utility for the current set of digital assets will appear. Given the speed with which technological innovations evolve, it is important for nonprofits to reevaluate their gift acceptance policies on a regular basis to ensure that their policies match the current state of the digital asset field.

In addition to the current crop of major cryptocurrencies such as Bitcoin, Litecoin and Ethereum, new cryptos are gaining traction. Dogecoin, which started as a joke, skyrocketed in value in early 2021. The Chia Network also emerged in 2021 using an alternative method of coin creation. Chia is farmed using "proofs of space and time," whereas Bitcoin is mined using "proof of work." While the technical details of these competing processes are beyond the scope of this article, it is important to understand the general difference between the two. Bitcoin is mined using computations. This proof of work model typically consumes large amounts of energy. Chia's proofs of space and time model, on the other hand, relies on hard drive capacity rather than computational power. The creators of Chia assert that this model will consume far less energy than other cryptocurrencies, such as Bitcoin.

New cryptocurrencies like Chia often generate a lot of interest among younger investors. However, nonprofits should be aware of the potential issues related to accepting relatively new cryptocurrencies. A cryptocurrency that has not yet been widely adopted may be more volatile than some of the more well-established ones. Additionally, the major cryptocurrency exchanges, especially those based in the U.S., may not yet support the cryptocurrency. The nonprofit will need to evaluate whether any new cryptocurrency is sufficiently mainstream prior to including it in a category of digital assets that it will accept. The cryptocurrency will be a readily liquidated asset if it is on a major cryptocurrency exchange.

The nonprofit may choose to freely accept all cryptocurrencies supported by one specific trading platform. This helps to ensure that the organization will be able to quickly and easily sell the asset upon receipt, without the need to create accounts on each existing exchange. The nonprofit might decide that acceptance of other cryptocurrencies is either not permitted or is subject to the approval of a committee or senior executive.

The organization may also decide to accept outright gifts of cryptocurrency and either reject or require approval of donations to fund life income gifts. Many organizations impose limits on the types of assets that will fund charitable gift annuities (CGAs) and charitable remainder trusts (CRTs). Nonprofits that offer CGAs are often cautious about accepting real property to fund the CGA. This is due to the fact that it may be difficult to sell the real property prior to the first payout date. The value of the property could change dramatically between the date it is received and the date it is sold. While cryptocurrency may be sold much more quickly than real property, the cryptocurrency market is much more volatile than the real estate market. A donation of $50,000 worth of cryptocurrency might be sold the next day for $25,000. Therefore, it is incumbent upon the organization to assess the potential risks and plan accordingly.

One strategy for mitigating the risk in this situation would be for the nonprofit to require that the donor serve as the initial trustee of the CRT until the property is sold. Once the property is sold, the nonprofit may take over as trustee. The nonprofit will then reinvest the sales proceeds according to the prudent investor standards governing the trust. Therefore, the nonprofit has no risk related to trust investments until after the highly-volatile assets are sold.

Another decision the nonprofit must make is who will provide special authorization prior to accepting certain gifts of digital assets. If special authorization is required, the organization will need to designate an officer or committee to authorize the acceptance. This will depend on the organization's structure.

Example Gift Acceptance Policy

GIFTS OF DIGITAL ASSETS

The organization may accept gifts of certain digital assets, including but not limited to, blockchain-based assets such as virtual currency, cryptocurrency or nonfungible tokens.

Approval

Gifts of digital assets, whether outright gifts, donor advised fund gifts, gifts to fund charitable gift annuities and gifts made to the organization as trustee of a charitable trust must be approved by [the President/an executive officer/the gift acceptance committee].

[or]

Approved Digital Assets

Gifts of the following cryptocurrency assets are approved for acceptance by the organization: Bitcoin, Bitcoin Cash, Ethereum, Litecoin, Ripple and Dogecoin. All other gifts of digital assets must be approved by [the President/an executive officer/the gift acceptance committee].

Receipt of Digital Assets

The organization holds a digital wallet with [X platform]. The [President/Chief Development Officer/Director of Gift Planning] must approve acceptance of the gift and facilitate the transfer process.

Disposal of Donated Property

The organization shall sell all digital assets received as outright gifts or gifts to fund donor advised funds or charitable gift annuities as soon as possible. It is the best practice for the organization to sell all digital assets received as trustee of a charitable remainder trust as soon as possible. However, the trustee may choose to hold a percentage of the original funding asset so long as the trustee's actions are consistent with the principles of the prudent investor standard.

[or]

Initial Trustee of Charitable Remainder Trusts

The organization shall not agree to serve as the initial trustee of a charitable remainder trust funded with digital assets such as cryptocurrency. The organization may agree to serve as successor trustee of a charitable remainder trust funded with digital assets. The initial trustee of the charitable remainder trust may be the donor or a third party. The organization may assume the role of trustee only after the initial funding asset is sold by the initial trustee.

How to Receive Cryptocurrency

When a donor is considering transferring cryptocurrency to a nonprofit, it may catch the nonprofit off guard. The nonprofit will often need some guidance to understand what exactly it is receiving and how to take possession of it. The organization will need to quickly figure out what steps must be taken in order to receive the assets.

The first step, as mentioned above is determining what type of cryptocurrency is being transferred and whether the asset is supported by a reputable cryptocurrency exchange. Popular platforms such as Coinbase and Binance each accept a variety of cryptocurrencies. Regardless of whether the nonprofit actually decides to use one of these platforms, it can be helpful to find out whether these platforms support the particular cryptocurrency that the donor is considering transferring. If the cryptocurrency is not supported by one of the major platforms, the nonprofit will need to investigate further to decide whether the risk of accepting this particular cryptocurrency is worth it for the organization.

The second step is determining what method to use to accept the transfer. This may take several forms. The several major cryptocurrency exchanges typically allow users to buy, sell and transfer cryptocurrency on their platforms. The nonprofit may choose instead to have a standalone cryptocurrency wallet. The wallets themselves may take several forms. The two major forms of cryptocurrency wallets are "hot wallets" and "cold storage."

Hot wallets store vital cryptocurrency information online. This allows for ease of access and ease of use. Due to the fact that hot wallets are stored online, they are more vulnerable to cybersecurity issues. There are many hot wallet options available, including those offered by the major exchanges. The wallets are usually available for download onto the user's computer or mobile device.

The user may instead consider using a cold storage method. With cold storage, the cryptocurrency's information is stored on a device that is not connected to the internet. In order to send or receive any cryptocurrency, the owner of the cold storage device must connect it to a computer or mobile device with an internet connection, log in to the device and initiate the transfer. While this method of storage is more secure than a hot wallet, it does have a potential downside. If the cold storage device is misplaced or stolen, the cryptocurrency it holds may be irretrievably lost. Most of the time, nonprofits will choose to sell the cryptocurrency immediately after receiving it in order to minimize risk of lost value. Therefore, it is unlikely the nonprofit will need a long-term, secure cold storage option.

In addition to receiving the cryptocurrency directly from the donor, the nonprofit might instead prefer to use a third-party service to facilitate the transfer of cryptocurrency. Such services provide a digital platform through which a donor may quickly and easily enter the information necessary to initiate the transfer. These platforms typically have a feature that allows the nonprofit to choose whether to automatically exchange the cryptocurrency for cash or to allow the nonprofit to manually sell some or all of the donated cryptocurrency. As with the various exchanges, these platforms only support a limited number of cryptocurrencies. Therefore, it is essential that the nonprofit verify whether the third-party service is compatible with the cryptocurrency the donor wishes to donate.

It is important to understand not only the platforms and services that the nonprofit uses to receive the cryptocurrency, but also the platform used by the donor. The nonprofit should ask the donor for this information in advance of the attempted transfer to ensure a smooth transaction. If the donor holds the cryptocurrency through a retail investment platform, the transfer may not be possible. Robinhood, for example, states on its website that it does not allow a user to withdraw cryptocurrency or transfer it to an external wallet. This effectively prevents Robinhood's investors from being able to use those assets for charitable donations. Anyone who holds cryptocurrency on the platform and wishes to donate it must sell the asset, withdraw the cash proceeds and donate the cash to a nonprofit. The donor does not bypass capital gains taxation using this method.

Conclusion

Cryptocurrency can be an exciting yet intimidating new type of asset. It may be tempting for nonprofit leaders to either dismiss these digital assets as a passing fad or become overly enthusiastic about their potential for growth. Nonprofits should take a level-headed approach, seeking to learn about cryptocurrency's pros and cons and incorporating that understanding in their gift acceptance policies. Cryptocurrency can be an excellent source of charitable donations, allowing donors to take substantial charitable income tax deductions and providing nonprofits with significant value. By setting the appropriate boundaries around the receipt of cryptocurrency gifts, nonprofits can minimize the risks of accepting volatile assets while also opening the door to a new source of funding.

Editor's Note: Part I of this series discussed the valuation requirements for charitable donations of cryptocurrency. Currently, IRS rules include cryptocurrency in the requirement for qualified appraisals for gifts of noncash assets in excess of $5,000. In other transactions involving cryptocurrency, the IRS accepts reference to the exchange rate for cryptocurrency as the fair market value on the date of the transaction. On June 10, 2021, Representative Tom Emmer (R-MN), along with other six members of Congress, sent a letter to the IRS urging the elimination of the appraisal requirement for cryptocurrency gifts to nonprofits. Nevertheless, this requirement currently remains in place. Donors should consult with their professional advisors to determine the appropriate valuation method for their cryptocurrency gifts.