Cryptoassets like bitcoin might still drive headlines, but the broader digital asset space has continued to rapidly develop, expand, and create new questions for accounting professionals to answer. There is a new form of digital asset that instructors and students should be discussing: nonfungible tokens (NFTs). This is an area that is of interest to younger people, students included; Millennial and Gen Z investors are among the most likely to buy and trade digital assets of all kinds.
Digital asset and blockchain-based applications have been developed by many large accounting firms, and this trend does not seem to be abating. Students are aware of the headlines and understand that crypto and blockchain will have a fundamental impact on their professional careers.
A growing trend
Just what exactly are NFTs? The following definition from the Wall Street Blockchain Alliance (WSBA) and CPA.com joint publication Non-Fungible Tokens: An NFT Primer for Accounting Professionals works well in this context. It defines an NFT as "a unique, differentiated and noninterchangeable digital asset directly connected to either a virtual or tangible asset, with ownership secured by an immutable blockchain record." In essence, what an NFT provides to creators, investors, and holders of these instruments is an immutable and traceable record of ownership over either digital assets or physical assets.
The implications of NFTs go far beyond the speculation around crypto artwork that has continued to dominate the conversation to date. A few of the applications of NFTs that are beginning to be explored include health care records, real estate transactions, intellectual property monetization, academic credentials, the gaming industry, authenticating records (including in the vaccine and pharmaceutical space), and even reducing the prevalence of counterfeits in certain industries. For instance, there are some jurisdictions that are in the process of adopting NFT-based vaccine passport records.
Examples of organizations using NFTs include, but are not limited to, Taco Bell, Coca-Cola, Nike, the NBA, Robert Mondavi, Adidas, AMC, McDonald's, Ray-Ban, and even the Coachella Valley Music & Arts Festival. While the specifics of these projects will vary, and while NFTs certainly do not represent a material nor majority of revenues at these organizations, the trend is undeniable. Crypto at large and NFTs in particular are being experimented with at organizations throughout the entire U.S. economy.
Possible accounting implications of NFTs
NFTs have numerous accounting implications that would be interesting for instructors to address in courses. The following items should not be considered an exhaustive listing, but rather topic areas that can be refined and tweaked as a course requires.
Valuation: NFTs represent unique and differentiated digital assets that are connected to external assets. Crypto valuation is already an area that can be challenging for practitioners, but students should realize that NFTs can complicate these conversations even further. For example, the valuation of an NFT can be different at different stages in its life cycle (i.e., whether it is being originated, traded, or held).
Taxes: Since NFT trading and investing has become increasingly popular, and easy to do via mobile applications (including Coinbase, the largest U.S. crypto exchange), taxation is not simply a theoretical concern. Crypto taxation is an area that almost uniformly creates headaches for practitioners seeking to offer advice around it, and NFTs are only making these ongoing conversations more complex. The tax assessment and planning process can — and often does — differ depending on what aspect of the NFT process is being examined. For example, the same NFT can create ordinary income obligations, capital gain obligations, or even an obligation at the collectibles tax rate. The tax implications of NFTs is a topic that can — in a direct and logical way — be brought into existing courses.
Risks and internal controls: An issue that can go overlooked in the accounting classroom is the importance of discussing risk management and internal controls. Digital assets in general tend to raise the risk profile and risks connected to operations at organizations seeking to implement them, and NFTs are no exception to this rule.
Several specific characteristics of NFTs can amplify these risks. Since NFTs are connected to an underlying asset — either virtual or physical in nature — other considerations need to be discussed. These include, but are not limited to, the question of who has custody over the underlying asset. The crypto-physical connection can introduce counterparty risk, insurance considerations, and systemic concerns that had not previously existed. For example, NFTs can cause several decentralized exchanges (and counterparties) to be linked together, which will also create a need for more consistent reporting standards.
Other topics faculty can use in the classroom include cybersecurity around the NFT (the token) itself; verifying the connection to the underlying asset; and how crypto volatility can change how these assets are reported on an organization's external financial statements.
Faculty can examine the characteristics of successful NFTs from both a financial and operational perspective. This can include discussions around how the NFTs are coded, marketed, and operated, as well as the connection these NFTs have with underlying businesses. Especially since information related to NFTs is beginning to appear in public reports and filings — which are in turn guided by U.S. GAAP — students and practitioners would be well advised to watch the pace at which the adoption of NFTs accelerates.
Which courses are a good fit?
NFTs could be a good topic to integrate into the following courses:
- Audit: Even relatively straightforward audit assertions such as valuation, completeness, and accuracy are complicated by the very nature of NFTs. Since a large percentage of NFTs are issued and governed by decentralized exchanges this can make obtaining accurate records and data even more complicated. Audit procedures will need to evolve to address this, and students need to be made aware of these changes.
- Tax: Tax issues around digital assets have only become more complicated during the last several years, and NFTs are ranked among the most complicated instruments to correctly advise clients or colleagues about. For example, depending on the ownership record and provenance of the assets in question, the tax rates assessed on NFTs can vary from ordinary income, to capital gains, to being assessed at the marginally higher collectibles tax rate.
- Financial accounting or finance courses at both the undergraduate and graduate levels: Specifically, financial markets courses could examine the market structures underpinning NFTs; decentralized markets and lower liquidity (when compared to debt or equity) can create distortions that professionals need to be prepared to address. From an accounting perspective this also creates a situation in which the consistency and standardization of reporting can become a material issue.
NFTs are a rapidly developing aspect of the digital asset landscape, and it makes sense that accounting instructors would be interested in incorporating this topic into courses. By learning more about this emerging technology, motivated and proactive faculty members will reap the benefits for their students, their institutions, and their own professional development.
— Sean Stein Smith, CPA, CGMA, DBA, is an assistant professor at Lehman College in New York City. To comment on this article or to suggest an idea for another article, contact Courtney Vien at Courtney.Vien@aicpa-cima.com.