How to Classify Crypto Assets

By Elfi Sixt on ALTCOIN MAGAZINE

Elfi Sixt

Published in

The Capital

10 min readNov 28, 2018

In classifying crypto assets — Tokens — for tax and accounting purposes the following aspects have to be allowed for:

a) the economic substance of the relationship between any Token Issuer and the Token Holder.

b) the nature of the digital asset by identifying the rights associated with the particular crypto asset.

The distinction between centralized and decentralized business ecosystems (networks)

The economic relationship between the Token Issuer (if identifiable) and the Token Holder is relevant for the distinction between centralized and decentralized business ecosystems[1]:

If one of the seven points is fulfilled, a centralized network is established:

If there is a Token Seller or a group who plays a significant role in the development and maintenance of the asset and its potential increase in value.
If this person or group retained a stake or other interest in the digital asset such that it would be motivated to expend efforts to cause an increase in value in the digital asset.
If the promoter raised an amount of funds in excess of what may be needed to establish a functional network, and, if the promoter has already indicated that those funds or funds from the operations may be used to support the value of the Tokens or to increase the value of the enterprise.
If the Instrument is marketed and sold to the general public instead of to potential users of the network at a price that does not reasonably correlates with the market value of the good or service in the network.
If there is a person or an entity, others that are relying on that plays a key role in the profit-making of the enterprise such that disclosure of their activities and plans would be important to investors.
If informational asymmetries exist between the promoters and potential purchasers/investors in the digital asset?
Do persons or entities other than the Token Seller exercise governance rights or meaningful influence?

Only in case no Project Owner/Token Issuer can be identified according to the above given list a decentralized business network empowered by a crypto asset/Token is established.

Add-on: Real Asset Tokens also termed as Asset Backed Tokens are digital assets backed by physical assets[2]. So such equity Token could just be the digital representation of the stock of a corporation or a debt Token represents the debt investment in a centralized organization.

Centralized network Tokens

The main feature of all Tokens useable within a centralized network (business ecosystem) is the right to be used resp. to access the network exclusively in this business ecosphere established and controlled by the Token Issuer. Very often the establishment of such networks is funded by selling crypto assets upfront during a Token Sale.

Very often these Access Tokens show additional rights and functionalities which cause them to be classified differently for legal and economic purposes:

Please be aware that most of the Access Tokens are used as means of exchange within the centralized business ecosystems:

Tokens within a centralized network can be summarized as follows:

Security Tokens

When crypto assets grant the right to participate in a centralized network and in addition show features comparable to an ownership stake in an entity like voting rights and rights for a profit sharing of the Token-issuing entity, or any other interest in the success of a future such Tokens qualify legally and economically as Security Tokens[3].

Depending on the exact legal structure of the specific Token agreements such Tokens can represent equity or debt instruments.

Tokens which neither qualify as debt or equity but entitle the holder to a percentage of the gross revenues from the company are also called Revenue Tokens (also profit participation Tokens) for regulatory purposes also qualify as Security Token.

If rights like profit participation, repayment of the money, a share in liquidation proceeds and so on are granted, there is always a responsible project owner and therefore a centralized application.

It is irrelevant whether the Token Sale takes place before or after the establishment of an application, the Tokens always qualify as Security Tokens.

Consumer Tokens

In addition to grant access some crypto assets sold to provide the owner of the Tokens with a functional benefit in a network. Within this network such Tokens can have different additional rights e.g.:

A right to enable the user to contribute to a value-adding action for the network or market that is being built.
the holding of the Token results in a monetizable reward based on an action by the user (active work)
the Token grants the user a value based on sharing or disclosing some data about them (passive work)
the Token Holder is entitled to sell something as part of the business model
the Token entitles the holder to create a new product or service?
The Token enables the Token-holder to run a smart contract or to fund an oracle? (an oracle is a source of information or data that other a smart contract can use)[4]

Such consumer Tokens including those Tokens which solely grant the right to actively participate in an application with/or without the Token also serving as means of exchange are also referred to as Utility Tokens[5] for legal purposes

For accounting and tax purposes consumer Tokens must be further distinguished:

Voucher Tokens to be redeemed with the Token Issuer

If any Token Sale agreement conveys the right for the Token Holder to request — in addition to the right to participate in the business economy — the delivery of goods or services in exchange for the Token (the digital instrument) (with either the goods or services to be supplied or the identities of the potential suppliers being specified in the terms and conditions of the Token[6] (smart contract)), the Tokens qualify as Voucher Tokens. Such Voucher Tokens are supposed to be redeemed finally with the Token Issuer.

If such a right for the delivery of goods or services in exchange for the Tokens are granted, there is always a responsible project owner and therefore a centralized network. Only in centralized apps/networks there are Voucher Tokens in which the Token Holder has the right to exchange the crypto assets for services or products offered by the Token Issuer.

In case it is a genuine voucher Token meaning the main focus of the Token Holder is to consume the goods or the services to be delivered, it is irrelevant whether the Token Sale is done before or after the establishment of the application.

Also, the right to participate in a to be established network represents the purchase of the right to a service and qualifies as a Voucher Token[7] in case of a pre-sale.

A presale of a utility Token could be qualified as a pre-sale of services (the right to participate) comparable to a pre-sale of a Voucher Token. The application of blockchain concepts and cryptographic technologies in these reward-based crowdfunding campaigns results in the issuance of Tokens representing a digital and tradable form of the right of the Token Holder.

Very often such pre-sale Token agreements provide for a preliminary ECR20 Token which will be exchanged for the specific network Token, after the future blockchain protocol resp. the decentralized network is finished (comparable to the US SAFT agreements).

Cryptocurrencies/Payment Tokens

Only if in a centralized network in addition to the Tokens issued by the Token Issuer also other Tokens or legal currencies can be used to pay for the services and goods delivered within the established app/network, they qualify as Payment Token (also termed cryptocurrency). Tokens in a centralized application (i.e. an identified issuer…) can be understood as special means of payment in that they are accepted as means of payment in a certain environment (“ecosphere”).

In case crypto assets with the sole purpose to be used as cryptocurrency on a specific centralized platform/application have to be bought upfront the crypto assets and if these Tokens are exclusively accepted as the means of payment between users or also between the network operator and users these Tokens are to be qualified as Access Tokens.

Decentralized Network Tokens

If no one of the seven points stated above is fulfilled, no central issuer can be identified.

Tokens which are mined/or otherwise generated by smart contracts/ in a decentralized network can never qualify as Access Tokens.

Also Tokens within a decentralized network can never qualify as Security Tokens as no central entity promising profits,

Work Tokens within a decentralized business ecosphere can provide the owner of the Tokens with a functional benefit in a blockchain-based network (organized by smart contracts). Within this network such Tokens can have the same rights as Consumer Tokens within a centralized business ecosphere e.g.:

A right to enable the user to contribute to a value-adding action for the network or market that is being built.
the holding of the Token results in a monetizable reward based on an action by the user (active work)
the Token grants the user a value based on sharing or disclosing some data about them (passive work)
the Token Holder is entitled to sell something as part of the business model
the Token entitles the holder to create a new product or service?
The Token enables the Token-holder to run a smart contract or to fund an oracle? (an oracle is a source of information or data that other a smart contract can use)[8]

As there is no central party promising to accept the Tokens in exchange for rights (access rights), goods and services to be delivered, Consumer Tokens within a decentralized network never qualify as Voucher ‘Tokens (as defined for tax and accounting purposes).

Very often Tokens in a decentralized network qualify as Cryptocurrencies like Monero, ZCash, Bitcoin, .. are Tokens which are accepted exclusively as a means of payment for transactions between users or and also between the network operator and users. Such payment Tokens also very often referred to as Coins are mined in a decentralized network.

Change from centralized networks to decentralized networks

Please be aware that governance structures can change over the lifetime of networks, so centralized networks can reclassify to decentralized networks if the central authority vanishes. Accordingly, Tokens change their economic functionality over their lifespan and thus may be re-classified[9]:

Please be also aware that they know that the delimitation between centralized and decentralized networks is very often not that easy as described in this paper. Especially regarding governance and voting of the future development resp. BIP it is sometimes quite tricky to differentiate between a centralized and a decentralized network — as a rule of thumb, we propose that in any case if there is one decisive decision maker the network qualifies as a centralized network.

[1] https://www.sec.gov/news/speech/speech-hinman-061418#_ftnref11

[2] https://midlifecroesus.com/2018/02/what-is-an-asset-backed-Token/

1) [3] “Investment/Security Tokens”: comparable to conventional securities pursuant to Article 4 (1) №44 of Directive 2014/65/EU (“MiFID II”), in particular, conventional debt instruments and equity instruments. This category includes Tokens that represent assets. Such Tokens can in particular represent a debt or equity claim on the issuer. They promise, for example, a share in future company earnings or future capital flows. In terms of economic function, these Tokens ae therefore analogous to equities, bonds, or derivative financial instruments.

[4] Pls refer to https://medium.com/@wmougayar/Tokenomics-a-business-guide-to-Token-usage-utility-and-value-b19242053416 for a much more comprehensive lists of possible Utility Tokens

[5] Utility Tokens” means on the one hand Tokens designed to provide the holders of the Tokens with functional benefits in the form of access to a decentralized ecosystems to be build. These Tokens can have special rights, such as: (i) a right of access to a (future) service / product (once developed); (ii) a right to redeem the Token against a utility Token or service / product; (iii) voting rights often intended to affect the functionality of the service or product.

[6] Pls be aware if neither the range of services to be provided nor the iden

tities of the potential customers, the Token does not qualify as voucher but constitutes a means of exchange.

[7] Voucher Tokens grant the right to a service resp. a delivery from the Token Issuer.

[8] Pls refer to https://medium.com/@wmougayar/Tokenomics-a-business-guide-to-Token-usage-utility-and-value-b19242053416 for a much more comprehensive lists of possible Utility Tokens

[9] They could, for example, start as security Token deployed by an issuer to raise funds to develop a project or platform. Once the platform is established and functional, the Token then could become a utility Token for using services on the platform. Filecoin with its SAFT (Simple Agreement for a Future Token) may be a case in point for this scenario.