Shortly before the FY 2017 tax filing deadline, Ripple contributed approximately $29 million worth of its XRP to DonorsChoose, a 501(c)(3) nonprofit organization. Depending on how the Internal Revenue Service approaches XRP, Ripple – the effective creator and steward of the tokens – could be eligible for a large tax deduction, though the implications of such a deduction are concerning.
The Good Press
A few weeks ago, “Late Show” host Stephen Colbert recognized Ripple for gifting approximately $29 million worth of XRP (the native currency of the Ripple Ledger) to DonorsChoose, a New York-based nonprofit organization that facilitates donations to public school classroom projects. In one fell swoop, Ripple fulfilled more than 35,600 project requests, and thereby ensured that thousands of teachers across the country had the supplies they needed for their students. According to the New York Times, Ripple’s XRP donation was “by far the largest ever received by the charity.”
Now that the fairytale dust has settled and the taxman cometh, I found myself wondering whether Ripple could claim a tax deduction for its charitable contribution. After all, charitable contributions made in bitcoin are tax-deductible. Could it be the same for XRP?
ETHNews reached out to Ripple to ask whether the company plans on making a tax deduction for its XRP charitable contribution. Unfortunately, despite repeated requests for comment and numerous attempts to reach executives, the company did not reply.
ETHNews did hear from Chris Pearsall, vice president of brand and communications for DonorsChoose, who shed some light on the large XRP donation. He explained that over a two-week stretch prior to the announcement on March 27, DonorsChoose converted the XRP donation to US dollars “through both the Bitstamp exchange and direct sales to a few buyers.” Pearsall called the process “relatively easy,” but said that it “took time to avoid having an effect on the market.”
The XRP price on Bitstamp actually did decline pretty significantly during the two-week liquidation period, dropping from approximately $0.74 per XRP to a shade under $0.58 per XRP, a 21.8 percent decrease. To be fair, the price of XRP declined similarly on other exchanges during the same timeframe.
Note: Although it supports the XRP/USD trading pair, Bitstamp is actually a London-based cryptocurrency exchange.
When asked whether DonorsChoose considers XRP tax-deductible, Mr. Pearsall relayed information from Chief Financial Officer Geoff Hill, who claimed that “donations in cryptocurrency like XRP are tax deductible.” Hill passed along an explanatory post about charitable contributions made in bitcoin for reference.
But, here’s the question: Do charitable contributions of bitcoin and charitable contributions of XRP deserve the same tax treatment? (Remember, too, that the XRP donation in question was made by Ripple, the creator of the XRP digital tokens.)
Food for thought: Would charitable contributions made in bitcoin by Satoshi Nakamoto be tax-deductible?
The history and ostensible technical centralization of the Ripple Ledger have been well-documented. Even if XRP qualifies as a “cryptocurrency” (meaning that it is cryptographically secured) and as a “virtual currency” (meaning that XRP is neither issued nor guaranteed by any jurisdiction), these designations do not mean that XRP is similar to bitcoin.
Bitcoin is ostensibly decentralized in its issuance and ownership – notwithstanding dominant mining pools or the long-dormant wallets of Satoshi Nakamoto (or various “bitcoin whales”). By comparison, XRP is primarily owned and controlled by Ripple. The company issued 100 billion XRP (a fixed supply), and now holds approximately 55 billion (yes, billion) of those units in an escrow reserve.
Note: The founders of Ripple also possess several billion XRP each.
Let’s pause here for a moment and revisit the company’s March 2018 gift to DonorsChoose. It’s difficult to determine the average price per XRP during liquidation, but by conservative estimates, the $29 million donation corresponded to approximately 44.6 million XRP (this is using a conversion rate of $0.65 per XRP).
By the numbers:
- The DonorsChoose transaction is about 0.08 percent of Ripple’s 55 billion XRP reserve.
- The gift from Ripple to DonorsChoose comprises a meager 0.11 percent of the circulating XRP (39.1 billion units).
- The donation equates to approximately 0.045 percent of the total XRP that Ripple created (approx. 100 billion units).
It doesn’t matter that the XRP donation by Ripple is just a tiny fraction of its holdings. Billionaires make charitable contributions that are infinitesimal compared to their net worth. The question – or problem – is what Ripple is actually donating. In other words: What sort of asset is XRP? And does it have a fair market value?
Earlier this month, in an interview with CNBC, Ripple’s chief market strategist, Cory Johnson, claimed that XRP is not a stock. “We absolutely are not a security,” he declared. “We don’t meet the standards for what a security is based on the history of court law.”
Recently, Ripple spokesman Tom Channick reiterated that claim. “XRP does not give its owners an interest or stake in Ripple, and they are not paid dividends,” he said. “XRP exists independent of Ripple, was created before the company and will exist after it.”
Readers must take their statements with a grain of salt. It’s worth noting that neither Johnson’s nor Channick’s assertions carry the weight of the law. (See: Securities and Exchange Commission v. W. J. Howey Co., 328 U.S. 293, 1946.)
So, to get a better sense of what XRP might be classified as legally, I discussed Ripple’s situation – and donation – with Dan Healy, a partner at law firm Anderson Kill and former trial attorney in the United States Department of Justice, Tax Division.
Healy proposed working backward from something that’s not quite a share, but instead a privately held money. He suggested posing the question, “What are the factors that drive control over XRP?”
Control and Value
Two major elements seem to drive control over XRP: 1) the validator nodes on the Ripple Ledger and 2) the actual units of XRP. A possible third avenue is access to liquid markets between XRP and other currencies, including bitcoin and the US dollar (more on this later).
Healy assessed, “My guess would be that [XRP] is something like a closely held corporate stock.” He pointed to the long history of litigation on such matters, explaining that there can be major disputes over the true value of an asset even among the parties to a transaction.
Healy’s comparison of XRP to a “closely held corporate stock” might be appropriate because Ripple could conceivably manufacture more XRP without the approval of other network participants (imagine a company’s board members diluting shares of non-board members). Ripple contends that it has no incentive to mint more XRP, but that’s like a deer giving hunting advice. The incentives are misaligned, not least of all because of the massive XRP reserve. Any XRP price increase necessarily lines the pockets of Ripple and its cohort.
This week, former Commodity Futures Trading Commission (CFTC) chairman Gary Gensler also suggested that XRP might be a security. Invoking the SEC’s Howey Test, he said, “Ripple Labs sure seems like a common enterprise.”
The major shortfall in the stock analogy is that (as Channick noted) XRP does not entitle its holders to any ownership stake in Ripple in the form of dividends, coupons, or assets in the event of bankruptcy. Furthermore, XRP ownership doesn’t provide voting power on the Ripple Ledger (though not all shares in a given company are necessarily voting shares either).
Unsurprisingly, when ETHNews asked the SEC whether it considers XRP a security, a public affairs specialist for the agency declined to comment. Luckily, the goal of this article is not to settle whether or not XRP will be deemed a security. We’re interested in whether XRP has a fair market value and whether charitable contributions by Ripple should be tax-deductible.
Healy suggested that Ripple might have made the gift to DonorsChoose, in part, to ensure that the company received a valuable tax write-off rather than holding the XRP indefinitely. “You have a market that’s pretty valuable,” he said. “Given the overall environment, if I were that charity, I’d want to liquidate the donation as quickly as possible,” he added. Obviously, Ripple also received wonderful PR for its seemingly magnanimous contribution. It might also have made more sense for Ripple to donate XRP rather than dollars because of potential savings related to capital gains taxes (i.e., converting XRP into dollars prior to the donation would have made the gift smaller because of tax requirements).
It’s also worth noting that if Ripple somehow knew that the XRP price would fall in the near future (e.g., because of its inability to get XRP listed on digital asset exchanges like Gemini and Coinbase), the company could have decided to maximize its tax deduction by making the charitable contribution ahead of the decline. As the Wall Street Journal has noted before, generous securities donations have occurred with uncanny timing in the stock market. It’s not inconceivable that something similar could happen in the notorious cryptocurrency markets. This is yet another factor to consider when determining the legal classification of XRP.
Depending on how XRP is treated by the IRS (and other authorities), it’s possible that Ripple could receive a tax write-off equivalent to the fair market value of the XRP at the time of its donation. As a result, even though DonorsChoose acquired $29 million for the donated XRP, Ripple might be able to claim a significantly larger deduction.
Note: Theoretically, the price of XRP could have risen during the liquidation period, and Ripple’s potential tax deduction would have been less than the amount that DonorsChoose ultimately received.
The challenge for financial authorities is to determine whether companies should have the ability to claim tax deductions on digital assets when they are donated at prices that might not reflect the fair market value and may not have a clear use case. Regulators also must study the volume of digital assets traded on individual exchanges because prices often vary significantly across platforms. The absence of a single agreed-upon pricing system for cryptocurrencies could pose a major challenge as investors and businesses try to comply with financial reporting requirements. This is a critical issue, especially in light of severely imbalanced digital asset economies, wherein founders have frequently retained vast sums of the very cryptocurrencies that they created.
Considerations for Stakeholders
At least in the case of Ripple, all of this is contingent on XRP’s asset classification in the first place. That is to say, it depends on whether the IRS is willing to recognize XRP as property, as a security, as a commodity, or as something else entirely. Before financial authorities decide on the tax treatment of any digital asset, they would be wise to anticipate the ripple effects of their decisions.