"If a token forks in the woods...how should it be taxed?"
The taxation of forks is a vexing, unresolved issue right now.
Consider for example, that a forked cryptocurrency is like a stock split (which is taxed one way) or a stock dividend (which is taxed another way). Or maybe it should be taxed like interest, and treated as a "capital" asset.
The American Bar Association ("ABA") recently called on the Internal Revenue System ("IRS") to provide guidance on the issue.
Specifically, the ABA has asked the IRS to provide a temporary safe harbor while they sort out just what the heck a fork is.
The ABA proposed that the harbor treats forks as taxable events, and that the owner gets a basis of zero. This effectively means the owner is taxed on the full amount of the newly forked digital assets. Additionally, under these rules, the holding period starts at the time of the fork. This matters because once a "capital" asset is held for a year, it gets a much more favorable tax rate.
So you could say that the ABA's proposal isn't exactly friendly to fork recipients. But since there's no guidance whatsoever on how to actually account for forks, it may be better for crypto holders to be able to comply with a tax law (even if it's unfavorable) than be potentially non-compliant depending on whatever the IRS later decides.
UPDATE - I spoke with a VC in San Francisco that confirmed he/she considerably saw the adverse selection effect in ICOs in 2017. As noted, this effect likely doesn't apply to all ICOs, but it is another layer to consider.
Zhao Changpeng, the CEO of Binance, recently wrote a post claiming that initial coin offerings are "necessary" in light of the venture capital world.
"[R]aising money through ICOs is about 100 times easier than through traditional VCs, if not more," he wrote. He focused on the absurdity of courting VCs, preparing business plans and presentations, negotiating terms with lawyers, VC control, and other "drawbacks" of the VC world.
"ICO investors are early adopters (and learners)," Changpeng writes.
Counter argument: VCs sift and winnow the good from the bad, so that companies that spurn VC funding and choose to do an ICO are actually subject to adverse selection.
VCs function as hurdles many entrepreneurs need to face. Yes, it's additional work to making your idea reality. But maybe it's a necessary hurdle to proving your idea has some viability.
Changpeng writes that having to come up with business plans and pitches is a "downside" of the VC process. But this ignores the fact that many entrepreneurs haven't fully formed their idea or even thought about logistically bringing it to market.
The VC System Has Benefits
Business plans force nascent companies to ask hard questions. For example, many tech entrepreneurs start by valuing their total addressable market with a top-down approach. They say "well, we think it's reasonable we could get 1% of the market, which is worth..."
But that's lazy. That's the easy way. And a good VC will call it out by asking the hard questions, because they've likely seen the failure of companies that didn't ask those tough questions.
"We can't get what we want so we're gonna make our own capital raising ecosystem!"
The VC system vets and snuffs out this self-deceiving naivety.
It forces founders to learn skills like pitching, thinking through the true costs involved, actually verifying demand, etc. And VCs bring experience and networks.
While ICO investors may be "early adapters", as Changpeng writes, what are they early adopters of? Most of them don't have the first-hand experience helping companies grow that VCs do. They don't add much value other than capital. They may be early adapters, but maybe they're early adapters of a system where the blind lead the blind.
Throw irrational herd behavior on top of that and you should be skeptical that ICO investors can accurately choose and value tokens (see, for example, the current crypto market value despite very, very few validated test cases outside of a "store of value"). All an ICO needs to be successful is effective (...scammy?) marketing **cough** BitConnecct **cough**.
It's possible that ICOs attract the worst businesses, the ones that weren't good enough to get VC funding. There are many companies that truly and earnestly belong on blockchains and require native digital assets...but it's possible many token companies out there slapped a blockchain in their model so they don't have to face the hard, experience-earned vetting that venture capital requires.
And so there may be an adverse selection ICO effect: it's possible the companies that choose ICOs over VC funding are companies that aren't viable since they couldn't (or wouldn't) have gotten funding under the VC model.
Thoughts? Comments? Let us know below.
This Time Is Not Different: A Brief History of Private Money and Crypto
Initial Coin Offering (ICO) Security Exemptions
Given increasing scrutiny from the Securities and Exchange Commission (“SEC”), Initial Coin Offerings (“ICOs”) are trying to limit their exposure to SEC regulation by placing themselves outside SEC jurisdiction.
The main way ICOs are doing this (...or are unintentionally trying to do this) is by fitting into Regulation S (“Reg S”).