There’s a good chance NFTs, or non-fungible tokens, are becoming more of a topic of discussion for leaders at organizations across industries. The global market for NFTs hit $22 billion in 2021,[1] compared with $100 million in 2020. And investor interest continues to grow: the blockchain and crypto sector attracted a record $30.2 billion in global investment in 2021[2] - up from $5.5 billion in 2020 and more than three times the previous record of $8.2 billion in 2018 - making it the fastest-growing sector in fintech. What does that mean for companies looking to purchase, issue and invest in NFTs?
The value of digital assets: more than just digital art
For many potential investors, their first exposure to NFTs likely came through art. In March 2021, digital artist Beeple sold a piece of art, Everydays: The First 5,000 Days, for more than $69 million. More recently, purchases of NFTs from the Bored Ape Yacht Club helped usher in more mainstream understanding of NFTs as more than just digital art.[3] They can come with membership benefits, intellectual property rights, and other perks that affect valuation.
In 2022 companies from consumer goods to gaming and banking to brewing have already announced intentions to purchase and issue their own tokens.
While interest in NFTs continues to grow, boards and the finance and tax leaders of companies considering jumping into the NFT fray should strategize and carefully consider how they will account for and report on NFT investments.
Understand accounting considerations before taking the leap
As previously detailed in What to know before you go crypto,[4] since there are no generally accepted accounting principles in the United States (U.S. GAAP) specific to digital assets (including NFTs), an operating company that takes an investment position in digital assets may end up applying accounting guidance that was not written with digital assets in mind. It is critical for issuers and buyers to understand the legal and contractual nature of the target NFT to determine how to account for it.
Consider the following questions:
Does the NFT represent the right to use certain intellectual property? What rights does the holder have?
For the buyer, the reality of purchasing a NFT is often not as straightforward as purchasing a physical asset. For example, when Twitter co-founder Jack Dorsey sold one of his tweets on the Valuables NFT platform, the platform characterized the NFT as "an autographed certificate of the tweet," making it clear that Dorsey did not transfer the copyright of the tweet to the buyer. Companies buying or selling NFTs should carefully evaluate what they are actually transacting, as the ownership of an NFT does not automatically equate to ownership of the underlying asset.
Is the NFT associated with an ongoing license or royalty arrangement?
Some NFTs allow for new ways for content creators to monetize their content, such as earning royalties on every subsequent sale of an NFT via smart contracts. This aspect of NFTs is of particular interest to businesses and content creators within the gaming and music sectors.[5]
Does the NFT provide the holder with contractual rights to additional goods or services?
NFTs can act as tickets or membership cards with online or real-life perks. Examples include exclusive access to concerts, networking events, merchandise sites, and online discussion groups. For an NFT buyer’s accounting, it’s important to know whether the purchase gives the buyer any more than an intangible asset, which would be subject to periodic impairment assessments, and whether part of the purchase price is a prepayment for certain other goods and services.
For an NFT issuer’s accounting, it’s important to understand whether part of the sales price of an NFT must be deferred to account for ongoing obligations to the buyer, such as providing other goods and services associated with the sale.
Additionally, because NFTs can be of high value, and are sold and reside on the same ledgers as cryptocurrencies, both issuers and holders will need to consider appropriate internal controls around custody and the authorization and initiation of transactions.
Overall, the terms and conditions attached to the NFT are critical to both buyers and issuers in mapping different components of the transaction into appropriate financial accounting standards.
