Forking headaches: Institutions are wary of entering crypto markets because of coin splits, KPMG analyst says

Crypto forks are holding back institutional investors from diving into the nascent digital coin market, says one KPMG crypto analyst. 

“Dealing with forks and the implications of forks is a pretty significant concern,” Kiran Nagaraj, a managing director at consultancy firm KPMG, said in an interview. Nagaraj led efforts behind a recent report the firm put out Thursday on the institutionalization of cryptocurrency assets. The report was published the same day that bitcoin cash, a spin-off of the original bitcoin, underwent a much-anticipated hard fork.

To recap, a crypto fork could lead to a crypto splitting into multiple variants. On Thursday, Bitcoin Cash blockchain split between two implementations: Bitcoin ABC and Bitcoin SV. In August 2017, bitcoin cash split away from bitcoin. 

“When you look at an institution if they provided exposure of a crypto to their clients, and that crypto forks, then the clients are going to expect to have the additional funds,” Nagaraj said. “But it isn’t that simple. The company providing exposure has to deal with the technological implications. They might not have the infrastructure to support it. And you have the tax implications of a fork.”

As noted by the report, forks result in “difficult tax-related questions that have not yet been addressed.”

Using two different examples, the report noted two tax-related problems when it comes to crypto forks:

1. Do crypto duplications = taxable income?: “Immediately before the hard fork, the taxpayer owned one Bitcoin. Immediately after the hard fork, the taxpayer owned one Bitcoin and one Bitcoin Cash. The Bitcoin Cash has value and can be sold for dollars. While not addressed in the limited IRS guidance on crypto, a number of practitioners believe that a hard fork is a taxable event to the holder under general tax principles. However, what is the nature of that income? Is it akin to a dividend? Does it occur at the time of the hard fork or later when the crypto is claimed?”
2. What is the tax basis?:  “Consider, for example, the Ethereum fork. A taxpayer owning Ethereum on the date of the Ethereum fork received new Ethereum (ETH) at the time of the fork and continued to own Ethereum (now referenced as Ethereum Classic (ETC)). If the amount paid for the original Ethereum remained with the ETC, the taxpayer would be treated as having paid nothing for the ETH, unless the taxpayer recognized some gain at the time of the fork or when the taxpayer claimed the ETH. As a practical matter, ETH is considered the “true” Ethereum. If no tax basis is allocated to ETH in connection with the fork, a taxpayer using ETH may have significantly more gain than what seems appropriate and would not have a way to recover what the taxpayer originally paid for Ethereum prior to the fork.”