Blockchain Applications in the Nonprofit Sector: Part IV – Cryptocurrencies

This is Part IV of a four-part series about applications of blockchain technology in the nonprofit sector. Part I of this series introduced blockchain technology generally. Part II examined smart contracts. Part III discussed decentralized autonomous organizations. In this final Part, we discuss how cryptocurrencies may reinvent nonprofit fundraising, charitable investing, and international philanthropy.

What is Cryptocurrency?

Cryptocurrency, or “crypto”, is a digital form of currency. Its name is derived from the word cryptography, which underpins all blockchain technology. Cryptocurrency is intangible, and unlike traditional fiat money, cryptocurrency transactions occur exclusively online on the blockchain. The hallmarks of many cryptocurrencies are their secure and semi-autonomous nature.

Cryptocurrencies are extremely secure because each transaction is encrypted and anonymous. Additionally, cryptocurrency transactions do not require third-party intermediaries, such as banks or other financial institutions, to facilitate the transaction. Instead, crypto-transactions utilize the blockchain to complete transfers.

Virtual currencies are heavily decentralized. They are not created nor effectively regulated by any sovereign government. This means no single person or entity controls or creates cryptocurrency. Rather, cryptocurrency is created and verified through a process called mining.

Mining is performed by computers that attempt to solve extremely complex computational math problems. When a computer successfully solves a problem, it is rewarded with cryptocurrency. Anyone who has a computer powerful enough to solve these complex math problems is capable of mining.

Computers located everywhere in the world are constantly creating smaller and smaller amounts of cryptocurrency until a certain limit is reached. In the case of Bitcoin, for example, only twenty-one million Bitcoins can exist.

Solving convoluted math problems serves a different purpose as well. The problems are actually cryptocurrency transactions. Once a computer solves a problem, the transaction is completed. Computers mining all over the world race to solve problems so they can be rewarded with cryptocurrency; and in solving those problems, they are facilitating transactions.

Applications for Nonprofits

Fundraising.

Nonprofits’, especially tax-exempt nonprofits, primary revenue stream is public donations. Cryptocurrency technology has opened the door to new fundraising opportunities for nonprofits.

Organizations of any size can setup a digital wallet to accept digital gifts such as crypto; and the transparency blockchain offers helps legitimize contributions and nonprofits alike.

However, blockchain’s security and encryption may not be a total blessing for nonprofits. A significant challenge within the nonprofit sector is the issue of anonymous charitable giving. While a name can be attached to cryptocurrency transaction, it does not have to. Accordingly, crypto-donations can be given anonymously.

Accepting anonymous donations is a primary driver of skepticism around nonprofits transparency and accountability. The use of blockchain encryption would fuel, not mitigate, this problem. However, a 2019 suggests that nonprofits accepting cryptocurrency actually increased their perceived reputation among contributors.

Cryptocurrencies inherent volatility could put nonprofits at risk of losing their donation. Imagine a nonprofit is gifted cryptocurrency and the cryptocurrency market crashes. Suddenly the donation loses the majority of its value before the nonprofit has a chance to convert the donation into traditional fiat money.

The uncertainty and evolving nature of crypto-valuation would be concerning for many nonprofits. Nonetheless, more than three hundred million dollars are given to nonprofits in the form of cryptocurrency each year.

Investment Considerations.

Exempt organizations are subject to investment rules to ensure the nonprofit is fulfilling its charitable purposes and not operating for private gain. Nonprofits are subject to these rules to level the playing field for for-profits making investments and paying taxes on those investments.

While state laws vary, the generally accepted rules for exempt organizations investing are contained in the Uniform Prudent Management of Institutional Funds Act (“UPMIFA”). UPMIFA in some form or another has been adopted by nearly every U.S. state.

UPMIFA requires nonprofits to act with the care an ordinarily prudent person in a like position would exercise under similar circumstances. Further, UPMIFA requires nonprofits  managing and investing funds to consider

(a) general economic conditions;

(b) the possible effect of inflation or deflation;

(c) the expected tax consequences of their investment decisions and strategies;

(d) the role that each investment or course of action plays within their overall investment portfolio;

(e) the expected total return from income and the appreciation of investments; (f) the nonprofit’s other resources; (g) the nonprofit’s and fund’s needs to make distributions and to preserve capital; and (h) the assets special relationship or value to the nonprofit’s charitable purposes.

Accordingly, UPMIFA is generally meant to ensure nonprofits invest funds conservatively. Cryptocurrencies are an unstable and newly emerging technology without widespread adoption. Under UPMIFA, nonprofits should be very cautious about investing in or with cryptocurrency. I

ndeed, some of UPMIFA’s requirements conflict with the natural characteristics of cryptocurrency.

First, cryptocurrency volatility makes expected total return hard to measure.

Second, nonprofits tend not to have large reserves of cash, so their need for funds are generally high while their other resources are generally low.

Third, investing with or in, mining, or holding cryptocurrency is unlikely to be deemed a charitable purpose by the IRS.

Therefore, it is unlikely that a special relationship exists between a nonprofit and the crypto being invested. Finally, the IRs has issued some guidance regarding the tax consequences of cryptocurrency, but the tax implications remain largely unclear at this time.

International Philanthropy.

Many nonprofits provide aid overseas. With the advent of cryptocurrency, nonprofits now have the option of providing aid via crypto-donations. Normally, international business transactions adhere to international law and customs, as well as laws preserving American national security, such as the Foreign Agents Registration Act and Office of Foreign Assets Control regulations.

National security laws are meant to keep resources out of the hands of terrorist groups and other nefarious individuals or entities. Aid which is sent overseas may be intercepted by bad actors, but the highly secure and encrypted nature of cryptocurrencies would ensure that aid is only received by its intended parties.

Crypto-donations overseas would be fast and efficient. Because the blockchain eliminates the need for third party intermediaries, aid would be transferred much more quickly, especially in rural and third-world regions. Crypto could then be used to purchase supplies to help communities in need or be given to individuals directly so they can spend it how they choose.

In fact, the World Food Programme (“WFP”) does just that. WFP’s Building Blocks Initiative helps distribute cash-for-food aid to more than half a million Syrian refugees in Jordan. WFP utilizes the Ethereum blockchain to setup virtual accounts for each refugee.

The accounts are then loaded with cryptocurrency for the refugees to use in shops where Building Blocks tokens are accepted. To learn more about WFP’s Building Blocks Initiative, visit their website here.

Sources:

[1] Jake Frankenfield, Cryptocurrency Explained With Pros and Cons for Investment (Sept. 26, 2022), https://www.investopedia.com/terms/c/cryptocurrency.asp.

2 Mining Explained: A Detailed Guide on How Cryptocurrency Mining Works, Freeman Law (last visited Dec. 9, 2022), https://freemanlaw.com/mining-explained-a-detailed-guide-on-how-cryptocurrency-mining-works/.

3 Bitcoin.org, Frequently Asked Questions (last visited Dec. 9, 2022), https://bitcoin.org/en/faq#what-is-bitcoin.

4 Crystal A. Evans & Abigail B. Schneider, Nonprofit Reputation and Blockchain Use, 40 J. of Ideology 1, 19 (2019).

5 Daniel Lindley, Should Your Nonprofit Seek, Accept Cryptocurrency Donations?, 24 Major Gifts Rep. (2022).

6 National Conference of Commissioners on Uniform State Laws, Uniform Management of Institutional Funds Act (2006).

7 Peter Howson, Crypto-giving and Surveillance Philanthropy: Exploring Trade-offs in Blockchain Innovation for Nonprofits, Wiley Periodicals 805, 814 (2020).

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