A different approach to applying blockchain
Three years ago, Richmond, Va.-based accountant Louise W. Reed, CPA, knew little about blockchain. Today, she's launching a blockchain-based marketplace for tax credit transfers and looking to transition out of her traditional tax practice. Why the dramatic change? This is her story.
A couple of years ago, I attended a blockchain class at the CCH Connections conference. There were eight people in the class, and I was the only CPA. I had no idea what I was walking into, but I have a master's degree in physics and something about the math behind blockchain spoke to me. Over the next year and a half, I became increasingly knowledgeable about blockchain, cryptocurrencies, and smart contracts. I learned a lot at several different conferences, but it wasn't until I tried to help a friend sell $500,000 worth of tax credits that I realized how blockchain could apply to accounting (see the sidebar, "What Is Blockchain?").
You can't sell most tax credits, but some are legally transferable. Some states allow this to encourage certain types of behaviors. For example, the Commonwealth of Virginia offers land preservation tax credits to landowners who agree not to develop their land. However, you can't use tax credits to get tax refunds. That's a problem for a lot of farmers and other landowners who owe little-to-no Virginia income tax. To address this, Virginia lets the landowners sell their tax credits to individual taxpayers with a Virginia income tax burden, who can buy these tax credits at a discount.
Let's say that a farmer with a lot of land outside of Washington, D.C., decides to donate the land to a conservation trust, promising in perpetuity to preserve the land. After working with appraisers, lawyers, and the Virginia Department of Conservation and Recreation, the farmer might have $800,000 worth of tax credits. At that point, the farmer would go to one of the larger CPA firms to help find a buyer for the credits. Because tax credits are typically bought and sold in bulk, the farmer usually wants a CPA with access to buyers with a lot of state income who would be willing to buy credits at a discount to offset their taxes, although any state taxpayer can use the credits to offset their state income tax.
My CPA firm is not big. I have 50 clients, but, as I mentioned before, I had a friend with $500,000 worth of tax credits to sell. I thought, "This is fantastic. I can help him out, and one of my clients can buy tax credits at a discount." Unfortunately, personalities and emotions created a complicated situation. My friend wanted cash, but my client didn't want to reveal themselves to the seller. Because the two sides couldn't trust each other, the deal didn't get done.
When the tax credits situation happened with my friend, I immediately thought of blockchain. Because trading tax credits involves a lot of trust regarding the validity of the credits and the buyer having cash, an old boys' network has developed around the buyers and sellers. Fewer buyers means fewer people a seller needs to trust, creating a necessity for buyers to buy credits in bulk and therefore to have enough cash to afford it. This creates an ecosystem of wealthy taxpayers and credit holders — a very limited market. Because blockchain instills trust through its technology rather than individual people, it can help create a much larger market for tax credit transfers.
I decided to set up a blockchain-based marketplace for tax credit transfers called Afloat. The project started last year. The first phase was finding the right team. I did a lot of learning and a lot of talking to people to see if they could do the project. This was not a straight path. Some people said no. I eventually went with programmers in Poland, Argentina, and New York and a guy in the Richmond area who is general counsel and project manager. For the past year, I have been trying to integrate this project into my life and phase out of my tax practice. It's really fun and exciting.
Afloat is designed to democratize tax credit trades, enabling any taxpayer with cash to buy credits from sellers. Anyone familiar with the bid-ask spread of the stock market will also be familiar with Afloat's setup. Buyers and sellers put in transparent limit orders, and the blockchain takes care of the rest, such as verifying the credits and ensuring payment. Say you have a tax client who could benefit from about $2,000 worth of tax credits on their state return. You can send the client an invitation. After they log in, they will see a dynamic chart showing who has put in a limit order. Someone might put in an order to buy $2,000 of tax credits if the price is no more than 50 cents on the dollar. And someone else might enter an order to sell $800,000 worth of credits if they get 98 cents on the dollar.
The blockchain allows the potential for governments to participate in our database. If the buyers and sellers are in the same database, but the state has its own database, the result of an approved transfer is delayed. The reliance on two databases means there's not much security or transparency. Currently, Afloat does not have a real-time solution, but in my vision, governments will become part of our blockchain. When the transactions are posted to the same blockchain, it allows all parties to trust the data.
We originally set out to make a true public blockchain, but we had to pivot to a permissioned blockchain. The initial plan was to use the Solidity smart contract programming language on the Ethereum platform, but the software that you use to code on blockchain, especially a public blockchain, is relatively new. If we were to create a public blockchain marketplace, we would be at more risk of someone exploiting a vulnerability in the code. Over time, the Afloat marketplace can become decentralized, but we have better control over security if we roll it out slowly. We can increasingly add nodes and broaden the umbrella of information.
We don't know of any other companies looking to facilitate tax credit trades directly. A company already established to aid companies in managing their tax credits is The OIX. Although it doesn't completely eradicate the intermediary as Afloat aims to do through blockchain, The OIX diminishes administrative costs with technology and charges for annual or monthly usage of their product. The OIX is software as a service, but it is not blockchain-based. We hope to become the first blockchain-based solution in the space for transfers of tax credits.
What is blockchain?
Blockchain decentralizes transactions through an immutable public ledger. This allows two unknown parties to trust each other in an exchange without an intermediary. A smart contract, which is an application of blockchain technology, ensures that both parties uphold their end of the bargain before allowing the transaction to occur. With intellectual property, for example, blockchain technology has the capability to track people who enjoy copyrighted material and to then transfer royalties to the creator, therefore minimizing, though not eliminating, pirated content. The possibilities for smart contracts in the real world involve any information worth recording in an automatic and accurate source.