Cryptocurrency is a bit of a loaded term. For some, it is a fascinating form of the future incarnate. For others, just reading the term “cryptocurrency” in an article triggers an automatic reflex to click on another story. Regardless of your comfort level, the reality is that cryptocurrency is here and trending to become more and more commonplace. Two recent examples show just how prevalent cryptocurrencies have become. Exhibit A: PayPal, one of the largest online payment systems in the world, has announced that it will be launching a cryptocurrency checkout service allowing consumers to purchase items using certain forms of cryptocurrency.  Exhibit B: Tesla announced that it will begin accepting certain forms of cryptocurrency to purchase, you guessed it, Tesla cars.  These announcements portend a continued increase in the use of digital currency in everyday commerce.

What does this mean for the construction industry? Will contractors be paid in Dogecoin for services rendered?  From both a legal and risk management perspective, it is important to understand how these emerging technologies may impact your business and business practices.

1.    Cryptocurrency, Bitcoin, Blockchain . . . what?
Boiling it down to the basics, cryptocurrency is a form of payment that can be exchanged online for goods and services. Cryptocurrency is similar to a token: You exchange fiat currency (e.g., US dollars) for a token to purchase goods or services. Bitcoin is the largest and most heavily reported form of cryptocurrency, though many, many other forms already exist, such as Ethereum, Litecoin, or Dogecoin.

Part of the appeal of cryptocurrency is that it is based on blockchain technology. Blockchain is a decentralized system of managing transactions, with transactions being recorded across a number of computers. This is in contrast to a single, centralized ledger that has traditionally been used to manage transactions.  Supporters of blockchain argue that the technology is safer than traditional methods as it is less likely to result in late payments, overpayments, or outright fraud.

2.    Cryptocurrency is…payment
One issue with cryptocurrency is whether businesses will or will not accept cryptocurrency as a valid form of payment. What will a contractor do if payment is tendered, but it is not equipped to handle (or willing) to accept such form of payment? This is akin to the angry person who pays with a bucket of pennies.  While the law does not require a private business accept all types of currency including cryptocurrency, not identifying the forms of currency that will be accepted may fray relationships between the project team members and create yet one more dispute that has to be resolved during the construction process.

One way to combat this issue is to specify the forms of acceptable payment in the contract between the parties. For instance, contracts among parties who do business internationally frequently specify the denomination and means of payment.  With no exchange fees, no transactional fees, or almost immediate payment, cryptocurrencies are alluring and may be specified as a form/denomination of payment.

3.    Cryptocurrency is . . . property
An interesting and confusing legal aspect of cryptocurrency is how the central authorities in the US treat cryptocurrency. The IRS currently defines cryptocurrencies as property rather than as currency. This may have unintended tax implications. Unlike fiat currencies like the US dollar, cryptocurrency profits may be subject to capital gains taxes regardless of where or how the digital currency was acquired.

In the construction context, this can create additional tax burdens not envisioned or allocated in the contracts between the parties.  By way of example, in the standard bid-build construction delivery system, the owner pays the general contractor, the general contractor pays its subcontractor, and so on.  If the owner pays the general contractor, but the general contractor withholds payment from its subcontractor due to some contractually allowed reason, and the general contractor continues to withhold payment past the end of its fiscal/tax year, will there be a capital gains tax consequence to the general contractor when it converts the cryptocurrency into legal tender to pay the subcontractor?  If so, who bears that risk and must pay those taxes?

4.    Cryptocurrency is . . . volatile.
Another potentially troublesome legal aspect is how to address the volatility of most cryptocurrencies.  For instance, in January 2020, Bitcoin was trading at $7,200.  By the end of December 2020, it was trading near $24,000. This creates conditions akin to performing work in hyper-inflationary or -deflationary markets.  Not many contractors are running to bid work in Venezuela without guarantees of payment in US dollars or other stable fiat currencies.

Who rides the risk for the volatility?  Under the standard bid-build delivery system, if general contractor is paid in Bitcoin for its November pay application, but between November and December the value of Bitcoin plummets, who rides the risk of the downturn? Conversely, if the value of Bitcoin skyrockets, does  the general contractor have the option to convert the Bitcoin into fiat currency and pocket the profit after paying capital gains taxes?  Contrary to the promise of greater accountability and speed using blockchain technology, cryptocurrency as a form of payment may encourage delays to maximize short-term capital gain.

As cryptocurrency gains wider acceptance, its use in the construction industry is inevitable. Accounting for these new payment forms in all tiers of contracts—developer, contractor, subcontractor—takes on seminal importance for purposes of managing the project and the new risks associated with payment.  The attorneys in our Dallas and Austin offices are available to answer any questions you may have and to help you and your company best prepare for what’s ahead.  Contact us at info@gstexlaw.com if you have any questions.

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