Case Study: Blockchain

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With the growing demand for borderless liquidity and platforms that offer trustless transactions and immutable records, blockchain development is at the cutting edge of financial systems technology today. As such, much of the activity that goes into the development of any part of the custodial, trading, and financial infrastructure can qualify for the credit. In addition, with the rise of dApps (decentralized applications), the power of the blockchain has expanded exponentially. Due to the cutting edge nature of this type of development, much of the wide spectrum of applications that are developed and deployed on blockchain infrastructure can qualify for the R&D tax credit.

What is the Research and Development Tax Credit?

The R&D Tax Credit was created in 1981 to reward companies for conducting research and development on products and processes in the United States. Since its creation, its reach has expanded to encompass many industries including the ever-growing umbrella of software development. Based on the qualification of the products and/or processes that the company is creating or improving, there are 4 different pools of expenses that can be qualified:
  • Wages
  • Outside Contractors
  • Supplies
  • Cloud Computing Costs

Qualified Research Activities for Blockchain Developers

  • Development of new blockchains
  • Development of decentralized applications
  • Development of hardware and software wallet solutions
  • Development of nodes
  • Development of new user experiences (e.g. virtual environments, admin and user environments)
  • Development of blockchain security infrastructure
  • Development of asset management infrastructure
  • Development of smart contract infrastructure
  • Development of APIs

R&D Tax Credit Case Study: Hardware and Software Wallets

One of the lynchpins of any cryptocurrency infrastructure is the ability to maintain custody of tokens. Companies that are developing software or hardware based custodial and non-custodial solutions can qualify numerous types of expenses.

First, the wages related to the development of the software and/or hardware wallets would qualify. This includes the conceptualization, detailed development, engineering, prototyping, and testing of the solution. This can also be a part of a larger ecosystem as in the case of exchanges with custodial solutions for storage of assets for the users of the platforms themselves.

When developing hardware solutions, R&D credit qualifying expenditures include not only the time spent by the employees on engineering, design, programming, and testing, but also any prototyping expenses. This includes handmade prototypes, low rate initial production (LRIP), first articles, and validation samples. With hardware, devices often need to be certificated via third party which is also qualifiable for the credit. Manufacturers of these products can include customized equipment and machinery in their qualified costs. When equipment is designed for a specific purpose and is not commercially available, companies can classify these expenses as R&D equipment costs and deduct the expenses currently as opposed to depreciating them. Further, the costs also qualify for the R&D tax credit.

R&D Tax Credit Case Study: Game & Virtual Environment Development

For years, numerous companies have evaluated blockchain infrastructure to be able to support more graphics-driven experiences. When doing traditional development for games and Virtual Reality (VR) environments, the biggest constraint is the hardware that these experiences are deployed on. For instance, if a company is creating a game for PCs and consoles, often, that company will need to make decisions based on the capabilities of the consoles since console hardware, more often than not, is limited compared to its PC counterparts. This is also the case in game and VR development on blockchain architecture. Like traditional software development, qualifying activities include:

  • Development of framework,
  • Development of in-game assets,
  • Iterative development to improve performance (e.g. graphics and latency),
  • In-game physics,
  • Development of game engines, testing and validations and,
  • Development of in-game custodial solutions (e.g. funds and non-fungible-tokens).

Further, because of the complexities surrounding blockchain and its performance limitations, developing even simple, casual games atop blockchains is much more complicated than traditional game development and comes with inherent risk. In some cases, even outside development costs done by independent contractors or third-party development firms can be qualified for the credit depending on contract language and payment mechanisms.

R&D Tax Credit Case Study: Cryptocurrency Trading Platforms

Investment and speculation are the main drivers for the extremely high valuations of various cryptocurrencies. Since the infancy of the cryptocurrency industry, there have been numerous efforts to replicate the success that algorithmic trading has offered investors in the traditional world of publicly traded securities. Development of these platforms and the algorithms that drive them are another highly-qualifying R&D activity with regard to the R&D tax credit.

This includes developing automated trading and risk management platforms, developing performance-testing environments with real-time data feeds, data connections to existing exchanges, developing front-end experiences to deliver functionality to users and administrators, developing advanced algorithms to accurately identify signals in the market, creating systems to meet regulatory requirements, and finally validating these systems for accuracy and performance. In this constantly changing landscape, developing, deploying, and maintaining systems is a never-ending task. That perpetual change lends itself to ongoing annual R&D credits. Further, these tend to grow with the size and scope of the company conducting the research.

R&D Tax Credit Case Study: Non-Fungible Tokens (NFTs)

Another growing segment for blockchain is the NFT market. Non-fungible tokens are essentially digital certificates confirming ownership of a digital asset on a specific blockchain. Since the birth of smart contracts, NFTs have exploded and now cover items such as digital works of art, virtual trading cards, and even digital land deeds for game and VR environments. Developing the assets themselves will not always qualify, but the time in creating new blockchain infrastructure, mechanisms for minting (creating) NFTs, custodial infrastructure, unique user experiences, and even testing can qualify for the R&D tax credit. Within the NFT world, companies may also have extensive hosting requirements. Where this is done via traditional cloud servers, costs for any development sandboxes can also be qualified for the credit as long as the environment is purely for testing and development.

R&D Tax Credit Case Study: Decentralized Finance (DeFi)

The ultimate demonstration of the utility of cryptocurrency is the push toward decentralized finance (DeFi). DeFi is a blockchain-based form of financial infrastructure that does not rely on traditional banks, exchange, or other financial institutions to deliver financing, hedge against risk, and earn interest via smart contracts to create a trustless financial network. Development of this type of infrastructure is cutting edge and much of it, like its other blockchain counterparts qualifies for the R&D tax credit. Functionality such as development of liquidity pools, collateralized lending pools, flash loan infrastructure, among others are all considered qualifying activity. Once development on these types of features is completed, additional time can be qualified for the testing and validation of these elements within the platform.

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