Weed's Crypto Temptation: An Obvious Next Step For The Cannabis Industry Or Far Too Convoluted?

This article by Jackie Bryant was originally published on WeedWeek, and appears here with permission.

As cannabis banking legislation continues to stall in Congress, businesses are eager to access the national banking system. Rather than wait for the federal government to get on board, though, some owners and operators are increasingly looking to cryptocurrencies, like Bitcoin and Ethereum, to solve their banking woes. 

Because they are not beholden to federal banking regulations, cryptocurrencies offer a number of possibilities for cannabis businesses. Using cryptocurrencies can provide cannabis companies with benefits including blockchain transparency and security, the ability to transact online and internationally, an inflation hedge in a volatile foreign exchange market, and a formal banking alternative that isn’t subject to regulatory scrutiny. Culturally, using cryptocurrencies could also be a fit for many in the cannabis industry, especially those who have operated in the legacy market and are used to working outside laws and regulations.

Despite its potential benefits, using cryptocurrencies comes with a number of question marks. The volatility of crypto prices creates risk for sellers and can trigger tax issues. There are also a number of unknown factors in dealing with cryptocurrency which the cannabis industry could further amplify.

An obvious next step?

Some people think it’s an obvious next step for the industry. “Cannabis and crypto make for good bedfellows,” says Steve Gormley, Chairman of the Board of Directors of CoinMover, a Boston-based Bitcoin ATM operator and CEO of Radiko Holdings, a publicly-traded Canadian cannabis company with operations in California and Nevada.

“Cannabis consumers and crypto consumers share many of the same demographics, psychographics, and consumption patterns,” Gormley says. The type of people who operate in both spaces “tend to be early adopters,” who are comfortable adapting to shifting regulatory environments. 

There is also a practical reason why crypto and cannabis go well together. “To put it simply, the cannabis industry is particularly well-suited to crypto because of the lack of banking regulations,” says Nic Shafer, VP of Marketing & Strategy at Precision Extraction Solutions, which manufactures cannabis extraction equipment and sells to companies such as Gage, Curaleaf, Jushi, and others. Precision Extraction Solutions accepts both Bitcoin and Ethereum as payments from vendors. 

“The traditional banking system has massive roadblocks for cannabis due to banking regulations, and we have no idea when SAFE Banking will finally pass in the Senate,” Shafer says, referring to the bill that would offer safe harbor to financial institutions housing money from cannabis companies (the House of Representatives recently passed it for the fourth time). “Crypto provides a parallel monetary ecosystem to transact in that it is faster, cheaper, safer, and more innovative than the traditional banking system,” Shafer adds.

Because of cannabis’ federal illegality, using national banks is out of the question, generally leaving cannabis companies with regional banks or credit unions as the only options. This is only the tip of the iceberg as far as cannabis and banking problems are concerned.

“There is no credit card processing–the only option is ATMs in stores,” says Lorenzo Nourafchan, CEO of Northstar Financial Consulting Group, an accounting firm that specializes in the cannabis, tech, and entertainment industries. 

Nourafchan says his cannabis clients are paying 1-2% on cash deposit and pick-up fees, which adds up when a business does, say, millions of dollars of transactions in a month. Additionally, insurance is expensive and hard to get. Theft claims are difficult to prove, especially with cash businesses. 

“Cash-heavy businesses also face very complicated issues related to timing and operations–like when the funds hit the bank, payroll, audits, managing the cash, theft, security, et cetera–in addition to the hefty fees,” Nourafchan says, adding that he has had clients who have been robbed at gunpoint. 

Reputational reasons

While federal prohibition has created a difficult banking climate for the cannabis industry, Nathaniel Gurien CEO of Fincann, which offers financial consulting and electronic payment processing for cannabis businesses, says that the issue isn’t necessarily because of actual federal restriction. Rather, it’s from the reluctance of private companies, like banks and major credit card networks, to work with cannabis companies for what Gurien says are “reputational reasons.”

Gurien says there is a large enough network of financial institutions around the country that provide “compliant, transparent, sustainable” banking to legal cannabis businesses regardless of industry sector or location. The problem is that it’s still too expensive to do so because banks charge high fees to supervise and manage cannabis accounts–especially those of “THC licensees.” These businesses tend to be cash-heavy and therefore require extra layers of anti-money laundering compliance measures, as well as meticulous accounting procedures.

“As the banking industry scales up to accept and meet demand and the industry continues to grow exponentially, the cost will continue to come down,” Gurien says. 

“Artificial intelligence is already featured by some cannabis banking solutions, which will further drive costs down. He also says that increasing the use of “blockchain consensus-based verification technology,” used with or without a crypto component, is also likely to aid in lowering compliance costs. Though cryptocurrencies provide a level of secrecy and insulation from scrutiny should businesses choose to use it that way, the opposite is also true. Utilizing cryptocurrencies and, therefore, the blockchain can provide an accurate accounting of currency transactions at each step in a product’s lifespan or a company’s accounting process. 

The road to normalcy

Federal legalization of cannabis is the ultimate goal, regardless of whether a company decides to use crypto or not. Legalization will legitimize cannabis businesses in the eyes of national banks, lowering the compliance risks and costs of doing business with them. This has already happened in the hemp and CBD industries, thanks to 2018’s Farm Bill. Gurien says the long-term trajectory for cannabis banking is to get to where the alcohol or tobacco industries are, which essentially boils down to having reasonable banking costs.

Until then, cryptocurrencies offer what many see as attractive solutions. Nourafchan says that allowing crypto into their clients’ business models could allow them to enable virtual payments, which is an option Northstar is currently exploring for its clients. 

Another benefit is that crypto can be an appreciating asset. “Tesla has profited more from the appreciation of bitcoin than from all the profit they’ve made selling Teslas,” Nourafchan says, offering an example. “If cash ATMs were replaced with bitcoin ATMs, you can pay with bitcoin throughout the entire supply chain,” he adds. 

However, cryptocurrencies, like Bitcoin, are volatile and have not achieved the market stability that foreign currency trading has, exposing the holder to extreme downside risk. Nourafchan says that a possible hedge to this problem is using cryptocurrencies that are tethered to the dollar, but that also requires each member of a particular supply chain to also adopt the same currency, which is not likely to be possible at this point in time.

Shafer offers other practical benefits gleaned from Precision Extract Solutions’ experience in working with crypto. 

“Crypto offers near-instantaneous fee-free transactions and zero counterparty banking risk– like cannabis accounts being shut down–or from fractional reserve banking practices,” he says. Bitcoin is a bearer asset, which removes counterparty risk. There is also no risk of debasement, like there is with fiat currencies, so holding a currency like Bitcoin long-term on a company’s balance sheet can act as an inflation hedge.

Crypto isn’t easy

Like with any seemingly easy solution, there are problems. Firstly, there are possible tax concerns, especially if the value of the held currency appreciates, which could trigger capital gains taxes.

Nourafchan offers an example by explaining a possible transaction at a dispensary that accepts crypto as payment. “The seed to sale system in place at the dispensary records a $100 transaction at the counter. In 24 hours, when the crypto is deposited, the valuation is $120. The additional $20 over what was recorded in the seed-to-sale software would need to be tracked as capital gains,” he says. 

Not doing this could trigger an audit, which is a losing proposition for any cannabis company. “The IRS never loses an audit with a cannabis company,” Nourafchan says. 

Currently, Northstar has begun assembling what it calls a consortium of willing operators to test out the implementation of crypto in their businesses. “Because we have clients at every level of the supply chain, we are able to strategically put together the right consortium with our current client base,” Nourafchan says.

Northstar is getting started by focusing on the California market, where each member of their consortium will adopt a currency of choice. Once they have enough clients mobilized, their plan is to do an Initial Coin Offering (ICO) for a cannabis coin, which is the currency version of an IPO.

Nourafchan explains that it will be an improvement on current cannabis coins, in that this new coin would be tied to assets, like products, and would serve as an appreciable asset as more companies buy-in over time. “Everyone that adopts the coin can then be rewarded with additional coins. A likely effect is that banks will likely respond with lower fees, so our clients would have a win there as well,” he says.

Finally, one of the greatest risks is that of the unknown. “Because both cannabis and crypto are so new, there are a lot of things that are very murky,” says Nourafchan. 

Though he says Northstar is working closely with regulators while trying to give their clients the best possible service, the laws are still developing. “It’s hard to be able to say with absolute certainty what course of action will protect our clients and what the actual risks are. For an accounting and finance team that our clients lean on for guidance, that can be a tricky spot to be in,” he says.

Gormley agrees that cryptocurrency’s nascence is one of its biggest hurdles. “There are no compliance departments with the major banks that seem to have the infrastructure to handle crypto or even understand the scope of what crypto currency means to consumers and the market,” he says. 

He, like many who are watching and waiting, thinks it will take more time for banks to understand how the cryptocurrency market works. Beyond navigating the mechanics of integrating crypto into a formal banking system, there will have to be a change in overall perception about the efficacy and legitimacy of digital currency.

This column is made possible by Dama Financial. Column sponsors don’t influence their subject matter or content. 

Read the original article on WeedWeek.

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