Over the past several years, digital or virtual currencies known as cryptocurrency have grown massively in popularity. Not only have individual investors shown interest, but corporations are also beginning to invest in the digital currency more—especially in recent years, as its value has soared. Cryptocurrency is known for its volatility, allowing people to make or lose large sums of money in very short periods of time. The lack of regulation and accounting guidance has produced a market that some have termed to be the Wild West. All of this points to the need to understand cryptocurrency as an asset, relevant accounting standards or lack thereof, and valuation strategies.
Cryptocurrency as an Asset
Advocates of cryptocurrency point to its decentralization as a central strength; there is no single government entity controlling the supply and demand of the currency. This leads to the perception that the currency is fair and that decentralization can make the currency attractive for people in nations outside of the U.S. who do not like the idea of another government controlling their currency.
Because of crypto’s decentralization, there is an inability to identify who is participating in the trades. On one hand, this makes trades secure because it hides the identity of the buyer/seller. But if a malicious actor can control the crypto network, then steal or alter the currency, they are able to control the supply and demand, whereas this sort of malicious control is harder to achieve with a currency backed by a country.
The lack of central regulation also makes it hard to understand exactly what events cause fluctuations in the value of the asset, which makes it challenging to forecast those fluctuations. Social media activity, governments deciding to accept a specific cryptocurrency, and black-market exchanges can all influence the value of the currency. Crypto’s decentralization can also lead to difficulties in cashing out into a fiat currency, though that process is getting easier as larger banks, funds, and firms are embracing crypto as an asset.
Accounting for Crypto on the Balance Sheet
In recent years, as companies have begun investing and holding cryptocurrency in greater numbers, there has been a greater focus on the question: What is the “right” value of my cryptocurrency assets on my balance sheet? Because of cryptocurrency’s relative novelty, there is very little official guidance or standards on how companies should account for their crypto assets. The guidance that does exist tends to recommend accounting for crypto as an intangible asset, though this means the asset’s value can only be impaired for decreases in value but cannot be written up for subsequent increases in value.
In one recent case, MicroStrategy, a publicly traded business intelligence software vendor, recorded its crypto holdings as an intangible asset. Because the intangible asset accounting guidance does not give them the benefit of being able to write the asset up when its fair market value increases, the company used a non-GAAP measure to try to give investors a more accurate picture of what the crypto assets were worth. The Securities and Exchange Commission objected and asked MicroStrategy to amend its filing to exclude this non-GAAP measure.
As cryptocurrency has grown in popularity, many have asked the accounting standard setters to tackle the gaps in existing accounting guidance and provide more clarity in the current rules in relation to digital assets. Although it’s unclear whether improvements to the accounting guidance related specifically to cryptocurrency will be a part of the Financial Accounting Standards Board’s official agenda for 2022, the U.S. accounting standard setter did note that it would undertake a project to research how best to account for and disclose cryptocurrency.
Cryptocurrency’s volatility and the challenge in predicting future worth makes it difficult to value, but valuations are important for financial reporting following payment in crypto assets, for tax planning, and for informed investment decisions.
A cost approach to valuation calculates the value of a cryptocurrency by looking at the value it takes to produce/mine one token. Any digital currency takes a certain amount of computational power to mine, so calculating the cost of electricity and energy consumption, combined with other relevant variables, can yield the value of a coin.
The network of a cryptocurrency can also be valued. One could look at the value of the entire blockchain where a cryptocurrency resides by understanding the number of nodes in the network used to mine the currency, the security of the network, and the number of transactions it can support in the long run. By valuing the network in this way, one can value the currency that lives within the network.
Lastly, another approach would look to value cryptocurrency as regular fiat currency. In this case, the valuation method is based on a modified equation of exchange and the acceptance and speed of economic transactions with banks and foreign exchange desks, using the quantity theory of money to understand the exchange rate, and deducing a value from that.
Cryptocurrency will likely grow even more in popularity and relevance and, over time, it is expected that clearer accounting guidance and tax treatment will emerge.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Fotis Konstantinidis is a managing director at Stout, leading the Digital & Data Analytics practice. He started his career as a brain researcher and held leadership positions delivering AI-driven products and services at McKinsey & Company, Accenture, Visa, and CO-OP Financial Services.
Ashley Ross is a licensed CPA and vice president in the Accounting and Reporting Advisory practice at Stout. She has experience in technical accounting and financial reporting, serving a variety of publicly traded companies across multiple industries, including telecommunications, health care and media.
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