The growth of cryptoassets has made it incredibly challenging for regulators worldwide to standardize and issue authoritative guidance. Professional accounting standards setting bodies, including FASB and the IASB, are certainly no exception. Accountants with a deep knowledge of cryptoassets and blockchain technology are already increasingly in demand, as an intricate understanding of both the technology and accounting standards is required to provide appropriate guidance.
What started out with Bitcoin in 2009 grew to a handful of cryptocurrencies with a combined market value of approximately $1 billion in 2013; this ballooned into an $800 billion sector by the fourth quarter of 2017, followed by a significant crash in 2018. Over $3.2 billion were invested in crypto startups through initial coin offerings (ICO) in 2017, and Bitcoin alone transacts multiple billions of dollars every day. As of this writing, there are more than 2,000 different cryptoassets, and while Bitcoin accounts for the majority of the total market value, there are also many other cryptoassets that do not seek to function primarily as a form of payment.
As the global economic and regulatory landscape has evolved, new categories of cryptoassets have emerged. Historically, all cryptoassets have been commonly referred to as cryptocurrencies, which can be misleading, as not all seek to function as a form of payment. Various classification frameworks are being published, and some of the most common other categories include utility tokens, which are intended to provide access to an application or service by means of a blockchain-based infrastructure; security-or asset-backed tokens, which function like stocks, bonds, and other traditional securities; and cryptocollectibles, which are cryptographically unique and limited in quantity.
This emerging asset class does not fit well into the existing regulatory environment. The IRS ruled in 2014 to have Bitcoin taxed as property in the United States, effectively limiting it for its intended purpose of payment for goods and services. In addition, dozens of crypto startups have left the United States because of regulation such as the BitLicense in New York. Besides the SEC and the IRS, a litany of other regulators have weighed in, including the U.S. Commodity Futures Trading Commission (CFTC), Financial Crimes Enforcement Network (FinCEN), and the Financial Industry Regulatory Authority (FINRA).
As of yet, no specific guidance for cryptocurrencies has been issued under either U.S. GAAP or IFRS. How are companies accounting for cryptoassets, and are existing accounting standards sufficient and appropriate to be applied to this new emerging asset class? It is important to realize that the term “cryptoasset” is broad and, depending on the coin or token being evaluated, can vary widely in associated terms and conditions. In addition, terms and conditions may evolve and thus need to be reevaluated for appropriate accounting treatment. Other considerations include the purpose of the holder and the business model of the entity in question. The scope of this article is limited to cryptocurrencies or coins that function as a form of payment, such as Bitcoin, ZCash, and Litecoin.
Meeting the Definition of an Asset
It is important to consider whether cryptocurrencies do, in fact, meet the definition and recognition criteria of an asset. Under U.S. GAAP, an item that meets the definition of an asset is recognized when its cost or value can be measured reliably. Note that the probability of any future economic benefit associated with the item is not a recognition requirement under U.S. GAAP. Under IFRS, an asset is a “resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.”
An item that meets the definition of an asset is recognized when it is probable that any future economic benefit associated with the item will flow to the entity and the item’s cost or value can be measured with reliability. “Probable” under IFRS is defined as “more likely than not,” that is, a probability of greater than 50%. Under U.S. GAAP, probable is defined as “likely,” and no percentage threshold is defined. Entities will need to assess whether a cryptocurrency meets such criteria and determine whether the uncertainty around its future economic benefits is not sufficiently volatile that it is not an asset.
Cash or Cash Equivalents
If it has been determined that the definition and recognition criteria of an asset have been met, the next question is one of classification. Is the asset cash or a cash equivalent? The significant volatility of cryptocurrencies, along with the fact that they are not considered legal tender (because they are not backed by a government nor widely accepted as a medium of exchange) would prevent holders from being able to “convert to a known amount of cash.” Thus, cryptocurrencies cannot be classified as cash or cash equivalents under U.S. GAAP or IFRS.
As defined under both IFRS and U.S. GAAP, financial instruments would seem like a natural classification for cryptocurrencies, allowing measurement at fair value and recording of changes in fair value in profit and loss. Cryptocurrencies, however, generally do not provide the holder with a contractual right to receive or exchange cash or a financial instrument and thus are not financial assets. That said, certain cryptocurrency futures (contracts to buy or sell cryptocurrencies in the future) that settle in cash could be considered derivatives and accounted for as financial instruments. In addition, there may be circumstances under which an entity holds cryptocurrency as an investment that falls within the scope of “investment company status” under U.S. GAAP, which would result in accounting for such investment, initially and subsequently, at fair value.
Cryptocurrencies are often mined or purchased with the intention of reselling them, and thus it can be argued that they meet at least part of the definition of inventory under both U.S. GAAP and IFRS. As cryptocurrencies are not tangible in nature, however, they cannot meet the definition of inventory under U.S. GAAP. Because inventory under IFRS does not need to be tangible, a case can be made that cryptocurrencies may meet this definition; however, the volume of trading may not be sufficient to qualify as “held in the ordinary course of business.”
If the inventory standard were chosen to account for cryptocurrency, the currency would need to be held at the lower of cost and net realizable value under both IFRS and U.S. GAAP. It is fair to say that accounting for cryptocurrency under the aforementioned measurement criteria in the current volatile market would not provide useful information to users of financial statements. One exception would be commodity broker-dealers buying or selling cryptocurrencies within the normal course of business. This would allow cryptocurrencies to be measured at fair value, less costs to sell, with changes recognized in profit and loss.
Being purely digital in nature, cryptocurrencies may meet the definition of “intangible assets” under both U.S. GAAP and IFRS. Cryptocurrencies such as Bitcoin generally have indefinite useful lives with no expiration date or limit on the period in which they can be exchanged for cash, goods, or services. Under U.S. GAAP, indefinite-lived intangibles are initially measured at cost and need to be tested for impairment annually. A decline below cost as quoted on a cryptocurrency exchange may be considered an event indicative of impairment. IFRS allows for intangible assets to be accounted for either at cost or revaluation at “fair value at the date of the revaluation less any subsequent … accumulated impairment losses.” The revaluation model can only be applied if the fair value can be determined by reference to an active market, defined as “a market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis.”
Cryptocurrencies may meet the definition of an intangible asset, with potential circumstances for inventory or investment accounting by an investment company. The relevant accounting standards, however, were written before the birth of blockchain and cryptoassets and thus do not provide for their unique economic makeup. Careful consideration should therefore be given to the facts and circumstances of each cryptoasset case after consulting with advisors who understand their intricacies. The author implores FASB and the IASB to provide authoritative guidance that specifically addresses the recognition, measurement, presentation, and disclosure requirements for this dynamic new asset class.