The launching of the first ever bitcoin exchange traded fund (ETF) in the United States has made headlines, and is indicative of the increasingly mainstream nature of crypto from a legal and regulatory perspective. While this is certainly excellent news for the sector, and should be recognized for the legitimization it brings, it also has the potential to assist in addressing one other lingering issue for crypto advocates; the accounting for crypto.
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Accounting might not always make the buzziest or most exciting headlines, but is absolutely essential for individuals and institutions seeking to fully integrate crypto into everyday transactions. The lack of crypto-specific accounting and reporting rules is not only an obstacle toward wider utilization of crypto, but is also not reflective of the economic reality connected to cryptoassets. Launching tradeable and investable bitcoin and crypto products that are available to be invested in by virtually everyone is a dramatic step in the right direction, but current accounting treatment will remain a significant headwind for the time being.
Let’s take a look at the current treatment, what issues this raises, and other options that – indirectly – the launching of a bitcoin ETF opens up for the marketplace.
The problem. Current consensus around how to account for and report cryptoassets is to treat them as if they were the equivalent to indefinite lived intangible assets. On the surface this looks like a perfectly reasonable approach; cryptoassets are intangible in nature, and even tokenizing physical assets still results in the creation of intangible tokens. Where the issue arises, however, is that by classifying and treating crypto as such means that these assets must also be tested for impairment on a recurring basis.
Without diving into too much accounting minutia the test for impairment is a multi-step process that needs to be performed either 1) an annual basis, and/or 2) when a change in economic conditions necessitates a more frequent test. Given the volatility of bitcoin and other cryptoassets – which have been trending upward recently but has not always been a straight line up – this could lead to organizations having to mark down different crypto holdings. These losses, even if no external transactions take place at these lower price levels – will be shown both on the balance sheet and income statement of these organizations.
The real issue, however, is that these losses are permanent and are not ever able to be reversed, even if the prices of these assets subsequently recover. In other words, the reality of asset valuations might not be shown in the financial statements prepared in accordance with Generally Accepted Accounting Principles (GAAP). As organizations across different economic sectors transact in bitcoin, hold some in reserve on balance sheets, or hold them on behalf of clients, this is quickly becoming a common consideration in the marketplace.
A potential solution. Launching a bitcoin ETF might not, at first, seem like a potential solution to the above issues raised around accounting, impairment, and reporting of cryptoassets. Taking a closer look, however, reveals several key takeaways that market participants should notice and incorporate going forward.
Firstly, the launching of a bitcoin ETF signals the approval of this idea – rather obviously – by the Securities and Exchange Commission (SEC). Setting aside the ongoing discourse regarding whether crypto are securities for the moment, there is another angle to this story. Put simply the fact that, in addition the Internal Revenue Service (IRS), the SEC is actively engaging with the sector opens the door to revisit the issues of how crypto is accounted for since policymakers are clearly interested in – and better understanding – the space.
Secondly, and building on this greater acceptance and understanding is the opportunity for market participants to attempt and reorient the regulatory conversation. As increasing numbers of organizations buy, sell, hold, and otherwise utilize crypto as a core component of operations it makes sense that the regulatory – and hopefully accounting – conversations will evolve and mature.
It is too soon to state with any authority how the conversation around crypto accounting will evolve, since depending on the specific cryptoasset in question the accounting treatment could logically vary quite a bit. Treating and classifying crypto as derivatives, commodities, cash equivalents, or inventory might all make sense depending on the facts and circumstances of the situation. With that context, and complications that come with such a multi-faceted sector and space, attempting to address every accounting and reporting issue at once would be foolhardy.
One place to start this process, however, is by incorporating cryptoassets into existing accounting and reporting frameworks and allow organizations to hold these financial instruments at fair market value (current market price). Volatility will never vanish from the crypto sector, nor any other space, but allowing these changes to shown in a transparent, comparable, and consistent matter is essential. The entire point of accounting and reporting rules, after all, is to communicate information and data as they relate to the performance of the organization or asset, and it is time that crypto accounting caught up with market realities.
