Cryptocurrency: Understanding the Basics and Accounting Challenges
Bitcoin and other cryptocurrencies are becoming more mainstream. It seems to be showing up everywhere you turn these days. We see advertisements on billboards and television commercials. It has not only made its way into the financial or investing world but also into many other areas such as sports, art, music, and gaming to name a few.
But do you really know the basics of cryptocurrencies? Or how to account for them? Well, that’s what this blog post is for!
Cryptocurrency basics
Cryptocurrency is a medium of exchange or form of currency that only exists digitally. It is secured by cryptography and runs on a blockchain. Cryptocurrency can be used to transfer value directly from one party to another anywhere in the world, without needing to rely on a trusted third party in the middle. The value of any given cryptocurrency is determined by the buyers and sellers in the market.
Cryptocurrencies are built on a blockchain. A blockchain is a decentralized, distributed public ledger that records transactions. Transactions are recorded in blocks that confirm the exact time and sequence of transactions and are linked together using cryptography. Once a block is added to the blockchain, it is immutable. And, because a blockchain is a distributed ledger, it means that all participants in the network have access.
There are thousands of cryptocurrencies that serve various purposes (e.g., units of exchange for goods and services, to serve as a store of value, to solve a problem, to serve a specific industry, etc.). Examples of the most well-known ones include, Bitcoin, Ethereum, Tether, Ripple, and Cardano.
Bitcoin: The oldest cryptocurrency
Bitcoin is the oldest cryptocurrency and the largest by market cap. It was initially introduced in late 2008 via a whitepaper entitled, Bitcoin: A Peer-to-Peer Electronic Cash System. The author was named as Satoshi Nakamoto but the identity of the inventor remains a mystery. The whitepaper described Bitcoin as “a purely peer-to-peer version of electronic cash [that] would allow online payments to be sent directly from one party to another without going through a financial institution”.
The first Bitcoin transaction took place in early 2009 when the starting block of the Bitcoin blockchain was mined. Mining is the process by which new units of digital currency are created. The last bitcoin is expected to be mined around 2140 as the total supply of Bitcoin was programmed into the code by its creator and cannot be changed.
Bitcoin has now been around for over 13 years and large corporations, such as MicroStrategy, Tesla, Block, and Coinbase have added it to their balance sheet. CEO of MicroStrategy, Michael Saylor, explained his reasoning after their first purchase in August 2020 as follows:
“This investment reflects our belief that Bitcoin, as the world’s most widely-adopted cryptocurrency, is a dependable store of value and an attractive investment asset with more long-term appreciation potential than holding cash. Since its inception over a decade ago, Bitcoin has emerged as a significant addition to the global financial system, with characteristics that are useful to both individuals and institutions. MicroStrategy has recognized Bitcoin as a legitimate investment asset that can be superior to cash and accordingly has made Bitcoin the principal holding in its treasury reserve strategy.”
Cryptocurrency status
According to CoinMarketCap, one of the most popular price-tracking websites for crypto assets, at the time of writing this blog, the global crypto market cap is $2.17 trillion, down from an all-time high of $3.3 trillion in November 2021. And according to Ark Investment Management, “Ark expects crypto assets and digital wallets to command nearly $50 trillion in equity market capitalization by 2030.”
Current U.S. President Joe Biden signed an executive order on March 9, 2022, calling for a “whole-of-government approach” to ensure responsible development of digital assets, including cryptocurrencies. We hear of more and more companies getting involved, whether it be investing in cryptocurrency, accepting cryptocurrency as payments, or launching non-fungible tokens (NFTs) or NFT marketplaces.
As government starts the process of creating regulations for digital assets and corporations embrace cryptocurrency, it becomes more and more important for us to understand the basics of digital assets, including cryptocurrencies, and the accounting for them.
Accounting for cryptocurrency
As of the date of this blog, there are no U.S. GAAP accounting standards that specifically address the accounting for digital assets. In practice, the accounting treatment under U.S. GAAP is to account for cryptocurrencies as intangible assets.
This poses some challenges though, as under intangible asset accounting, a cryptocurrency is accounted for at cost and is subject to impairment testing. If the cryptocurrency is deemed impaired, then it is written down. If the price of the cryptocurrency goes up or if a cryptocurrency that was previously written-down subsequently recovers, it cannot be written up.
This can be misleading as we know the cryptocurrency market can be quite volatile. If we look at Bitcoin for example, it hit an all-time high price of approximately $68,600 on November 10, 2021, but declined by February 28, 2022 with a closing price of approximately $37,706.
Under current acceptable accounting practice, since only the downside is captured, the economic value may not be reflected in the financial statements, especially if a cryptocurrency investment experiences large increases in value.
2024 update
New cryptocurrency guidance under U.S. GAAP has been issued! ASC 350-60 now requires all in-scope crypto assets to be subsequently measured at fair value (in accordance with ASC 820), with any changes in fair value recorded into the income statement. There are some considerations for what’s in scope, some exceptions that exist and various required disclosures, which we all discuss in our Crypto Assets elearning course.
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Disclaimer
This post is for informational purposes only and should not be relied upon as official accounting guidance. While we’ve ensured accuracy as of the publishing date, standards evolve. Please consult a professional for specific advice.
