In his regular column, J.W. Verret, a law professor, attorney, CPA, and head of the Crypto Freedom Lab covers law and regulation of cryptocurrency with a focus on decentralized finance (DeFi) and financial privacy.
Institutional adoption is an exciting yet frustrating topic in crypto. The true modern-day crypto inheritors of the 90s cypherpunk legacy have a vision for crypto as human empowerment through decentralization. That vision includes breaking down the intermediaries that charge rents and threaten human freedom and privacy. On the other hand, Crypto Twitter becomes abuzz when a large financial institution makes new moves into crypto.
Dogecoin (DOGE) mooned on the hopes that Elon Musk would use Twitter to help the cryptocurrency’s adoption. The cognitive dissonance extends to the institutions themselves, as banks start crypto projects without considering how a crypto payment system built on the Bitcoin Lightning Network or an Ethereum layer 2 is intended to make that very bank obsolete.
Those broader philosophical questions aside, the United States-based Financial Accounting Standards Board, or FASB, instituted a change to accounting standards in October that will help public companies hold digital assets on their balance sheet. For now, that’s good for both institutions and crypto.
The old method of accounting for crypto on company books was to account for it as software. It went on the balance sheet at its historical cost and then was written down as a value impairment on every price drop (but not written up again when prices went up). This was a deterrent to public company holdings for anyone but the die-hard Michael Saylors of the world. It’s hard to hold an asset that might remain recorded on your books at the bottomed-out price of the last bear market.
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The new rules take a more reasonable approach and implement the same fair value accounting rules that apply to company holdings of publicly traded stock. Crypto covered by the rule will simply be valued at the publicly listed price.
This shouldn’t be the end of accounting standard deliberation over crypto, however, and there are still many questions left to consider. For one, stablecoins backed by other assets are not included in the new accounting methodology.
Many public companies that are willing to accept crypto from customers do so to humor the customer and immediately convert that crypto into fiat dollars. That may not always be the case, and if companies start using crypto as currency themselves, then inclusion in some kind of new balance sheet quasi-case or digital cash category would be appropriate.
Another thing to consider is the differences in asset-backed stablecoins. USD Coin (USDC) is basically just a cash equivalent and would readily fit the standard cash equivalent category in generally accepted accounting principles, or GAAP. Tether (USDT) is a closer case and was historically backed by riskier commercial paper, though that is changing. Maker’s Dai (DAI) is a very different form of stablecoin, partially backed by USDC and partially by other cryptocurrencies. Dai seems like it would need a novel quasi-cash or quasi-currency category.
And what about cryptocurrencies such as Bitcoin (BTC) or Ether (ETH) that a company holds for the purposes of using it to pay for things, like cash, and not for investment purposes? Will Bitcoin used as a means of payment be accounted for in a new quasi-currency category, or will it remain in an investment category despite its partial payment use case? While it is designed for payments, it is highly volatile, unlike stablecoins.
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Fair valuation methods will be relatively straightforward to apply to liquid, highly traded currencies like Bitcoin and Ether, which is most of what companies are holding. But as companies start holding and using other types of cryptocurrencies, there will be a wealth of questions to consider.
For those digital assets not in actively traded markets, it will be a challenge to apply classic financial valuation models to their valuation. Existing financial valuation methods for assets like stock in public companies may not entirely carry over to cryptocurrencies because of the unique design of the asset class.
The FASB should be saluted for its thoughtful adaption of accounting principles to this new technology, an approach the Securities and Exchange Commission and other financial regulators might learn from. The FASB hired crypto-native experts and adapted their rules to the reality of this new technology in a short period of time, ensuring that in the crypto revolution, GAAP is going to make it.
Many questions remain in GAAP accounting for crypto. Crypto natives will need to continue to develop their own accounting methods once we decentralize finance. For now, it’s a helpful change to encourage institutional crypto holding.
J.W. Verret is an associate professor at the George Mason Law School. He is a practicing crypto forensic accountant and also practices securities law at Lawrence Law LLC. He is a member of the Financial Accounting Standards Board’s Advisory Council and a former member of the SEC Investor Advisory Committee. He also leads the Crypto Freedom Lab, a think tank fighting for policy change to preserve freedom and privacy for crypto developers and users.
This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.