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The moves by organizations into bitcoin and other cryptocurrencies, highlighted dramatically by the $1.5 billion investment made by Tesla TSLA , have been heralded by many as paradigm shifting events. While it remains to be seen how this ultimately plays out, there is one area of blockchain and cryptocurrency that continues to lag behind; how should organizations do the accounting for these investments on financial statements?

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Bitcoin

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Especially with bitcoin continuing to hit all-time highs, the issues with the current accounting consensus are clear. These 20th century standards are not equipped to handle the 21st century crypto economy, and do not reflect economic reality.

Accounting guidelines might seem like a relatively mundane issue to discuss, but because there are no crypto-specific accounting guidelines, confirmed again recently by the Financial Accounting Standards Board (FASB), this can create situations where financial statements can vary significantly from what might otherwise be expected. Let’s take a look at what this issue is, and what potential solutions exist.

In the face of no authoritative guidance from standard setting bodies, there seems to be a consensus that cryptocurrencies are to be treated as an indefinite lived intangible asset, much like goodwill. On the surface this seems to make sense, as cryptocurrencies are indeed intangible in nature, and do not have a fixed economic useful life. Those surface level similarities aside, however, this patchwork approach to crypto accounting creates several fundamental problems. These problems center around the fact that the prices of cryptocurrencies continue to move back up and down, and these changes should be reflected on financial statements.

Granted, these issues and problems have been around since cryptocurrencies first emerged, but with increasing numbers of institutions allocating millions (or billions) to bitcoin and other cryptocurrencies, these could quickly become serious reporting and disclosure issues.

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Let’s take a look at some of these issues

Impairment. Assets that are classified as indefinite lived intangible assets have to periodically go through what is referred to as an impairment test, where the organization examines the asset to determine if the stated value on the financial statements is overstated versus the marketplace. Without going into the specifics of this process, if there are business conditions or other external forces that cause management to believe that the value of the asset has dropped, an impairment must be taken.

This causes short-term effects, via the reduction of asset value and associated expense on the income statement, but also has a longer term implication. Once an impairment has been taken, under U.S. Generally Accepted Accounting Principles (GAAP), there is no way to recover that lost value. What this means is that if crypto holdings experience a decline in price, this lower value will be permanent and will be unable to be reversed.

As has demonstrated time again, bitcoin and other cryptocurrencies routinely drop and increase in price by double-digit percentages; these price changes need to be reflected.

Collateral issues. Building on this first point, if cryptocurrencies are being used as collateral for other business operations, or are serving as the foundational asset for decentralized finance (DeFi) projects, this could permanently hamper the ability of the organization to operate. Even if the market valuation has indeed recovered, and this knowledge is widespread throughout market participants, under this current consensus these price increases cannot be recorded on GAAP financials.

If an organization is simply buying and holding cryptocurrency as a longer-term bet on crypto becoming a reserve asset, this will have less of an impact, but still diminishes the functionality of crypto in this use case. If, however, organizations are seeking to leverage and use cryptocurrency as a core part of operations, this permanent diminishment of the carrying value of these cryptoassets can hamper, or even halt completely, some of those operations.

So, what could be done to improve the valuation, reporting, and disclosures around cryptocurrencies as they increasingly appear on corporate financial statements? There are actually two potential paths forward, both of which make business sense and would assist in accelerating adoption.

Most simply, an approach that could be taken is to treat cryptocurrency holdings, from an accounting and reporting perspective, as the equivalent of commodities. Not getting bogged down in the accounting codifications, this treatment would mean that 1) cryptocurrencies will be held at their fair market value, and that 2) any gains or losses will be reported on the income statement (or other comprehensive income) as they occur. Clearly there are questions around what this potential increased volatility could do to the financial statements, how often crypto should be measured for fair value, and what external sources should be utilized, but those could certainly be worked through and resolved.

Another potential solution, but one that would require significantly more work and collaboration, is the development of entirely new crypto-specific accounting standards. The potential path forward could be the development of separate sub-categories of cryptocurrencies (crypto-equity, crypto-commodity, etc.), or by trying to integrate various pieces of existing standards while adapting them to crypto-specific issues.

Regardless of what ultimately comes out of the conversations, the takeaway point is that trying to apply existing accounting standards (such as for intangible assets) to cryptocurrencies is akin to trying to fit a square peg into a round hole. Blockchain and cryptocurrencies, among other attributes, have the potential to deliver increased traceability and transparency across the wider economy. In other to do this, however, the rules surrounding how these assets and associated information must be market-based, reflective of market realities, and conducive to wider enterprise and individual use.