In his regular column, JW Verret, law professor, lawyer, CPA and head of the Crypto Freedom Lab covers cryptocurrency law and regulation with a focus on decentralized finance (DeFi) and financial privacy.
Institutional adoption is an exciting but frustrating topic in crypto. The true modern crypto heirs of the 90s cypherpunk legacy have a vision of crypto as human empowerment through decentralization. This vision includes the destruction of intermediaries who charge rent and threaten people’s freedom and privacy. On the other hand, Crypto Twitter becomes abuzz when a major financial institution makes new moves towards crypto.
Dogecoin (DOGE) hoped Elon Musk would use Twitter to help cryptocurrency adoption. The cognitive dissonance extends to the institutions themselves, as banks launch 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 same bank obsolete.
Those broader philosophical issues aside, the U.S.-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 sheets. For now, it’s good for institutions and crypto.
The old method of accounting for crypto on company books was to account for it as software. It appeared on the balance sheet at its historical cost, then was depreciated in depreciation with each fall in price (but was not revalued when prices rose). This has had a chilling effect on public company holdings, except for the diehard Michael Saylors of the world. It’s hard to hold an asset that could stay on your books at the bottom 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 companies with publicly traded shares. The crypto covered by the rule will simply be valued at the exchange-listed price.
However, this should not be the end of deliberations on crypto accounting standards, and there are still many questions to consider. For one thing, 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 please the customer and immediately convert that crypto into fiat dollars. This may not always be the case, and if companies start to use crypto as a currency themselves, then inclusion in some kind of new near balance sheet case or digital cash category would be appropriate. .
Another thing to consider is the differences between asset-backed stablecoins. The USD Coin (USDC) is basically just a cash equivalent and would easily fall into the standard cash equivalent category under generally accepted accounting principles, or GAAP. Tether (USDT) is a closer case and was historically backed by riskier commercial paper, although 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 to need a new category of quasi-cash or quasi-currency.
And what about cryptocurrencies such as Bitcoin (BTC) or Ether (ETH) that a company holds for the purpose of using it to pay for things, like money, and not for purposes investment? Will bitcoin used as a means of payment be counted in a new category of quasi-currency, or will it remain in an investment category despite its partial payment use case? Although it is designed for payments, it is highly volatile, unlike stablecoins.
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Fair valuation methods will be relatively simple to apply to liquid and heavily traded currencies like Bitcoin and Ether, which account for most of what companies hold. But as businesses begin to hold and use other types of cryptocurrencies, many questions will arise.
For digital assets that are not in actively traded markets, it will be difficult to apply conventional financial valuation models to their valuation. Existing financial valuation methods for assets such as shares of public companies may not be fully applicable to cryptocurrencies due to the unique design of the asset class.
The FASB is to be commended for its thoughtful adaptation of accounting principles to this new technology, an approach that the Securities and Exchange Commission and other financial regulators could emulate. The FASB hired crypto-native experts and adapted its rules to the reality of this new technology in a short period of time, ensuring that in the crypto revolution, GAAPs will succeed.
Many questions remain in GAAP accounting for crypto. Crypto natives will have to continue to develop their own accounting methods once we have decentralized finance. For now, this is a useful change to encourage institutional crypto ownership.
JW Verret is an Associate Professor at George Mason Law School. He is a crypto-forensic CPA and also practices securities law at Lawrence Law LLC. He is a member of the Advisory Board of the Financial Accounting Standards Board and a former member of the SEC’s Investor Advisory Committee. He also leads the Crypto Freedom Lab, a think tank fighting for policy change to preserve the freedom and privacy of crypto developers and users.
This article is for general informational purposes and is not intended to be and should not be considered legal or investment advice. The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.