A Position on the Accounting of Cryptocurrency
Following the publication of the famous whitepaper “Bitcoin: A Peer-to-Peer Electronic Cash System”, penned by Satoshi Nakamoto in 2008, cryptocurrency and its underlying blockchain mechanism have become household terms (Nakamoto, 2008; Gupta, 2017). In the succeeding years, the use of both cryptocurrency and blockchain technology have expanded beyond finance and into other commercial industries, creating overnight millionaires and a market cap of over $100B (Boring, 2017). While cryptocurrency is but one application of blockchain, it is perhaps the most controversial, posing legal and ethical issues alike. Chief among these concerns is how cryptocurrency fits into the traditional frameworks of finance and accounting. To answer this question, one must first review the categories by which assets are classified. Once these definitions have been established, both the theory and practical reality of cryptocurrency can be reviewed, and an argument can be made to support which method cryptocurrency filing should be handled.
When discussing how corporations who are required to comply with GAAP standards classify assets, four specific categories are used: Cash and Cash Equivalents, Financial Instruments, Intangibles, and Inventory (Boring, 2017). Each category is defined in the Master Glossary in U.S. GAAP by several criteria that must apply for an asset to be labeled as one of the four categories. The criteria for each are briefly summarized as follows. For Cash and Cash Equivalents, cash includes currency as well as demand deposits, and any charges and credits that exist between an account and the relevant bank. Cash Equivalents are short-term investments of a highly liquid nature that can be quickly converted into cash and mature enough that the risk of changes in value is insignificant (Boring, 2017).
Financial Instruments impose a contractual obligation between entities to deliver and receive cash or other instruments from one entity to another on terms that favor the first entity or disfavor the second. Financial Instruments can represent cash, an ownership interest, or a contract that establishes an obligation. Intangible Assets lack physical substance that allow an entity to receive cash or other Instrument from a second entity or exchange instruments in a manner favorable to the second entity. Lastly, Inventory Assets consists of tangible personal property that is held for sale, items in the production process, or any resources consumed during the production process (Boring, 2017).
With a basic outline of the four asset categories having been established, one may now apply the criteria to cryptocurrency to determine the applicable method. Perhaps the most efficient method is to eliminate the categories with the least potential. A review of the available literature delivers a recurring theme in that neither the Inventory nor Financial Instruments categories are applicable to cryptocurrency as compared to the Cash or Intangible categories (Boring, 2017). As noted in the Chamber of Digital Commerce’s letter to the Financial Accounting Standards Board (FASB), cryptocurrency is not a debt security nor is it an equity security as it does not represent ownership interest or establish a contract. Additionally, the Inventory Asset definition fails as cryptocurrency does not represent tangible personal property and, if exceptions to this rule were made, accounting for currency under the Inventory method would fail to provide sufficient information about the currency’s present value.
Of the remaining categories, Intangible is the oft chosen option (Meyer, 2019). This is largely due to the entirely digitized aspect of cryptocurrency. While imperfect, many proponents believe this option is the most applicable short of establishing an entirely new category tailored exclusively to cryptocurrency (Paul et al., 2018). Due to the nature of crypto and the blockchain ledger system, special attention is given to the indefinite-life aspect of Intangibles (Kordyban, 2019). Another reason for the Intangible option being favored is the negation of the Cash and Cash Equivalent category, rather than the promotion of the Intangibles category. This negation occurs because of two specific criteria that cryptocurrency fails to meet: crypto is not issued by a country’s government and does not represent legal tender (AccountingTools, 2020). Despite the practical application of cryptocurrency closely resembling the function of cash and other cash equivalents, the two above criteria corral cryptocurrencies into the Intangible Assets category.
However, Intangible Assets commonly consist of items such as patents, other copyrights, and intellectual property, none of which cryptocurrency fall under (AccountingTools, 2020). Furthermore, with the development of Non-Fungible Tokens (NFTs), one could argue that the Cash and Cash Equivalent category is better suited for standard cryptocurrency. Non-Fungible Tokens effectively monetize traceability, giving buyers a nearly irrefutable claim to originality, a function with wide-ranging implications for Intangible Assets. These NFT’s can be bought and traded with cryptocurrency, as had been infamously done with countless tangible assets since the deployment of bitcoin. The existence of NFT’s highlights the traditional monetary function of cryptocurrency (Aki, 2021).
All that remains are the two criteria which have acted as a roadblock to filing cryptocurrency under Cash and Cash Equivalents. These two criteria run counter to the central themes of cryptocurrency and blockchain technology, namely decentralization of authority and value derived from transparency. These criteria represent an outdated view of the nature of currency. By requiring cryptocurrency to be government issue, decentralization is defeated. Additionally, the value of cryptocurrency is derived from communal belief in its value and the transparency afforded by the blockchain ledger. To underline that point further, one must simply look to the nature of traditional currency itself. It is estimated that only 8% of the world’s currency exists in a physical form, and “mainstream” currency is fiat, not commodity, based (Chang, 2017). Essentially, both forms of currency rely on trust and belief in the respective value of each. In short, one could argue that cryptocurrency will be more effectively accounted under the Cash and Cash Equivalents category.
As digital currencies and the technologies that drive them continue to experience wider degrees of adoption, refinement and specialization will allow financial and accounting agencies to develop methods that are better suited to the e-commerce landscape. While current methods suffer various shortcomings, recognizing the practical application of cryptocurrency as a cash equivalent will allow contemporary bodies to function with minimal disruption.
Aki, J. (2021, April 8). NFTs explained: What are NFTs and how do they work? BeInCrypto. https://beincrypto.com/learn/nfts-explainer/
Boring, P. (2017). Letter from Chamber of Digital Commerce. Chamber of Digital Commerce.
Cash and cash equivalents — AccountingTools. (2020, September 3). AccountingTools. https://www.accountingtools.com/articles/what-are-cash-and-cash-equivalents.html
Chandrasekera, S. (2020, May 21). How Are Cryptocurrencies Classified In GAAP Financials? Forbes. https://www.forbes.com/sites/shehanchandrasekera/2020/05/21/how-are-cryptocurrencies-classified-in-gaap-financials/?sh=b62229665b24
Chang, S. (2017, November 28). Here’s all the money in the world, in one chart. MarketWatch. https://www.marketwatch.com/story/this-is-how-much-money-exists-in-the-entire-world-in-one-chart-2015-12-18
Gupta, V. (2017, February 28). A brief history of blockchain. Harvard Business Review. https://hbr.org/2017/02/a-brief-history-of-blockchain
Intangible assets definition — AccountingTools. (2020, December 14). AccountingTools. https://www.accountingtools.com/articles/what-are-intangible-assets.html
Kordyban, S. (2019, December 19). Is crypto an intangible asset? HedgeTrade Blog. https://hedgetrade.com/is-crypto-an-intangible-asset/
Meyer, R. (2019, September 24). Crypto is an intangible asset, global accounting standards body argues. CoinDesk. https://www.coindesk.com/crypto-is-an-intangible-asset-leading-accounting-standards-body-argues
Nakamoto, S. (2008). Bitcoin: A Peer-to-Peer Electronic Cash System. Bitcoin. https://bitcoin.org/bitcoin.pdf
Paul, B., Currie, C., & Ohl, A. (2018, March). Cryptocurrencies: Time to consider plan B. Viewpoint. https://viewpoint.pwc.com/dt/us/en/pwc/points_of_view/cryptocurrencies_tim/cryptocurrencies_tim_US/cryptocurrencies_tim_US.html