Accounting for Digital Assets: Key Considerations for Practitioners
In the aftermath of a disastrous year for cryptoasset prices, centralized crypto organizations and market sentiment around cryptoassets more generally, 2023 is going to be a recovery year. One fact remains abundantly clear: the sector is in clear need of comparable, consistent and understandable financial reporting and disclosure practices. As cryptoassets have become more mainstream, and blockchain-based applications have continued to be adopted by firms in virtually every economic area, the need for more transparency and better reporting continues to grow.
Due to the lack of authoritative accounting and audit standards directly connected to blockchain and cryptoassets, the profession has been seeking to provide solutions such as proof-of-reserves, proof-of-solvency practices and other services attempting to bring some much-needed transparency and reportability to the crypto space.
Setting aside specific services or service lines, let’s take a look at a few of the items that accounting practitioners need to keep an eye on as the calendar eventually moves past tax season.
Valuation is Still an Issue
One of the most difficult accounting-specific tasks connected to cryptoassets is obtaining an accurate valuation, but this is a nuanced point. For certain cryptoassets, such as bitcoin and ether, or other widely traded crypto, the valuation process is relatively straight-forward. The vast majority of cryptoassets, however, are not as widely traded or talked about in the mainstream media, and this requires some additional questions to be asked, such as:
- Where is the asset in question traded?
- Are there any “whales,” whose large ownership stakes can distort
- Where does this cryptoasset tend to be used by U.S. taxpayers or by international actors?
- Are there additional factors such as income production, staking or ownership rights that could influence valuation?
As the aftermath of the collapse of FTX continues to weigh heavily on the crypto space, as well as provide impetus for new and expansive regulation, a related accounting question has to do with how the cryptoassets in question are being held. Hot wallets, primarily involving investors depositing crypto information with an exchange or other trusted third-party, have certainly seen a decline in popularity as investors withdrew billions from such exchanges during late 2022 and early 2023. Cold wallets, or hardware wallets, are not nearly as convenient, but do provide an additional layer of security and the upsides associated with self-custodianship.
In any case, accounting professionals must be able to have productive and relatively in-depth conversations with clients around wallet security. If a hot wallet is utilized, some of those questions should center around the insurance or investor protection offered by the exchange, and for cold wallets, appropriate documentation and controls need to be established over the safeguarding of the physical device itself. In either case, internal controls, succession planning and data integrity over key information need to be a priority in any accounting conversation.
Regulation is Coming
One thing that is almost guaranteed is that regulation, be it from accounting standard-setters or some other body, is coming for the crypto space, and it will be coming sooner than many market actors might expect. While the accounting implications of more regulation are difficult to forecast, one area to keep an eye on is how (hopefully) private-sector solutions can have an impact on the final forms of regulation that do emerge. Mentioned above, proof-of-reserves is an accounting process already offered by several firms, but it is not an
authoritative accounting or auditing standard.
That means that, almost without a doubt, whatever accounting standards do emerge, there will be a period of volatility and dislocation that crypto investors will need to navigate successfully.
No matter what the regulation is that arises, accounting professionals are uniquely well positioned to help clients navigate these fast-changing times. Cryptoassets are here to stay, that much is widely agreed upon by developers, investors and policymakers alike; firms and practitioners must be up-to-date on changes in accounting and regulatory treatment to best advise both current and future clients.
Sean D. Stein Smith
Dr. Sean Stein Smith, CPA, DBA, CMA, CGMA, CFE, is a professor at the City University of New York – Lehman College. He is a member of the NJCPA Board of Trustees, participates on several interest groups.
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This article appeared in the Spring 2023 issue of New Jersey CPA magazine. Read the full issue.