Accounting for Crypto-Native Companies
The rise of cryptocurrencies and blockchain technology has created new challenges and opportunities for businesses that operate in whole or in part on-chain. Although transaction history is cryptographically stored in a blockchain, deciphering and properly accounting for transactions can be complex and cumbersome. For Web3 and crypto-native companies that are on the leading edge of innovation, this reporting can be a burden on valuable resources. The following are tips for navigating these nuances and what to consider when doing business in this new frontier.
Books and Records
Under U.S. Generally Accepted Accounting Principles (GAAP), crypto is generally accounted for as an intangible asset (ASC 350). This treatment applies to the majority of companies, other than investment companies, and dictates that crypto assets should be recorded at cost and evaluated for impairment, with a gain or loss recognized based on the crypto’s fair market value (FMV) at the time of disposal. While the Financial Accounting Standards Board (FASB) has proposed fair value treatment for certain crypto assets in a new accounting standards update exposure draft that may alleviate impairment analysis concerns, both the current U.S. GAAP recognition and potential future FMV treatment require diligent recordkeeping.
For each crypto transaction, records should include a transaction identifier (e.g., the transaction hash stored on the blockchain), the number of crypto asset units sent or received and their underlying cost basis, FMV and any associated gain/loss upon disposal, as well as identification of the customer or vendor. In addition, companies must also develop a process for assessing their crypto assets for impairment. In an industry where markets never close, this can be a monumental task in and of itself. Due to the limitations of modern-day accounting software packages, crypto-native companies often utilize additional crypto accounting software to track units, FMV, cost basis and impairment; these software solutions generate the requisite journal entries and often obtain transactions directly from the blockchain based on the company’s wallet address(es).
A central theme of cryptocurrency is the removal of centralized intermediaries. In traditional finance, these intermediaries (e.g., banks, brokerages) are responsible for account access, custody, monitoring, transaction settlement verification, reporting and compliance. Without these intermediaries, the onus falls on the users and therefore necessitates a robust, well-thought-out control framework. This includes assessment and implementation of appropriate controls for maintaining, executing and recording crypto transactions, safeguarding assets and maintaining regulatory compliance. For companies using outsourced crypto services, it also includes complimentary user controls outlined in the third party’s system and organization control (SOC) 2 reports.
Counterparty identification and documentation is another crucial consideration when conducting business on-chain. Cryptocurrency transactions are inherently pseudo-anonymous, requiring little more than a wallet address and private key to initiate a transaction. It is therefore the company’s responsibility to add a layer of identification to incoming and outgoing crypto transactions to make sure they know their counterparty. This is important for revenue/expense recognition, related-party identification and disclosure, and regulatory compliance.
It is easy to see how these considerations can quickly seem untenable for a crypto-native startup or enterprise looking to integrate blockchain technology. Having an accounting process with reliable reporting that follows the appropriate standards and industry best practices is critical for compliance and mitigating risks. By leveraging the expertise of reputable accounting, tax, technology and legal advisors, businesses can more successfully establish an internal or outsourced crypto accounting system that will support transactions on-chain.
Walter S. Zinenko
Walter S. Zinenko, CPA, is the blockchain and digital asset services manager at EisnerAmper. He is a member of the NJCPA.