Accounting and Recordkeeping for Digital Assets

In recent years, the financial world has witnessed a profound transformation with the advent of digital assets, which include cryptocurrencies, Non-Fungible Tokens (NFTs), and Stablecoins. These digital assets will progressively integrate into more users' everyday lives as they find more real-world applications. Understanding their accounting treatment under US GAAP becomes crucial for businesses that interact with these systems.

What Are Cryptocurrencies, NFTs, and Stablecoins?

Cryptocurrencies

Cryptocurrencies, such as Bitcoin and Ethereum, provide decentralized and secure alternatives for peer-to-peer transactions. Operating on blockchain technology, cryptocurrencies utilize cryptographic techniques to secure transactions of financial (tokens) and non-financial (data) assets. They seek to incentivize various actors to participate toward a common goal by controlling the supply of cryptocurrency tokens.

NFTs

Non-Fungible Tokens (NFTs) have also captured the spotlight, introducing a unique form of digital ownership for various things, from consumables such as event tickets to assets such as art and music rights, collectibles authenticity, and other digital assets. NFTs are distinct and indivisible tokens that verify the ownership and provenance of specific items.

Stablecoins

Furthermore, Stablecoins have emerged as a practical solution to address the price volatility inherent in many cryptocurrencies. Through various financial mechanisms not unfamiliar to the traditional finance world, Stablecoins seek to maintain a stable value and facilitate seamless transactions.

This blog will delve into high-level guidance on accounting for Fungible Cryptocurrency Tokens, NFTs, and Stablecoins, providing essential insights for accountants seeking to navigate this dynamic and innovative sector.

Best Practices for Accounting and Recordkeeping of Digital Assets

Before diving into detailed GAAP accounting for the various types of digital assets, it is important to build a good bookkeeping system for your assets. The accounting guidance is still being built out, so tracking details will provide options for reporting when guidance inevitably changes. Solid internal controls and bookkeeping practices are essential for businesses engaging with digital assets. The complexity of your internal controls should reflect the size and complexity of your business, but a few basics to strive for include:

• Separation of duties - The person with account (commonly referred to as ‘wallet’) access and private key knowledge (or the ability to send and receive digital assets) should be separate from the person accounting for those transactions.
• Reconciliation - Treat your digital asset accounts similar to your bank accounts. If you use a provider, they may provide statements or ‘snapshots.’ If you are managing your own assets, then you will need to go to the blockchain to see these records. Reconciling your accounting records to these blockchain records will help ensure that all activity is captured and reported to the business owners.

On the bookkeeping side, digital assets can be your friend, as all transactions are already tracked on a blockchain. This provides a great data set to start with rather than manually tracking each individual transaction. Maintaining separate accounts for each digital asset category or token (i.e., accounts for ‘bitcoin,’ ‘Ethereum,’ ‘USDC,’ and ‘NFTs’) will help with reconciliations and maintaining detailed income statement accounts.

These accounts will encompass transaction fees, minting costs (NFTs), staking rewards, realized gains/losses, and unrealized gains/losses and will provide you with insights for management to use in tax reporting and GAAP needs. A tracking system similar to inventory tracking (LIFO, FIFO, or Specific Identification) is necessary to calculate realized gains and losses on trades for tax purposes. Accurate records of purchase and sale transactions, including the token price for each transaction (in US dollars), will enable you to do these calculations and change your methodology should the IRS update its rules for which methods are allowed.

Example:

Let’s walk through a simple example of the purchase, wallet-to-wallet transfer, and sale of one Bitcoin (BTC) and one Ethereum (ETH).

You purchase one BTC and one ETH token each on a cryptocurrency exchange for a total of $30,900 ($1,900 for ETH and $29,000 for BTC). You also pay an exchange fee of $215 ($15 for ETH and $200 for BTC). These exchange fees are included in the cost of the assets recorded (see below).

At this time, you would also add your 1 BTC and 1 ETH token to their respective cryptocurrency inventory tracking sheets. These should include the date purchased, token name (i.e., BTC & ETH), quantity received (in tokens), price paid (in dollars), and transaction fees paid (in dollars – converted at the transaction price if paid with tokens).

You then want to move your ETH token to a different wallet so that you can access a decentralized application on the Ethereum blockchain. Upon doing so, you are charged a blockchain ‘gas’ fee of two cents. You do this immediately after purchase, so there has been no price fluctuation in ETH yet.

You would also record this transaction in your inventory tracking sheet because you pay Ethereum gas with ETH tokens. Rather than removing the previously purchased quantity, you would add a line to record the sale. That way, you can use this data for many different inventory tracking methods. For sale or disposal transactions – you need to track the following data:

• Date sold
• Token name
• Quantity sold
• Price received (in dollars)
• Transaction fees paid (in dollars)

For the next six months – you have no other cryptocurrency transaction activity. At the end of that time, you sell your tokens. You receive a price of $27,000 for your 1 BTC and pay $100 in transaction fees.

At this time, you also trade your ETH token for USDC (a stablecoin that ties its value to the US Dollar). You receive a price of $2,900 (in USDC) and pay transaction fees of $20.

You will record these transactions in your inventory tracking system as well, including the data referenced above. Because we only had one purchase price for each token, any inventory method (LIFO, HIFO, Specific Identification, etc.) will result in the same gain or loss above.

At the end of this example, you will have 2,880 USDC tokens in your cryptocurrency inventory and $2,880 of USDC value on your general ledger. You can also calculate the net realized loss on cryptocurrency trading of $1,334.98 with your inventory tracking sheet so your records are fully reconciled.

As you can see, there is a lot that goes into the tracking of digital asset activity. You may also consider using specialized accounting software that supports digital asset management and integrates with traditional bookkeeping systems. Software like Koinly, Cointracker, Cryptio, Coinbooks, and Integral typically handle the inventory tracking data-keeping portion of the process above. Some only track your tokens, purchases, and sales, and some integrate with accounting software and will record journal entries. In either case, you will still need to reconcile your inventory tracking and general ledger data regularly.

Finally, ensure your accountant or bookkeeper understands the nature of the assets, transactions, and business goals of using them so they can accurately record any accounting accruals that may be necessary for financial reporting. Cryptocurrency, stablecoin staking, and NFTs with embedded media rights or royalties are just a few examples where accounting transactions are needed even when no blockchain transactions occur.

Accounting for Digital Assets under Current and Impending GAAP Rules

Digital assets are looked at in three separate categories for GAAP accounting: Cryptocurrency tokens, Stablecoins and Central Bank Digital Currencies, and NFTs. Each is accounted for differently.

Current GAAP Accounting for Digital Assets

Under the current GAAP rules, businesses must adhere to the following accounting principles for digital assets:

Classification

Cryptocurrencies are typically classified as intangible assets or inventory, depending on the company's specific involvement and purpose for holding these assets.

• NFTs require more scrutiny for classification as they must be classified in line with the intangible assets they represent (i.e., rights to revenues, IP usage rights, etc.) and may sometimes include liabilities to the issuer or seller (such as royalties, etc.). In these cases, NFTs should be considered analogous to contractual media rights and accounted for accordingly. Accountants should understand all aspects encoded into the NFT, including items such as the storage responsibility of the underlying asset.
• Stablecoins and Central Bank Digital Currencies do not meet the definition of a crypto asset and instead may be classified as a currency or meet the definition of a financial asset, security, or derivative.

Initial Recognition

Businesses should recognize digital assets at their acquisition cost, which comprises the purchase price and any directly attributable costs incurred to bring the asset, such as transaction fees to a marketplace, blockchain transaction fees, etc.

Minting costs for NFTs may be looked at differently. For example, if the NFT represents rights to a song, these costs should be considered under the guidance of FAS 50 – Financial Reporting in the Record and Music Industry.

Subsequent Measurement

After initial recognition, companies must measure digital assets at their historical cost, less impairment losses (for cryptocurrencies), or accumulated depreciation/amortization (for NFTs, where applicable).

Impairment

Regularly assess digital assets for impairment. If the carrying amount of an asset exceeds its recoverable amount (fair value less costs to sell), the company must recognize an impairment loss. For cryptocurrencies traded on open markets, companies must impair their tokens when the trading price falls below the purchase price. It is also important to understand how widely traded the token is and if your holdings represent a substantial portion of the total circulating supply of tokens. In these cases, a discount from the market price is necessary as a transaction of your token quantity would likely require a below-market price to attract a trading partner.

Disclosure Requirements

Under current US GAAP, there is no explicit guidance for crypto assets. As a result, the presentation and disclosure of these assets and transactions should follow the rules for the accounting model chosen to apply to each asset. These will likely be ‘intangible assets’ for cryptocurrencies and ‘financial assets’ for stablecoins. NFTs may fall into a variety of categories depending on the nature of the NFT.

Impending GAAP Accounting Update for Digital Assets

In response to the dynamic and evolving nature of digital assets, the Financial Accounting Standards Board (FASB) has been actively working on an update to the GAAP rules. The impending update is expected to address digital assets' accounting and disclosure challenges and provide clearer guidance to businesses.

1. Measurement at Fair Value - The coming update is likely to require businesses to measure most digital assets, including cryptocurrencies, at fair value rather than historical cost. This change aims to reflect the market value of these assets more accurately due to their high volatility.
2. Disclosure Enhancements - The FASB intends to enhance the disclosure requirements to provide users of financial statements with more insightful information about the nature, risks, and valuation methods of digital assets.
3. Impairment Considerations - The new GAAP update may also introduce specific impairment considerations for digital assets, ensuring businesses account for potential declines in value more effectively.

By adhering to the current GAAP principles and preparing for the impending update, businesses can maintain accurate financial reporting, ensure compliance, and provide stakeholders with a clear understanding of their digital asset interactions. If you have questions about accounting for digital assets, please contact us.