Companies are beginning to enter into nontraditional investments, such as Bitcoin and other digital assets. With strong growth potential, digital assets are an appealing venture. For one, certain digital assets may act as a natural hedge against fluctuating government-issued (fiat) currencies. Also, as more companies embrace modern and open technology, digital assets could become a more common form of customer payment.
Like all investments, digital assets should fit into the broader investment strategy developed by your company. There’s an element of risk involved with cryptocurrencies because of the often volatile market, and regulators continue to evaluate how to oversee the evolving digital landscape. The rules of play are not set in stone, which makes risk assessment of digital assets crucial. Cryptocurrency investments will require constant monitoring of market and risk factors. The liquidity of digital assets will also need to be evaluated and aligned with the corporate investment strategy.
As these new digital investments and currency forms become more prevalent, there’s an increasing likelihood that your organization will interact with digital assets in one shape or form. Basic accounting and tax compliance with digital assets are challenging. However, the more we understand how digital assets work, the easier it will be to comply with laws and regulations.
Common Accounting Considerations
Right now, the U.S. GAAP, as represented by Financial Accounting Standards Board Codification, has yet to provide specific guidance on accounting for digital assets. In practice, though, most accountants choose to treat digital assets as indefinite lived tangible assets, subsequently evaluating them for impairment when required. Under the indefinite lived asset model, an impairment might require a write-down of the cost basis but does allow a "mark-up" to fair value even when the digital asset's price has recovered. Because digital assets are not accounted for at fair value, disclosures have been been used to provide meaningful information to the users of financial statements with respect to the market value of such digital asset investments. However, care should be taken as these disclosures may unknowingly venture into non-GAAP territory.
It's also important to note that digital assets held for investment purposes are typically deemed capital assets for tax purposes. Like most everything about digital assets, tax rules are still a work-in-process and may differ significantly depending on the jurisdiction.
Understanding Digital Asset Investment
A robust internal control system is crucial given the risks and uncertainty of investing and managing digital assets. Digital assets are unique in many ways, and these attributes mean that the risks associated with them may also be different. Companies must understand how each asset in which they are invested functions from a technical perspective, how each one operates, and assess related market vulnerabilities.
Another fundamental consideration is the custody of the asset. Can or will the company take custody of the asset or will the company rely on third-party vendors? Self-custody has certain advantages, such as ease of access, but disadvantages include the risk of loss due to accident or theft. Additionally, recordkeeping must be considered, such as the monitoring and recording of initiated transactions. Given the inherent complexity and risk associated with self-custody, it is common to engage third-party custodians. Third-party vendors carry their own set of risk considerations, so companies that use a digital asset custodian must adequately evaluate their vendor’s control procedures.
Segregation of duties is imperative as well – this is a form of a currency after all. A responsibilities matrix documenting the approved "chain of command" remains an essential tool to mitigate fraud and ensure that only authorized transactions are allowed. Timely monitoring of transactions that are committed to the blockchain must also take place. And remember, digital assets are not FDIC insured. Consider the need for other insurance in the event of a loss.
Other Important Notes
If your company uses digital assets or cryptocurrencies, be prepared for additional questions from your accounting and tax providers about the nature of your dealings. Be aware that regulators are rapidly evolving their guidance on reporting, so the rules of engagement today may be different in the years to come.
For additional comments, questions, or concerns, about reporting on cryptocurrencies please contact us.
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