Ep. 34 - Accounting for Bitcoin: The impact on corporate & institutional investment

Cryptocurrency, and mainly Bitcoin, have gained significant traction in mainstream media over the course of the last 12 - 16 months. Many practitioners in the space believe we’re at the beginning of a major bull run, which could see the Bitcoin price reach $100 - $200k (myself included). Considering this and Bitcoin’s performance over the past decade, which has seen it witness a CAGR of 200% annually, many would have expected Bitcoin to be on more public company balance sheets by Q4 2021.

Moreover, the United States recorded a 31 year inflationary high in October when CPI clocked in at 6.2%. Therefore, any bond you buy literally loses money [GICs and Money Market funds are completely useless]. So, we have negative-yielding bonds and inflation hitting all-time highs, while Bitcoin, the best performing asset of the last decade, still remains off the balance sheet of many corporations. Why is this?

Many believe it’s the volatility. However, volatility is the price we pay for asymmetric returns. Plus, many institutions and corporations have a much lower time preference than individuals (they hold investments for generations, whereas retail investors - me and you -  tend to be more emotional), so we’d expect them to be willing to ride the wave of volatility. Another thought is the fact Bitcoin fights against the US Dollar, which the Fed and the government at large don’t like. And we all know how closely tied Wall Street and the White House are, so potentially these companies don't want to 'stir the pot' with anyone in Washington. Hence, we only have true visionaries (Elon Musk, Michael Saylor, etc) making these bets and accumulating Bitcoin on their company (Tesla, MicroStrategy) balance sheets.

However, I will argue there is another major issue; the accounting for cryptocurrencies does not currently align with how the asset is viewed and operates. The current accounting framework leads to the increased complexion, administrative time, and investor confusion.

Current Accounting Codification

First, it’s important to note that cryptocurrencies, including Bitcoin, are not specifically covered in any accounting codifications, although all of the Big Four [PwC, KPMG, Deloitte, EY] have created their own interpretation of how these assets should be treated.

Currently, Bitcoin is treated as an indefinite-lived intangible asset according to KPMG and Deloitte under US GAAP. The main argument is that Bitcoin does not convey specific rights akin to traditional Financial Instruments. Indefinite-lived intangible assets are not amortized and are measured at historical cost. Impairment is recognized when their carrying value exceeds fair value, of which these impairment losses are not able to be reversed if the fair value subsequently increases. That means that when the asset is impaired, the company must write down the value on its books. The converse is not true. The value of the asset cannot be written up when, and if, the price goes up or a previously written-down asset subsequently recovers. Consequently, for accounting purposes, it is virtually impossible to book any ROI on digital assets held as investments. Clearly then, the rules and framework for digital assets present certain important constraints: It is not possible for the company’s accounting function to reflect the economics of how it may value its digital assets.

Herein lies the main issue - many believe Bitcoin would be better suited for fair value accounting (recognizing gains and losses as the price fluctuates), however, this is not allowed for indefinite-lived intangible assets under US GAAP.

For example, let’s say Company X bought one Bitcoin for $58k USD on April 20, 2021. Then on June 30, 2021 (end of Q2), the price of Bitcoin was $30k USD. So, Company X would recognize a loss of $28k USD, and the new value of the Bitcoin on the balance sheet would be $30k USD. Then, as of September 30, 2021, the value of Bitcoin is now $62k USD. But using the current accounting codification Company X cannot recognize the $32k USD increase in value, as I mentioned before, these impairment losses are not reversible. From a Company’s perspective, this is frustrating and it provides investors with a false picture of true operations. Although GAAP accounting is somewhat fugazi, the average investor may look at the bottom line and assume ‘Company X lost money this quarter’ when in fact their operations could have been net positive, however, their investments led to the net loss.

As we can see, the current accounting codification is not friendly for corporate adoption. This leads companies to include a ‘Non-GAAP’ section, plus a Q&A similar to what Microstrategy has done. It’s admin-heavy and complicates their financial statements.

Fair Value Accounting

I share the opinion of many practitioners in the space, who believe a more reasonable and fair approach to accounting for Bitcoin and other cryptocurrencies would be to account for them under ASC 321 - Investments, Equity Securities. Particularly it fits the below definition:

The fair value of equity security is readily determinable if sales prices or bid-and-asked quotations are currently available on a securities exchange registered with the U.S. Securities and Exchange Commission (SEC) or in the over-the-counter market, provided that those prices or quotations for the over-the-counter market are publicly reported by the National Association of Securities Dealers Automated Quotations systems or by OTC Markets Group Inc.

To demonstrate how this would alter a Company's financial statements, let’s use the same example. So, Company X bought one Bitcoin for $58k USD on April 20, 2021. Then on June 30, 2021 (end of Q2), the price of Bitcoin was $30k USD. So, Company X would recognize a loss of $28k USD (same as above). However, as of September 30, 2021, the value of Bitcoin is now $62k USD, therefore the Company would recognize a gain of $32k USD (net gain of $4k USD over the two quarters). Unlike the example above, Fair Value accounting allows companies to recognize gains and losses on a quarterly basis, whereas indefinite-lived intangibles only allow for non-reversible impairment losses.

This ability to recognize gains and losses similar to other investments would free the organization of admin costs and time, reduce confusion, and allow them to perform more of their accounting in-house (as opposed to hiring consultants, outside specialists, etc.).

Closing

These nuances are typical for early technology. The accounting boards are historically painfully slow at adopting change and filled with bureaucracy adding to the challenges.

There have been many letters written to FASB and other accounting boards, and many petitions signed in order to have this changed.

This simple change could open the floodgates for corporate adoption and be another catalyst in the meteoric rise of Bitcoin. Only time will tell.