Crypto is About to Change Bookkeeping Rules

Posted on November 21st, 2022

“Accounting is the language of business,” said Warren Buffett. “You have to be as comfortable with that as you are with your own native language to really evaluate businesses.”

Buffett is right. Modern accounting is so important that some consider double-entry bookkeeping one of the great innovations of all time. According to economist Tim Hartford and others, it enabled Venetian and Tuscan merchants in the 1300s “to keep track of … extraordinarily intricate web[s] of transactions” around the Mediterranean over time, laying the foundation for managing the modern global enterprise.

Perhaps because of its long history, vast size and enduring usefulness, the accounting profession takes time to absorb new information and update the rules.

Currently, there are no specific rules for how to do accounting for cryptocurrency, which makes sense since the asset class itself is barely a decade old. This has made for some awkward jerry-rigging as the profession has tried to make the old rules fit a new asset class. That may soon change.

Cryptoassets: Fair Value and Fair Treatment

Earlier this month, the Financial Accounting Standards Board concluded firms should measure cryptoassets using fair value accounting, with gains and losses recorded in current period comprehensive income. This decision is not final and so it will take time before these standards are reflected in US GAAP and other accounting rules that guide the profession's day-to-day decisions.

Still, this is a big step forward as it gets us closer to the day when it will be practical and straightforward for companies to carry cryptoassets on their balance sheets. Currently, the lack of clarity in accounting standards for cryptoassets is often cited as a reason for limited adoption of cryptoassets by firms.

According to a recent article in CPA Practice Advisor, most cryptoassets are accounted for as indefinite-lived intangible assets, such as trademarks, in the absence of crypto-specific US GAAP. This often means companies must carry the asset at the lowest value since purchase, rather than simply marking to market based on current values. Logically, a company will prefer not to hold an asset if it is carried at an artificially low value, especially if it means they need to take a significant impairment charge on that asset when it declines in value from the purchase price. Nonetheless, some companies like Block do carry Bitcoin despite the financial headache, while many more would like to do so.

In coming years, many enterprises will own cryptoassets, either as a treasury investment, or because it is essential to operating their day-to-day business—for example, it’s easy to imagine many corporations who offer web3 services needing to carry ETH on their balance sheets to act as a network validator. This should make adoption that much easier.

Mind the GAAP: Leapfrogging Traditional Accounting

In the short-medium term, this is a big positive that will ease the path for companies to own this asset class. Long term, however, we think that much of the accounting industry itself will be replaced as more transactions move on-chain. Blockchains enable triple-entry bookkeeping, with the third entry (or entries) appearing on-chain, that is, every transaction created an entry in a blockchain that anyone can see. Already, we can search, verify, and audit on-chain data across a range of blockchains. Soon, we will have a record of large amounts of economic activity, not only the movement of money, but also the trading in financial assets, IP, and even physical goods in this way.

The example of Yearn Finance is illustrative. The DeFi lender has made its GitHub repository a destination for data about the platform, all of which can be independently verified on-chain. On it, we can track every single Yearn transaction in real time, get transaction records and search protocol income, protocol expenses, income statements, end of month balances and more. We can see revenue projections, charts, tables, and other useful data. In the future some mix of verifiable on-chain raw data, data analysis tools, and verifiable information curated by individual projects like Yearn will replace the quarterly statements and other financial paperwork of today.

In a world where on-chain data gives us a perfect snapshot into the financial health of an organization, what role is there the accounting firm or auditor? Plenty, it turns out. However instead of auditing data in a spreadsheet, auditors will have to vet on-chain data and audit smart contracts. Time for them to brush up on Web3.

Source: Yahoo Finance