Break Out the Popcorn for Bitcoin Infighting and Legitimizing Cryptocurrencies

By | 2 weeks ago

There are certain words that cause me to zone out. Bitcoin. Cryptocurrency. Ethereum. Still, I’m starting to become intrigued as an accountant. Especially after a big shake up in the Financial Technology (fintech) industry this week.

In case you missed it, Bitcoin has a rocky road ahead. On Tuesday, the legacy Bitcoin cryptocurrency begrudgingly welcomed a little brother to the scene called Bitcoin Cash. Industry experts call it a hard fork, or even a civil war, between developers of this open-source technology. The phrasing alone implies people are not happy about it.

Not only is it messy now that a semi-imposter is floating around with the same name, but it also makes the whole barrel of monkeys seem less legit. Not to mention, investors in digital currencies are uneasy about the impact it will have on value. The Wall Street Journal reported that “there will now be two competing versions of Bitcoin, both vying for the support of investors, developers, and miners.”

But, hey, who doesn’t love a little drama? While drama is not the best in this budding industry, it’s nothing new. This week’s schism is just one of many examples over the last 8 or so years that demonstrates that cryptocurrencies are in their infancy, and remain volatile.

So, with the current events out of the way, let’s take a step back.

What are cryptocurrencies?

For those of you trying to avoid this topic, first, we’ll cover some basics. By definition, a cryptocurrency is a digital currency that does not exist in physical form. Operating independently, these currencies are not backed by any government or tied to any commodity or underlying asset. As of today, all cryptocurrencies combined have a market capitalization of $101 billion. The top five are Bitcoin (45%), Ethereum (21%), Ripple (7%), Bitcoin cash (6%), and Litecoin (2%). However, there are over 100 players in the fintech industry, each offering a different cryptocurrency.

Gaining legitimacy

Again, some of you may have been thinking that you could coast through life and just avoid cryptocurrencies altogether, but I’m sorry to say that accountants will not be able to blow off digital currencies forever. Earlier this summer, “Barclays’ CEO for personal and corporate banking, Ashok Vaswani, revealed the lender had opened discussions with UK regulators about adopting digital currencies.” according to The Guardian. Vaswani expressed cautious forward momentum with the goal of making these currencies more legit and mainstream, saying “Obviously [it’s] a new area, obviously an area we’ve got to be careful with. We are working our way through it.”

Central banks are getting in on the action, including the People’s Bank of China and the Danish central bank, both of which are looking into feasibility; not that a central bank is necessary since blockchain is used for regulation. Blockchain aside, if a central bank did decide to back a digital-only currency even if it wasn’t a blockchain skeleton, it would be a huge step in legitimacy. It may even put some of the infighting and volatility worries to bed.

Accounting for cryptocurrencies

Our accounting standards are great…until they fall short. This is one example. And, ambiguity in the applicability of accounting standards leads to variations in reporting. Never good.

Here’s the scenario: Your company wants to invest in Bitcoin Cash (or any of the other cryptocurrencies, actually).

Well, since you’re not using Bitcoin Cash as a functional currency at this point, you don’t have to deal with the translation of financial statements (thank goodness), but what about getting it on the balance sheet? Cash or cash equivalent? Investment? Intangible asset?

PwC China breaks down the definitions of each account based on the standards (which I assume are IFRS) and settles on the fact that our current guidance leads us to record Bitcoins as intangible assets. But, they conclude that this doesn’t make sense:

Due to the fact that it is being used as a currency-equivalent or alternative investment vehicle, its most relevant measurement basis is probably at fair value through the profit and loss. This is akin to treating cryptocurrencies as a foreign currency or investment, which is largely carried at fair value with fair value changes through profit and loss. However, it seems we are ‘stuck with’ the intangible assets standard at present and either carrying it at cost or fair value through OCI does not provide the most relevant information to users. There is indeed an urgent need to “fill the gaap” on the accounting for cryptocurrencies.

From a tax perspective, the IRS has been a little more proactive on issuing formal guidance. In 2014 (with Internal Revenue Bulletin 2014-16), the U.S. decreed that for federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency. This matches up with the current financial accounting treatment well.

According to one industry blog here’s what that means:

● Cryptocurrency is NOT treated as currency to determine losses or gains under tax laws.
● Taxpayers MUST include the fair market value of the virtual currency as taxable income when it is used to pay for goods or services.
● The fair market value is determined as of the date acquired; basically, it is (virtually) exchanged for U.S. dollars for tax purposes.
● A taxpayer can have a virtual loss or gain; for instance, if they bought the Bitcoins when they were at their peak of $1,000 or so, they would have a loss.
● Accounting services simply need to keep in mind that for regulatory compliance when accepting Bitcoins as income, they must choose a valuation strategy, place them on the Schedule C or 1120 Form, and reduce by business expenses throughout the year.

Fairly straightforward which, from a tax perspective, is nice for a change.

Also nice is that there are several companies that have cropped up to assist with the bookkeeping side of cryptocurrencies. Cole Sperry, a cryptocurrency blogger, gave two examples:

For example, LibraTax is a Sass (software-as-a-service) platform designed to easily connect to Bitcoin wallets, automatically import transactions, and calculate gains and losses. Other platforms such as Bitpay offer payroll services in Bitcoin.

While I’m not quite ready to invest in Bitcoin Cash or Ethereum, I think that we as accountants are on the verge of seeing more of this… you’ve been warned!

Image: iStockPhoto