Despite many challenges for accountants, crypto currencies remain a serious investment vehicle
Last month, after a crypto crash that saw half a trillion dollars wiped off the total market cap overnight, the rise and fall of cryptocurrencies hit the buffers once again, this time following a geeky fad dominated by rookie investors seeking a fast buck.
PKF Francis Clark’s Director of Blockchain and Cryptocurrency, Ben Lee, says that crypto has seen tremendous institutional adoption over the last 12 months, leading to an increase in the correlation between crypto and equity, he explains. “Increased interest rates have caused investors to consider less risky alternative investments and uncertainty around regulation in the US and other jurisdictions is also taking effect,” Lee says.
Crypto crash: investors get the jitters
Market volatility has left investors undoubtedly jittery since the start of the year – brought on by inflation, rising interest rates, as well as the war in Ukraine. The market crash in May can be directly attributed to the destabilisation of TerraUSD (UST), a stablecoin (a digital asset designed to maintain a stable value).
USDC is pegged to the US dollar, and projects maintain reserves of currency to maintain pegs. There are also algorithmic stablecoins, such as UST, whose value is maintained by coding. “Certain transactions led to UST losing its peg to the dollar, so the team behind UST dumped approximately $3bn from their Bitcoin reserves to defend the peg,” Lee explains.
Crypto crash: there’s a longer-term view
While crypto has been there before, the longer-term trends tell a very different story. The bitcoin price breached $20,000 at the end of 2017, followed by crypto winter, a period of low prices that lasted almost 18 months, with prices dipping to $3,236 by the end of the year.
Currently, Bitcoin is worth around $30,000. A similar crash took place in May of last year, with value dropping from $58,000 at the start of the month to $35,000 by the end (it seems May isn’t a good month for cryptos). In May 2020 the value was $10,000. It was $6,000 in May 2019.
In spite of these fluctuations, Lee likens the adoption of digital assets to the internet adoption in the 90s, when many considered the internet to be a fad. This isn’t the end for crypto, it’s just the beginning.”
Regulators: could crypto be more conventional?
As regulators try to bring some order to this unruly and rebellious world, wrangling between crypto organizations and regulatory bodies supports the hypothesis that crypto is becoming mainstream.
FCA last month hosted a two-day event called CryptoSprint to explore how the emerging world of cryptoassets could be regulated in the UK. AAT-qualified Joe David is founder and managing director of Nephos Group and MYNA, a blockchain and cryptocurrency advisory firm: “Regulation is being discussed quite a bit in the industry.”. Various use cases are being considered by the FCA. The first regulated crypto will likely be stablecoins, which are backed by fiat currency.
The rise and rise of crypto looks set to continue, with more and more countries legalizing cryptocurrency, and even some looking to follow El Salvador in making it legal tender; analysts predicted last year that the cryptocurrency market would triple in size by 2030 to a valuation of around $5 trillion.
HMRC shuns the currency question
HMRC also published a detailed Cryptoassets Manual to guide taxpayers on how to file taxes on cryptocurrencies. In general, the taxman does not view cryptocurrency as a form of currency, so the movement of digital assets generally falls under capital gains tax. However, where businesses or individuals deal exclusively with digital assets, there are thousands of transactions to account for.
Meanwhile, legislation and guidance are struggling to keep up with the pace of change in the industry. “Often the interaction between the legislation and economic activity can create a multitude of tax points over a series of transactions that can lead to complicated dry tax charges arising,” Lee warns.
How to account for crypto? …It depends
However, the absence of accounting standards for digital assets remains moot. According to Lee, there are over 18,000 different cryptocurrencies on the market. Some tokens may be used as a store of value, like bitcoin, while others, like Ethereum, are utility tokens. Others offer security.
As a result, digital assets could be classified as an intangible asset, a stock, or a financial asset depending on the purpose and how they are used. An understanding of the underlying asset is essential to ensure proper accounting treatment, Lee says.
Felix Honigwachs, CEO of cryptocurrency exchange Xchange Monster, says: “There is no clear definition of cryptocurrencies in accordance with IFRS (International Financial Reporting Standards). Disclosure of such information in the notes to the financial statements will be very important.”
Can accounting software cope?
Due to the fact that most accounting packages are built around currencies, they do not support transactions involving digital assets, which makes it difficult to keep track of transactions.
Although there are many cloud-based crypto tools to monitor blockchain activity for tax purposes, this requires a separate record of digital asset movements to be maintained outside of the usual bookkeeping software and incorporated into the books as necessary.
Auditors may need to change
Having to refer to existing standards presents a problem, says Rick Deacon, CEO or blockchain security expert Interlock. “Traditional accounting maintains and stores records in a centralised ledger based on a double-entry accounting system, where only the accountant has access, whereas blockchain relies on a decentralised system.
Blockchain may, therefore, mean auditors have to shift from an analytical capacity to more of a programming role.”
All, in all, more work is needed (and soon)
Pauline Wallace, Executive Chair of the UK Endorsement Board, said the board will focus on cryptocurrencies in the next few years as it attempts to define how they are used and account for them. “We are not aware of that many UK companies that hold significant portfolios of crypto currencies. Nonetheless, once you start thinking about how people are using them as a means of exchange then you realise how little accounting support there is for that type of thing,” Wallace said.
Although crypto assets are volatile by their very nature, Honigwachs believes current market conditions do not reflect the substance of the industry. “Overall, an opportunity exists to buy well-priced crypto assets at a larger than average discount and benefit from substantial yields when the market turns. These assets should be well researched and validated against peer review and analyst reports. As with any asset class, diversification within one’s portfolio is very important and one’s risk profile and risk tolerance evaluated.”
Hope ahead for accountants (if they stay the course)
Blockchain offers many potential benefits to accountants, including data reliability and financial statement audits, says Deacon. “Crypto currencies could make earnings a lot simpler to track when it comes to using the public distributed ledger that underpins a cryptocurrency. Everything is visible on the ledger, but you also need to track transaction fees, plus fluctuations in the currency’s value and this often trips people up.”
David says the biggest pitfalls are complexity and a rapidly changing crypto environment. “It’s tough to keep up. The lack of clear guidance is a challenge for accountants who are not fully immersed in the ecosystem.”