Financial reporting for cryptocurrency

Abstract

This study compares and contrasts US and international accounting and financial reporting practices for cryptocurrency. We analyze the financial statements of 40 global companies that have exposure to cryptocurrencies, including cryptocurrency purchases, mining, payments, trading, and investments in ICOs and early-stage blockchain ventures. We document inconsistency between Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), as well as distortions that can mislead users in assessing asset value, liquidity, profitability, and cash-generating abilities across firms. In particular, firms receiving cryptocurrencies in revenue-generating activities account for cryptocurrencies as intangibles using different measurement bases and classify the associated cash inflows differently. Some firms place cryptocurrencies in the usual long-term location of intangibles, while others consider intangibles as liquid, short-term assets. Limited guidance about crypto-assets from both IFRS and GAAP lets companies choose which existing standard to apply and how to apply it. Understanding the financial and valuation implications of these new virtual assets is vital for future accounting research and professional practice.

1 Introduction

This paper compares and contrasts the accounting and financial reporting practices for cryptocurrencies under US and international accounting frameworks. Currently there are no specific Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS) accounting standards for cryptocurrencies, giving firms much flexibility in choosing and applying existing standards to their cryptocurrency activities. We analyze the financial statements of 40 public companies from around the world that have exposure to cryptocurrencies. Our focus is on the crypto assets that our sample firms currently hold—primarily coins, tokens, and stablecoins.¹ The firms are organized into four groups based on the nature of their exposure: purchase/investments, mining, means of payment for products or services, and crypto trading in the secondary market and investment in initial coin offerings (ICOs) and early-stage blockchain projects. The paper discusses important implications of the firms’ respective accounting practices for financial analysis and valuation.

Our primary finding is that firms’ diverse applications of existing GAAP and IFRS standards lead to inconsistencies or distortions in their balance sheets, income statements, and statements of cash flow reporting. US firms recognize cryptocurrencies as intangible assets at cost less impairment, while most firms that follow IFRS account for cryptocurrencies as intangibles or inventory at fair value. A handful of other IFRS firms recognize intangibles at cost. Firms like Tesla account for cryptocurrencies at the lowest price since they were acquired, and deem the difference between cost and the lowest price as impairment charges. Given their volatile prices, the book value of cryptocurrencies can diverge significantly from their liquidating value and adversely affect a company’s profitability when prices are above the lowest price. Under both GAAP and IFRS standards, certain firms place cryptocurrencies in the usual long-term location of intangibles, while others consider intangibles to be liquid and short-term assets, even firms with long-term intent of holding. For most US mining companies and some international firms like Bitmain, cash inflows from the conversion of cryptocurrencies received in revenue-generating activities are classified as investing cash inflows, while mining firms following IFRS consider them to be operating cash inflows.

We recommend that accounting regulators undertake standard-setting specifically for cryptocurrencies instead of allowing companies to choose which existing standard to apply and how to do so. Cryptocurrencies are known as risky assets with volatile prices, and new cryptocurrencies continue to be created with a variety of characteristics and rights. We thus suggest a new asset category and fair value approach to account for cryptocurrencies, with changes in fair value recognized in profit or loss. For invested cryptocurrencies without active markets such as pre-ICO SAFT investments, investments can be valued at the initial contributions made by investors without adjustment, until active markets exist. Companies can place cryptocurrency assets separately and close to the position of “cash and cash equivalents” in order of liquidity, for both long-term and short-term intent of holding. For companies that receive cryptocurrencies as means of payment in revenue-generating operations, we would classify cash flows from the associated sale of cryptocurrencies as operating cash flows.

In the past 10 years, we have seen blockchain development and the increasing adoption of cryptocurrency as important means of value exchange and as alternative investment vehicles. Even though relatively few public companies hold cryptocurrencies worldwide and our examples illustrate generic cryptocurrencies, crypto asset transactions are rapidly evolving, and we anticipate that more companies will be exposed to new types of crypto assets in the future. We thus offer a comprehensive analysis of current cryptocurrency financial reporting practices to understand the associated problems and caveats.

This paper makes several contributions to accounting research on blockchains and cryptocurrencies. First, it provides practical knowledge on how firms account for cryptocurrencies in their financial statements. Public companies are starting to convert portions of their cash holdings to crypto assets. But since companies treat this asset differently in their respective financial statements, it is important for investors to fully understand how the accounting treatment of cryptocurrencies affects financial performance in terms of liquidity, profits, cash flows, and value of net assets. Second, many kinds of cryptocurrencies evolve from new economic scenarios not seen in traditional businesses, such as NFTs and DAO tokens. No uniform or definitive answers currently exist about how to account for these crypto assets. The financial distortions documented in this study stress the importance for regulatory bodies to issue authoritative and definitive accounting standards specifically for cryptocurrencies, from a global perspective, so that market participants can better understand the financial reporting of cryptocurrencies and their valuation implications.

In the remainder of this paper, Section 2 summarizes cryptocurrencies and related financial reporting guidance under IFRS and GAAP frameworks. Section 3 presents the sample firms’ financial statements and analyzes current financial reporting practices for each category of cryptocurrency exposure. In Section 4, we discuss the inconsistency and distortions resulting from the current accounting practices around cryptocurrencies, and provide recommendations. Section 5 concludes the paper.

2 Cryptocurrencies and related accounting standards

2.1 Bitcoin and cryptocurrencies

Bitcoin, a peer-to-peer electronic cash system invented in 2009, is the oldest and most widely used cryptocurrency (Nakamoto 2008). Cryptocurrencies are transferable digital representations of value secured by blockchains and cryptography. Blockchain is a distributed ledger technology that records cryptocurrency transactions into blocks and chains the blocks together by cryptography. While a blockchain ensures the integrity of transaction data as an immutable distributed ledger, cryptocurrency serves as a means of value exchange within the blockchain to incentivize participants’ usage and maintenance of the ledger (Deloitte 2018; PwC 2021).

Bitcoin implements proof-of-work consensus protocols. The mining process goes as follows. Mining nodes, referred to as “miners,” compete to solve cryptographic puzzles that deterministically increase in difficulty and that, once solved, can be easily verified. A successful miner is the first one to solve complex cryptographic algorithms. Each solution results in a new “block.” He/she will record newly occurring peer-to-peer payment transactions data in the newly created block, add the new block to the existing chain of blocks, and broadcast the new block to other mining nodes of the network so that they can update their individual ledgers. Each block contains an encrypted reference to the last block, thereby forming a “chain” and giving rise to the term “blockchain.” Profits to the successful miner from this mining process include a fixed number of Bitcoins (also referred to as “mining bitcoin”) and transaction fees paid by users of Bitcoin for recording their peer-to-peer payment transactions into blocks (Narayanan et al. 2016).²

In late 2013, Ethereum was created with a built-in, fully-fledged programming language that can write smart contract codes to support decentralized applications running on top of blockchains. This extended the use of blockchains beyond cryptocurrency payments to executing applications on a decentralized computer. Since 2016, thousands of blockchain ventures have designed tokens within a smart contract or a decentralized application and issued these tokens to investors as fundraising instruments. These tokens come in a variety of forms to access a crypto ecosystem, product, or service (i.e., utility tokens), or to represent a stake or ownership in certain assets (i.e., security tokens).³ In general, coins refer to native assets that can operate independently on a standalone blockchain, such as Bitcoin and Ethereum, while tokens refer to smart contract-generated assets that live on another standalone blockchain, such as Uni (Uniswap), which lives on the Ethereum blockchain.

Blockchain ventures looking to raise funds can issue tokens via an ICO public sale event, or use a Simple Agreement for Future Tokens (SAFT) agreement to attract seed investors in private sales prior to a public sale. A SAFT is an early stage investment, pre-ICO, where the investor provides upfront funding to the issuer in exchange for a promise to receive a variable number of tokens when the blockchain network starts to function. The number of tokens to be received by a SAFT investor usually depends on the percentage of his investment amount relative to the total value of the blockchain project and the total number of tokens on issuance. The majority of blockchain ventures claim to issue utility tokens instead of security tokens, because security-token issuers are obligated to register with the SEC before they can issue a security-like product for financing.

After Bitcoin and Ethereum, hundreds of coins with different consensus protocols and thousands of tokens have emerged. According to the price-tracking website CoinMarketCap, cryptocurrencies have exhibited a global boom with an aggregate value of around $1.106 trillion, and the number of crypto assets in existence has grown to 19,828 as of June 12, 2022. More and more traditional asset management firms and corporations have started to allocate funds into cryptocurrencies.⁴

2.2 Prior literature

Academic research is scarce on the financial reporting, auditing, and taxation issues surrounding this new ecosystem of blockchains and cryptocurrencies. Some studies provide preliminary discussions on how blockchain technology can improve current accounting information systems and auditing quality (e.g., Dai and Vasarhelyi 2017; Yu et al. 2019; Cao et al., 2019). A recent study by Bourveau et al. (2022) examines the role of disclosure and information intermediaries in the unregulated ICO fundraising process. They find that blockchain ventures with higher levels of voluntary disclosure through white papers, technical source code, and social media platforms have a greater ability to raise capital. Lyandres et al. (2021) compile a high-quality dataset of ICOs and find new determinants of ICO funding success and post-ICO operating performance. From a tax perspective, Cong et al. (2022) document how changes in tax scrutiny affect investors’ trading behavior in the crypto markets. Our paper instead focuses on the financial reporting implications of the new virtual assets and examines how global companies present their cryptocurrency activities in financial filings.

In the finance and economics literature, most prior studies on blockchain technology focus on economic dynamics arising from practices such as mining, smart contracts, decentralization, and token adoption and offerings (e.g., Cong et al. 2021a; Cong and He 2019; Cong et al. 2021b, Biais et al. 2019; Howell et al. 2020). Other researchers consider applications of blockchains and cryptocurrencies in the financial markets (e.g., Easley et al., 2019; Harvey 2016; Yermack 2017; Chiu and Koeppl 2019). A number of studies specifically discuss the pricing and returns of cryptocurrencies, such as Makarov and Schoar (2020), Griffin and Shams (2020), and Liu and Tsyvinski (2020).

Because public companies and asset management firms increasingly hold cryptocurrencies as an alternative investment and report them as a significant part of their assets and financial performance, it is essential for market participants to understand the financial and value implications of these new virtual assets. Current GAAP and IFRS guidance fail to specifically address many aspects of cryptocurrency that evolve from new types of transactions. We are the first study to use firm-level data from around the world to illustrate current financial reporting practices for cryptocurrency, and to highlight the resulting inconsistencies and distortions in assessing companies’ financial performance.

2.3 Related IFRS guidance

According to the definition of assets in the Conceptual Framework for Financial Reporting (March 2018), cryptocurrencies fall into the category of assets.⁵ Since the cryptocurrencies market evolved rapidly, in 2015 the IASB identified the topic of digital currencies as a potential new project through the Board’s Agenda Consultation process. Conversations have continued in various accounting standards board meetings, mostly focusing on the classification of cryptographic assets from the holder’s perspective. The IFRS Interpretations Committee finally reached an agenda decision in June 2019 and published Holdings of Cryptocurrencies to guide firms in applying existing IFRS Standards to the holding of cryptocurrencies. Practitioners such as the Big Four accounting firms also issued guidance. However, no IFRS accounting standard specifically addressing cryptocurrencies currently exists.

The Interpretations Committee concluded that the existing standard IAS 2 Inventories applies to cryptocurrencies when they are held for sale in the ordinary course of business. If IAS 2 is not applicable, an entity can apply IAS 38 Intangible Assets to holdings of cryptocurrencies. The guidance excludes a subset of cryptocurrencies that give rise to a contract between the holder and another party.⁶ According to IAS 32 Financial Instruments: Presentation, a cryptocurrency holding could be a financial asset when the holder has a contractual right to receive cash or another financial asset.⁷ Therefore, the Interpretations Committee does not regard a cryptocurrency holding as a financial asset in its range of considered cryptocurrencies. Cryptocurrency is not cash, but it can be a financial asset for security tokens that represent a residual interest in equity (e.g., rights to residual profits, dividends, or proceeds on liquidation), or for stable coins that give holders a legally enforceable right to redeem the coins for cash. As crypto asset transactions are rapidly evolving, there are many judgment calls that will require further investigations and guidance.

2.4 Related GAAP guidance

To date, there are still no specific requirements written into US GAAP (generally accepted accounting principles) on accounting for cryptocurrencies, even though various regulatory bodies stipulate rules from taxation, commodity trading, and ICO financing perspectives.⁸ In 2020, the American Institute of CPAs (AICPA) formed a Digital Assets Working Group and released a practice aid titled Accounting for and Auditing of Digital Assets to develop nonauthoritative guidance on how to account for digital assets under GAAP. Auditing firms such as PwC issued their own Crypto Assets guides in 2021. These practice guides apply the FASB Accounting Standards Codification and applicable accounting literature to determine crypto assets accounting.

The AICPA practice aid states that crypto assets lack physical substance and would generally be accounted for under FASB ASC 350 Intangibles-Goodwill and Other as indefinite-lived intangible assets.⁹ They are recorded at cost initially and subsequently tested for impairment loss. If an impairment loss is recognized, the balance of cryptocurrencies should not be adjusted upward, even if the subsequent value increases. If a crypto asset provides a contractual right to receive cash or another financial instrument, such as stablecoins, that includes a right to redeem the stablecoin for cash from the issuer, it would meet the definition of a financial asset. Under limited circumstances, a broker-dealer in the scope of FASB ASC 940 Financial Services – Brokers and Dealers may hold digital assets for sale in the ordinary course of business, such as proprietary trading. The broker-dealer can account for digital assets as inventory measured at fair value, with changes in fair value recognized in profit and loss. A company that qualifies as an investment company under FASB ASC 946 Financial Services – Investment Companies should determine whether the crypto assets it acquires represent a debt security, equity security, or other investment, and should measure its investments at fair value.

3 Current practices in financial reporting for cryptocurrencies

Given that there are no GAAP or IFRS accounting standards specifically for cryptocurrencies, the accounting profession is currently relying on concept statements, existing standards, nonauthoritative guidance, and discretionary judgment to account for cryptocurrencies. In this section, we investigate the accounting practices used for cryptocurrencies under IFRS and GAAP frameworks among 40 publicly traded companies. The website bitcointreasuries.net lists public and private companies, countries, and ETFs that hold Bitcoins. We use public companies’ annual financial statements for fiscal year 2020 to search for accounting treatments regarding cryptocurrencies. For companies that started engaging in cryptocurrency business in FY 2021 or ceased to hold cryptocurrency before FY 2020, we use the most relevant quarterly or semi-annual financial statements that present cryptocurrency activities.¹⁰

Table 1 provides summary information about the cryptocurrency business our sample firms are engaged in and how they account for cryptocurrencies in the balance sheets and cash flow statements. Panel A shows that public companies with cryptocurrency business are incorporated all over the world, with especially high concentrations in North America and the Cayman Islands. The company size ranges from $52 billion of assets for Tesla to $0.08 million for Coin Citadel. While 23 out of the sample of 40 companies report losses, some companies are very profitable: Coinbase earned $771 million profit for the first quarter of 2021, while Tesla earned $438 million over the same period. Panel B shows the main industry and the specific cryptocurrency business in which our sample firms operate. Twenty-eight out of 40 firms are in the blockchain and cryptocurrency industry; the other 12 focus on traditional industries such as tourism, insurance, and software services. Their cryptocurrency activities primarily involve investment, using cryptocurrency as a means of payment, mining, and digital asset trading and management.

Table 1 Descriptive Statistics of the Financial Reporting of Cryptocurrencies

Panel C of Table 1 summarizes the accounting treatment of cryptocurrency holdings in the asset sections and cash flow statements. We group firms by the type of cryptocurrency business: 1) crypto asset purchases/investments; 2) mining of crypto assets; 3) means of payment for products or services; 4) crypto asset trading in the secondary market and investment in ICOs or early-stage blockchain ventures; and 5) miscellaneous activities. Apparently, our sample firms chose different asset categories to recognize cryptocurrencies and treated the cash flow consequences differently, even firms in the same business such as cryptocurrency mining. The associated cash flows from converting cryptos to fiat currency are either operating or investing cash inflows, except for one company that borrows cryptocurrency as a loan and classifies the subsequent conversion as financing cash inflows.

To further analyze the financial reporting practice for cryptocurrency, we focus on representative companies that operate in the categories mentioned above.¹¹ For the business type 1, we use the US firms Tesla and MicroStrategy to illustrate the financial reporting of cryptocurrencies as intangible assets under GAAP when companies hold cryptocurrencies as long-term investments. For business type 2, we contrast the US firm Marathon Digital with two Canadian firms in the same mining industry (Hut 8 Mining and HIVE Blockchain Technologies) to show the differences in recognizing assets and classifying cash flows from the conversion of cryptocurrencies received from mining operations to fiat currency. For business type 3, we use Bitmain, which sells blockchain mining machines and accepts cryptocurrencies as a means of payment, to illustrate how the firm accounts for cryptocurrencies received from its revenue-generating activities under IFRS. We contrast Bitmain’s accounting practice with those of other mining firms that also receive cryptocurrencies in their revenue-generating activities. For business type 4, we use the financial service firm Galaxy Digital to illustrate how cryptocurrencies are accounted for as inventory and financial assets under IFRS in the firm’s trading, asset management, and investment business.

3.1 Digital asset purchases/investments

Tesla is an American electric vehicle and clean energy company. MicroStrategy pursues two main strategies: 1) enterprise analytics software and services, and 2) acquiring and holding Bitcoin. The two companies’ financial disclosures are pursuant to GAAP standards. During the three months ended March 31, 2021, Tesla purchased an aggregate of $1.50 billion in Bitcoin and began accepting Bitcoin as payment for sales of certain products. MicroStrategy started acquiring Bitcoin in 2020 and held approximately 71,079 Bitcoin as of February 8, 2021.

In their financial statements, both companies disclosed that they intended to hold Bitcoin for an extended period of time and not trade frequently. They accounted for Bitcoin as indefinite-lived intangible assets in accordance with ASC 350 Intangibles-Goodwill and Other. The Bitcoin was initially recorded at cost and subsequently remeasured for impairment.¹² Any decrease in its fair value below the company’s carrying value, subsequent to acquisition, will require recognizing impairment charges without any upward revisions for later market price increases. In the first quarter of 2021, Tesla recorded approximately $27 million of impairment losses resulting from changes to the carrying value of Bitcoin. During 2020, MicroStrategy incurred $71 million of impairment losses on its Bitcoin.¹³ As Bitcoin is subject to volatile market prices, with as much as a 40% drop in prices possible in one day, the carrying value of the Bitcoin assets could reflect the lowest price since the Bitcoins were acquired. The price may increase quickly after the impairment recognition, but increases in the price will not reverse the reduced carrying value of the Bitcoin assets. Thus, the recognition of impairment charges may adversely affect the evaluation of a company’s profitability when the Bitcoin price drops, and may result in the book value of cryptocurrencies diverging far from their liquidating value. Figure 1 shows that the daily prices of Bitcoin were very volatile from November 2017 to November 2021.

Fig. 1

Daily Bitcoin Prices from November 2017 to November 2021. Figure 1 depicts the daily price of Bitcoin obtained from CoinMarketCap during the period of November 1, 2017 to November 30, 2021

Table 2 presents the position of Bitcoin assets in the balance sheet. For both companies, digital assets are listed separately from intangible assets in the long-term asset section, with values much larger than those of other intangible assets. This asset position is consistent with the traditional liquidity implications of intangible assets and with the company’s intention to hold Bitcoin long-term, but inconsistent with Bitcoin’s highly liquid nature, which is similar to that of cash. Bitcoin assets are unlike most other intangibles, where valuation is more difficult and the asset may not be easily liquidated. To confirm our argument, Tesla recently disclosed in its 2022 10-Q filings that it believes in the long-term potential of digital assets as a liquid alternative to cash.

Table 2 Digital Asset Purchases/Investments

In both Tesla and MicroStrategy’s cash flow statements, as shown in Table 3, cash inflows and outflows related to Bitcoin purchases and sales are presented in cash flows from investing activities, as Bitcoin is accounted for as intangible assets.

Table 3 Digital Asset Purchases/Investments

3.2 Mining

Marathon Digital is a US firm primarily engaged in mining cryptocurrencies. In its income statement, the cryptocurrency awards Marathon received from its mining operations are recognized as mining revenues at the time of the firm’s successfully mining a block. In the balance sheet, these awards are considered indefinite-lived intangible assets and recorded at cost less impairment, with initial cost measured at the time of receipt. Similar to Tesla and MicroStrategy, any subsequent decrease in cryptocurrencies’ fair value below the carrying value will require recognizing impairment loss without later upward adjustments. As shown in Table 4, Marathon believes digital currencies are highly liquid assets and places them just below “cash and cash equivalents” in the current assets section of the balance sheet, contrary to what Tesla and MicroStrategy did. This would impose a direct conflict with the traditional long-term position of intangible assets. Indeed, other intangible assets the company owns are placed in the last line of the long-term assets.

Table 4 Mining of Crypto Assets

Although Marathon’s receipt of cryptocurrencies arises from its core mining operations, it classifies subsequent conversion of cryptocurrencies into fiat currencies as investing cash inflow.¹⁴ The cash flow statement in Table 4 shows that the company first reverses $4.3 million of cryptocurrency mining revenue in the “cash flows from operating activities,” the exact top-line revenue number reported in the income statement. Then the company reports $2.1 million of investing cash inflows from sales of digital cryptocurrencies. The treatment of cash inflows from converting cryptocurrencies into fiat currencies as investing cash inflows will mislead investors in evaluating the company’s ability to generate cash flows from core operations, as cryptocurrencies are indeed received from the company’s main revenue-generating activities.

Other companies following US GAAP that engage in the crypto mining business, such as Riot Blockchain, CleanSpark, Sino-Global Shipping, and Bit Digital, have similar accounting treatments as Marathon, where they recognize cryptocurrencies as short-term, indefinite-lived, intangible assets and treat the associated conversion to fiat currency as cash flows from investing activities. Among the sample, Coin Citadel and MGT Capital Investments are the only two companies that treat the conversion of cryptocurrencies as cash flows from operating activities.

In contrast to the US accounting practice, mining companies pursuing the IFRS framework recognize cryptocurrencies differently in their balance sheets and cash flow statements. Hut 8 Mining and HIVE Blockchain Technologies are two Canadian firms primarily engaged in mining cryptocurrencies. Table 5 presents their partial balance sheet and cash flow statement for the period ended December 31, 2020. Hut 8 Mining reports $102 million CAD of digital assets as intangible assets in the current asset section, which accounts for 70% of its total assets. The digital assets are measured using the revaluation method, where the company revalues the digital assets for each reporting period and records decreases in fair value in profit and loss and increases in fair value in other comprehensive income. HIVE Blockchain Technologies instead assesses that it acts as a commodity broker trader, as defined in IAS 2 Inventories, and it holds digital assets for the purpose of sale in the near future. Therefore, the company accounts for digital asset holdings as inventory measured using fair value, and includes changes in fair value in profit and loss.

Table 5 Mining of Crypto Assets

Other than the differences in valuing digital assets on the balance sheet, Hut 8 Mining and HIVE Blockchain Technologies each report subsequent cash inflows from converting cryptocurrencies into fiat currencies in the operating cash flows instead of investing cash flows, different from most of their US counterparts. As shown in Table 5, the company first reverses $38.9 million CAD of digital assets mined as revenue, the exact top-line revenue number reported in the income statement. Then, the company reports, in the operating section, $41.5 million CAD cash inflows from the conversion of digital cryptocurrencies into cash. Similarly, the next graph shows that HIVE Blockchain Technologies reports changes in its digital currency balance of $10.6 million in the operating cash flow section but reports nothing about digital currency in the investing section, implying that the company includes all cash inflows related to digital currency sales in operating cash flows. All other mining companies following IFRS include cash inflows from converting digital currencies in their operating cash flows.

Overall, the financial reporting of US and international companies in crypto mining businesses generates very different pictures of asset value and the ability to generate operating cash flows. US companies use the cost method to measure cryptocurrencies and mostly classify converted fiat currency as investing cash flows. In contrast, international firms following IFRS use the fair value method to value cryptocurrencies and classify converted fiat currency as operating cash flows. Current GAAP and IFRS guidance fail to specifically address asset recognition for crypto mining revenues and do not clarify its cash flow classification, leaving great room for mining companies to make judgments in applying the existing standards and selecting appropriate accounting policies.

3.3 Means of payment for products or services

Bitmain has been the world’s leading manufacturer of ASIC-based cryptocurrency mining hardware. According to Bloomberg, the chips sold by Bitmain generated as much as 80% of the world’s crypto assets as of the end of 2020.¹⁵ We obtain its financial data from its prospectus published in 2018, when the company filed for an IPO in Hong Kong.¹⁶ The financial statements were prepared in conformity with IFRS standards. The company accepts payment in the form of cryptocurrencies for sales of mining hardware and for its proprietary mining activities. As shown in the first exhibit of Table 6, the company generated over 94% of its total revenues from sales of mining hardware for the six months ended June 2018.

Table 6 Means of Payment

The company considers cryptocurrencies received from its main sales activity as indefinite-lived intangible assets. One side of the journal entry is intangible assets, and the other side records revenues from the provision of goods and services. The cryptocurrencies are recorded at cost initially at the time of sale and subsequently tested for impairment, without later upward adjustment for value increases. Even though Bitmain intends to hold cryptocurrencies for a long-term period, it presents assets in a decreasing order of liquidity and places cryptocurrencies just below “cash and cash equivalents” in the balance sheet, as shown in the second exhibit in Table 6. IAS1 Presentation of Financial Statements (paragraph 60) allows a presentation of assets in order of liquidity when such presentation provides more relevant information.

In its IPO filings, Bitmain disclosed that the conversion of cryptocurrencies into fiat currencies is classified as investing cash inflows instead of operating cash inflows. Interestingly, its asset recognition and cash flow classification of cryptocurrencies are opposite to the accounting treatment of mining firms under the same IFRS framework, but similar to those of US mining companies. The cash flow statement in Table 6 shows that the company experienced negative operating cash flows of $621 million over the six months ended June 30, 2018, even though the company generated $2.8 billion in revenue and $742 million in profit. The major contributing factor to the negative operating cash flows is that the company classifies $516 million in fiat currency converted from cryptocurrencies as cash inflows from investing activities. These cryptocurrencies are received as a form of payment from its major business of selling mining hardware. Therefore, the classification of associated cash inflows in the section of investing cash flows, instead of operating cash flows, may mislead investors in evaluating the company’s ability to generate cash flows from core operating activities.

3.4 Trading and investment in ICOs and early-stage blockchain ventures

Galaxy Digital Holdings LP, a Cayman Islands operating partnership, is one of the oldest digital asset financial services and investment management firms. We obtained the financial statement of Galaxy Digital Holdings LP for the year ended December 31, 2020, prepared in accordance with IFRS. The company operates in five primary business lines: trading, principal investments, asset management, investment banking, and mining.

The Partnership’s cryptocurrencies are primarily recognized as short-term “digital assets” and “investments” asset accounts. As shown in the footnote disclosure in Panel A of Table 7, “digital assets” and “investments” are associated with the trading, principal investments, and asset management segments. In its trading and asset management business, the Partnership determines that it acts in the capacity of a commodity broker-trader, as defined in IAS 2 Inventories, and purchases cryptocurrencies with the intent to resell them in the near future. In its principal investments business, the Partnership possesses certain cryptocurrencies that are locked in a proof-of-stake program or restricted due to a lock-up schedule after the related blockchain venture completes its token-generating event and starts distributing tokens to investors. As a result, the Partnership has determined to account for its holdings of digital assets from these three segments as inventory and recognize changes in fair value less cost to sell in profit or loss. Panel B in Table 7 shows a market value of $850 million for the “digital asset” account as of December 31, 2020, with both unrestricted and restricted digital assets.¹⁷

Table 7 Digital Asset Trading and Early Stage Investments

Different from the digital assets described above, some holdings of investments in the principal investments segment are not traded in active markets. As shown in Panel C of Table 7, the Partnership’s “investments” account comprises six types of investments. These investments are accounted for as financial assets and measured at fair value, with unrealized profit or loss in the income statement. The pre-ICO investments of $500,000 are the only investment category related to cryptocurrency. They represent contributions made to early-stage blockchain ventures, typically documented via a SAFT, that entitle the Partnership to receive cryptocurrency at a future date once the venture has completed its token-generating event or ICO. According to IAS 32 Financial Instruments: Presentation, a financial asset can be a contractual right to receive cash or another financial instrument from another entity. Therefore, the treatment of pre-ICO investments as financial assets implies that the Partnership obtains a right to receive cryptocurrencies qualified as financial instruments through a SAFT.¹⁸

In summary, Galaxy Digital accounts for its holdings of cryptocurrency that are primarily traded in active markets as inventory, and accounts for its holdings of investments that are not traded in active markets as financial assets. The distinction mainly centers around the timelines of the pre-ICO investments. Investments made to blockchain ventures before the venture completes its token-generating event and distributes the tokens to Galaxy Digital are deemed financial assets. Tokens distributed to Galaxy Digital after the venture has completed its token-generating event, or digital assets acquired through direct purchase in the open market, are deemed inventory.

4 Financial distortions to the financial statements

As there is no GAAP or IFRS standard specifically addressing the accounting for crypto assets, companies typically make judgments and determine the applicable accounting treatment. From previous analysis about accounting treatments by 40 companies worldwide, we find that no uniform or definitive answers exist, particularly regarding asset recognition, asset placement, and cash flow classifications. Consequently, current firm practice in cryptocurrency accounting leads to inconsistency between GAAP and IFRS and distortions in presenting a firm’s real operating performance, in the following ways.

First, there is inconsistency in asset recognition and value between firms following GAAP and firms following IFRS, as well as inconsistency among firms following IFRS. US firms recognize cryptocurrencies as intangible assets at cost and revalue them to reflect impairment loss without later upward adjustment. In contrast, most firms following IFRS recognize cryptocurrencies as intangibles and inventories using a fair value approach. Still, a few IFRS firms holding cryptocurrencies for long-term purposes recognize cryptocurrencies as intangible assets at cost. As shown in Fig. 1, cryptocurrencies are trading at highly volatile prices, with 40% down or up possible in one day. Impairment losses will be inevitable for US companies like Tesla because they compare the purchase cost with the lowest price at any time since acquiring the specific cryptocurrency held and define the difference as an impairment loss. Even if the market value of these digital assets increases sharply after the impairment recognition, the company’s assets value and profitability will remain downward biased until the sale of the assets. Compared to the fair value approach, presenting cryptocurrency holdings at cost as intangible assets, as Tesla and MicroStrategy do, will undermine the value relevance of financial reporting in terms of assets as well as income.

Second, the placement of cryptocurrencies recognized as intangible assets in the balance sheet may not fairly present a company’s liquidity position. Even though Tesla recently disclosed that it regards digital assets as a liquid alternative to cash, the company still places digital assets in the usual long-term position of intangible assets. Some other firms following GAAP and IFRS choose to do the same. In data aggregators such as Compustat, long-term cryptocurrency assets are aggregated into the other long-term assets account.¹⁹ If these liquid assets are of a significant amount, their omission from data aggregators will lead to inaccurate inferences about the company’s liquidity position, as cryptocurrencies like Bitcoin can be sold for cash instantly. However, some firms do the opposite and place cryptocurrencies recognized as intangible assets just below “cash and cash equivalents” as a short-term or liquid asset, even firms like Bitmain that intend to hold long-term. The short-term asset location provides more relevant information about the level of liquidity.

Third, the ability to generate cash flows from core operations is distorted for companies receiving cryptocurrencies as a form of payment for product sales or services. For most US mining companies and Bitmain, cryptocurrencies are received in the revenue-generating activities, but the related cash inflows from the conversion of cryptocurrencies into fiat currencies are classified as investing cash inflow instead of operating cash inflows. For Bitmain, the amount was huge: $2.8 billion of revenues came mostly from selling mining machines, but the company actually ended up with negative operating cash flows when it classified $516 million of cash inflows from cryptocurrency conversion as investing cash inflows. Even though the company is profitable with $742 million of earnings, this cash flow classification can distort its ability to generate cash flows from core operations.

In addition, volatile market prices of cryptocurrencies can make timely and reliable valuation difficult. When cryptocurrencies are accounted for at fair value, deciding which time and which exchange should be used to value the cryptos at the reporting date calls for judgment from the accountants, as cryptocurrencies are trading 24/7 across hundreds of exchanges at highly volatile prices. The determination of fair value for pre-ICO investments is subject to great discretion even with professional help, because there exist no active markets for invested tokens until several months to several years after the initial investment. With no surprise, companies such as Galaxy Digital have to engage independent valuation consultation services to provide valuations of their pre-ICO investments.

When the IFRS Interpretations Committee published Holdings of Cryptocurrencies in June 2019 to guide firms in how to apply existing IFRS Standards for the holding of cryptocurrencies, the IASB decided not to undertake new standard-setting but instead to monitor developments in crypto assets. The Board considered two main factors in its decision: 1) the usefulness of information that results from applying existing standards, and 2) the prevalence of holdings of cryptocurrencies. Given how the real-world adoption of cryptocurrencies and the number of public companies and funds accepting cryptocurrencies grew during the 2020 and 2021 bull markets, the standard setters might reconsider how to provide faithful financial reporting of the new type of assets, instead of relying on the existing standards. For example, cryptocurrencies did not even exist when the Board first adopted IAS 38 Intangible Assets in 2001. With all its later amendments, IAS 38 does not guide how to jointly account for the highly liquid and inherently long-term nature of intangibles. Based on the examples described in Sect. 3, the current accounting practice from applying existing GAAP and IFRS standards may mislead users in evaluating firm performance from the assets, income, and cash flow perspectives, potentially making firms incomparable across countries or across companies within the same accounting framework.

Overall, we recommend that accounting standard-setters issue a standard specific to cryptocurrencies to accommodate the nascent features of this new virtual asset. We suggest a new asset category and fair value approach to account for cryptocurrencies, with changes in fair value recognized in profit or loss. For invested cryptocurrencies without active markets such as pre-ICO SAFT investments, investments can be valued at the initial contributions made by investors without adjustment until active markets exist. The cryptocurrency assets can be placed separately and close to the position of “cash and cash equivalents” to reflect their liquid nature. For companies that receive cryptocurrencies as means of payment in revenue-generating operations, we would classify cash flows from the associated sale of cryptocurrencies as operating cash flows.

5 Conclusions

In this paper, we first explain the properties of cryptocurrencies and related blockchain technologies. We then illustrate the current financial reporting practice for cryptocurrencies, using financial statements from 40 firms that operate in typical cryptocurrency businesses: purchase/investments, mining, means of payment for products or services, and trading and asset management in the secondary market and investment in ICOs and early-stage blockchain projects.

Our sample companies account for cryptocurrencies as indefinite-lived intangible assets measured at cost or at fair value, inventory measured at fair value, or financial assets measured at fair value for various scenarios. We point out inconsistency between GAAP and IFRS and distortions that could mislead users in evaluating a firm’s assets value, profitability, and cash flows. US firms recognize cryptocurrencies as intangible assets at cost less impairment loss; most firms following IFRS measure intangibles at fair value, and some others recognize cryptocurrencies at cost. Some firms place digital assets in the long-term location of intangibles, and some firms consider digital assets as short-term and liquid intangibles. For most US mining companies and some international firms like Bitmain, cash inflows from the conversion of cryptocurrencies received as revenues are classified as investing cash inflow, while mining firms following IFRS consider them as operating cash inflows.

Through proper financial reporting of cryptocurrencies, corporations can communicate to investors, market participants can evaluate their valuation implications, and government agencies can ascertain capital market consequences and tax effects. While our discussions illustrate generic transactions, cryptographic asset transactions are rapidly evolving. The financial reporting issues are diverse and highly dependent on specific facts and circumstances, such as proof-of-stake mining, decentralized finance, various rights of non-fungible tokens, and the building of a crypto-world. No uniform or definitive answers currently exist. As the new technologies and ecosystems continue to develop, there is urgency for researchers and regulators to offer specific guidance on accounting treatments and valuation implications. Future research can focus on the financial reporting, auditing, and taxation issues surrounding the new ecosystem of blockchain and cryptocurrencies, particularly research questions that jointly consider traditional corporations and new cryptocurrency ecosystems with regard to valuation consequences, management incentives, corporate governance, and regulations.