What to Know Before You Go Crypto

by Robert Sledge

A company that invests in digital assets may end up applying accounting guidance that was not written with digital assets in mind.

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Once a new frontier maintained by a small group of early adopters, increased public acceptance of digital assets – cryptocurrencies such as Bitcoin – and non-fungible tokens (NFTs), has boosted the variety of offerings and encouraged corporate investment interest. Many companies are actively considering making investments in digital assets. Before doing so, they should thoughtfully assess their corporate governance, the accounting for digital assets, and whether they have the right internal controls in place.

Corporate governance

Companies should set up a clear investment strategy to guide all cryptocurrency activities before transacting. This strategy should be based on a clear understanding of the purpose of a company's investment, considering:

  • what assets and amounts the company is permitted to transact in, based on the company’s risk appetite;
  • how the company will transact in the digital assets (e.g., on exchanges or over-the-counter, using market makers);
  • how the company will hold/custody the digital assets (e.g., self-custody or with a third-party custodian);
  • how to use information coming from third-party providers; and
  • what approvals are necessary.

Knowing how you’re going to account for the digital assets

Since there are no Generally Accepted Accounting Principles (GAAP) in the United States specific to digital assets, a company that invests in digital assets may end up applying accounting guidance that was not written with digital assets in mind.

Many popular digital assets, including Bitcoin, Bitcoin Cash, Litecoin and Ethereum, inherently provide no contractual rights to cash or other assets to the holder. Unlike investment companies or broker-dealers that qualify for specialized accounting, operating companies transacting for the first time need to apply other standards to account for digital asset investments. Cryptocurrencies such as Bitcoin would typically be accounted for as indefinite-lived intangible assets under U.S. GAAP.

Often, rather than taking direct responsibility for securing private keys associated with digital assets, companies may involve a third party, such as an exchange or custodian. Involvements with third parties require an additional level of analysis to understand whether a company owns the digital assets (and they are just being custodied by the third party on the company’s behalf) or whether instead the company has a contractual receivable or other right from the third party that is tied to the value of a digital asset but does not represent current ownership of the digital asset itself. This analysis should involve an evaluation of the contractual agreement(s) between the company and the third party, as well as relevant laws, regulations and legal precedents. The form of the interest can impact the accounting.

Putting the right internal controls in place

Having the right internal controls in place is also critical. As controls may be challenging to implement once transactions have begun taking place, companies considering exposure to digital assets should establish policies and governance around:

  • transaction authorization (e.g., bank wire transfers to fund accounts, purchases, sales, transfers to custody);
  • segregation of duties;
  • monitoring of amounts on the blockchain;
  • valuation and impairment testing;
  • reconciling approvals, cash movements, and digital asset purchases/sales, along with balances per custodian, balances per blockchain, and balances per general ledger.

Companies may want to consider:

  • whether existing controls for treasury functions are sufficient for wire transfers for digital asset transactions; and
  • who can authorize different steps in the transactions, since companies may wish to avoid scenarios where individuals who can unilaterally approve wire transfers also complete transactions and create a wallet for asset storage.

Additional considerations include evaluating whether IT applications are home-grown and customized or provided by third parties, how and who should have access to applications, and how IT system controls integrate and work with controls at the exchange or custodian level.

Companies also often decide that they are not in the business of custody and engage third parties as custodians. In evaluating custodians, the company should establish controls that examine and test for:

  • Whether the service organization has a SOC I - Type II attestation report;
  • Whether the report addresses the relevant control objectives, including private key creation and management; and
  • End-user controls and how they work with controls at the service organization.

Additionally, companies should establish a validation process that ensures all transactions fall under the authorized types of transactions under their investment policy.

The evolving landscape brings risk … and opportunity

Accounting standard-setters are facing calls to create standards for reporting of digital assets, and the industry continues to evolve rapidly. There is an emerging consensus that increasing the use of fair value accounting for digital assets would provide more useful information to investors, as evidenced by many of the responses to the FASB’s request for comment on its future agenda.

At the same time, the decision to make a material investment in digital assets may be of heightened interest to external stakeholders, including investors and regulators. With this backdrop, companies adopting a digital asset investment policy for the first time should prepare to transact in a thoughtful way. A solid foundation in governance, accounting and internal controls will translate into a smoother process and help companies manage, account for and control the risks and rewards that come with digital assets.

Robert Sledge is a KPMG Audit Partner.