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Introduction to Digital Currency
Bitcoin and other cryptocurrencies revolutionized the conventional notion of what a currency is. These coins or tokens enable instantaneous transactions across borders without the need for a financial intermediary. Cryptocurrency has also recently influenced many countries around the world to develop and introduce their version of digital currencies.
Digital currencies are a very new idea, hence Financial Reporting Standards aren’t completely clear on how to account for digital currencies, in particular, cryptocurrencies. Before we think about how to treat them in our financial statements, we need to know exactly what digital currencies are.
Digital currencies are a form of currency that has no physical attributes. They are completely digital and do not require an individual to have the physical form of the currency. Just like physical currencies, they can be used to pay for goods and services on various platforms - online shopping sites, supermarkets, gaming sites, etc. It is important to note that not all digital currencies are cryptocurrencies. Generally, all digital currencies can be categorized into 3 different types.
Cryptocurrency | Central Bank Digital Currencies (CBDCs) | Virtual Currencies |
Virtual “coins” and “tokens” | Virtual form of fiat currency | Virtual currency that is controlled by its developers or/and organization. |
Secured and verified by Cryptography. These currencies are recorded in an unbreakable and unchangeable ledger stored in a cloud. Depending on the token, it may or may not be regulated. | Regulated by Central Banks | Unregulated but controlled by its developers. |
Typically used as a long-term store of value, and short-term trading. Can also be used to buy goods and services. | CBDCs can be used to pay for any form of goods and services. | Used as currency in gaming sites and online communities. Also has non-monetary benefits such as extra perks. |
Examples: Bitcoin, Ethereum | Examples: digital yuan | Example: gaming tokens |
Figure 1: Category of Digital Currencies
Source: Investopedia
Figure 2: How Blockchain Technology works
Now that you have a general understanding of how digital currencies work, let’s discuss some of the pros and cons of using them.
Pros
Without the need for financial intermediaries, the payer and payee can be connected directly. Hence, transactions can be made at a breakneck speed and at any time of the day as long as one has an electronic device to access the network and has an internet connection. This also lowers the cost of transacting by removing typical transaction and exchange fees involved by using a financial intermediary.
Digital currencies are also very secure and transparent. It achieves this by recording transactions on a blockchain ledger. Merkle trees offer a method to link together groups of authenticated transactions. They do this by utilizing hashing, a process that transforms a string of characters into a fixed-length value that represents the original string. Cryptocurrencies use pseudonyms that are not linked to any account or user. Different keys are also used to encrypt and decrypt messages. Hence, it is more secure when compared to transactions made through the bank. Also, anyone can view the previous transactions made, which allows for greater transparency.
Figure 3: Merkel trees
Another advantage to digital currency, specifically cryptocurrency, is the protection against inflation. When it comes to Bitcoin, there is a fixed market cap which is 21 million Bitcoins. As a result, the increased demand will see an increase in value, in the long run, hedging against inflation due to increasing demand and a fixed supply.
Cons
Despite the many advantages that come with digital currencies, they aren’t without their disadvantages. Since cryptocurrency activities are decentralized and highly secure, it is an insurmountable problem for the government to track down a particular user by their wallet address. Cybercriminals have used bitcoin as a mode of exchanging money and various illegal deals such as purchasing drugs on the dark web and money laundering.
While investing money in cryptocurrency comes with the potential of high returns, the crypto market is highly volatile and one may be in a riskier position of experiencing huge financial losses. Its volatile nature makes it almost undesirable for many to use it as currency for payments. For example, holders of Bitcoin would be reluctant to give away their coins due to the hope that their value will increase in the near future.
CBDCs, despite removing the need for financial intermediaries to aid in the transaction n process, are still centralized. Many will be worried about their privacy and rights as individuals to conduct transactions with who they want when central banks and the government can step in to prevent who the citizens transact with. The data involved in transactions may also be hacked by criminals.
Despite the number of ardent fans for digital currencies, it is not necessarily the future. Cryptocurrencies are neither money nor are a store of value; they have dubious inherent value and have not been universally accepted yet.
Corporates benefits from cryptocurrency adoption
In 2020, corporates began allocating cash to digital assets and cryptocurrencies. Companies made the switch to seek better returns and preserve the value of their capital over time compared to holding cash. Here are some of the rationale behind why some companies are currently using crypto:
●Cryptocurrency may open doors to new demographic groupings. Users frequently represent a more cutting-edge clientele that places a premium on transaction openness. According to a recent survey, up to 40% of clients who pay with cryptocurrency are firsttime customers with purchase amounts twice those of credit card users.
● Introducing crypto could help firms become more aware of this emerging technology. It might also help the corporation position itself in this key developing market, which could incorporate central bank digital currencies in the future.
●Traditional investments that have been tokenized, as well as new asset classes, could provide access to new capital and liquidity pools via cryptocurrency.
● Certain options provided by cryptocurrency are simply not available with fiat currency. For example, programmable money can enable real-time and accurate revenue sharing while also improving transparency to aid in back-office reconciliation.
●More businesses are discovering that important clients and vendors prefer to conduct business using cryptocurrency. As a result, your company may need to be prepared to receive and disburse cryptocurrency in order to ensure smooth transactions with key stakeholders.
●Cryptocurrency may be an effective alternative or balancing asset to cash, which may depreciate due to inflation over time. Cryptocurrency is an investable asset, and some, such as bitcoin, have done exceptionally well over the last five years. Of course, there are obvious volatility risks that must be carefully considered.
Tesla & MicroStrategy Case Study
Tesla and MicroStrategy, two of the most visible corporate adopters of cryptocurrency, both regard Bitcoin as an indefinite-lived intangible asset. They classify it as a "Digital Asset" on their balance sheets, and because it has an indefinite lifespan and accounts for no amortization.
IFRS Standards regarding cryptocurrency
Currently, there are no specific accounting standards to address how to account for cryptocurrencies in financial statements. Thus, accountants have to refer to existing standards. What you need to know: A cryptocurrency is a digital or virtual currency recorded on a distributed ledger that uses cryptography for security, not issued by a jurisdictional authority or other party, and does not give rise to a contract between the holder and another party.
Cryptocurrencies are not financial assets; in most circumstances, they are classified under intangible assets if held for the long term. However, in some scenarios and depending on an entity’s business model, it might be appropriate to account for cryptocurrencies as inventories under IAS 2 where it defines inventories as assets that are available for sale. Figure 4 summarizes the different possible classifications and measurement considerations:
Figure 4: How accounting methods may be applied
Source: PwC
In conclusion, digital currencies only exist in an electronic form. Hence, they can only be accessed with an electronic device such as a mobile phone. Cryptocurrencies, such as Bitcoin, threaten to disrupt financial services, removing the need for financial intermediaries to allow for seamless and cheaper transactions. This convenience has motivated many countries to adopt this concept by introducing electronic versions of their own currencies. However, many are worried about the potential misuse of personal data involved in personal transactions. As cryptocurrency is still a new phenomenon and not yet adopted widely and commonly by businesses, there is yet to be a specific financial reporting standard to address the reporting of cryptocurrency. Currently, cryptocurrency is generally treated as an intangible asset according to IAS 38 or inventory in other circumstances in accordance with IAS 2.
References
Conway, L. (2021, May 31st). Blockchain Explained. Blockchain Explained. https://www.investopedia.com/terms/b/blockchain.asp Cooper, S., & Jullens, D. (2021, February 15). Bitcoin: The financial reporting challenge for investors. Nil. https://www.footnotesanalyst.com/bitcoin-the-financial-reportingchallenge-for-investors/ Cowen, T. (2020, December 29). Cryptocurrency Is Not Necessarily the Future. Cryptocurrency Is Not Necessarily the Future. https://www.bloomberg.com/opinion/articles/2020-12-29/bitcoin-hits-new-high-butcryptocurrency-s-future-is-uncertain DeChesare, B. (-, - -). Cryptocurrency Accounting: Why Net Income and the P / E Multiple Have Become Even More Useless. Mergers & Acquisitions. https://www.mergersandinquisitions.com/cryptocurrency-accounting/ Deloitte. (n.d.). The rise of using cryptocurrency in business. Deloitte. https://www2.deloitte.com/us/en/pages/audit/articles/corporates-using-crypto.html EY. (2019, August 01). IFRS Development. Holdings of Cryptocurrency. https://assets.ey.com/content/dam/ey-sites/ey-com/en_gl/topics/ifrs/ey-devel150- cryptocurrency-holdings-august-2019.pdf Frankenfield, J. (2021, August 10th). Digital Currency. Digital Currency. https://www.investopedia.com/terms/d/digital-currency.asp IFRS. (2021). IAS 38 Intangible Assets. IAS 38 Intangible Assets. IAS 38 intangible assets: https://www.ifrs.org/issued-standards/list-of-standards/ias-38-intangibleassets.html/content/dam/ifrs/publications/htmlstandards/english/2021/issued/ias38/#standard Keracheva, E. (2021, March 4). Advantages and Disadvantages of Cryptocurrency. Advantages and Disadvantages of Cryptocurrency. https://ccm.net/faq/75869- advantages-and-disadvantages-of-cryptocurrency Lo, C. (2021, February 12). What is the problem with cryptocurrency (bitcoin)? What is the problem with cryptocurrency (bitcoin)? https://investors-corner.bnpparibasam.com/markets/what-is-the-problem-with-cryptocurrency-bitcoin/ North East Times Magazines. (n.d.). IDEAS: THE PROS AND CONS OF DIGITAL CURRENCY. IDEAS: THE PROS AND CONS OF DIGITAL CURRENCY. https://netimesmagazine.co.uk/magazine/times-live/ideas-the-pros-and-cons-of-digitalcurrency/ SETH, S. (2021, August 25th). Central Bank Digital Currency. Central Bank Digital Currency. https://www.investopedia.com/terms/c/central-bank-digital-currency-cbdc.asp
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