The Node Ahead 19: Accounting for crypto, The World Bank’s crypto report and digital preservation

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Good Morning!

On Sunday May 15, the president of El Salvador hosted a meeting with central banks and financial authorities from 44 different countries with the sole purpose of discussing the rollout of bitcoin as legal tender and the benefits it has had to the country. It’s been less than a year since bitcoin was made legal tender in El Salvador and not only have other countries done the same, but the number of countries actively exploring the adoption of bitcoin is increasing at a rapid pace. 

Accounting for crypto

In August 2020, MicroStrategy became the first publicly traded company to buy and hold bitcoin on its balance sheet.  Since then, more than thirty public companies including Square, Tesla, MassMutual, and KPMG have also added bitcoin to their companies’ treasuries.  While it was a good start, there hasn’t been the wave of companies adding bitcoin to their balance sheets at the rate many previously predicted.  The biggest obstacle preventing more corporations from buying bitcoin has nothing to do with the asset itself, it has to do with accounting rules. That’s right, forget DeFi, NFTs and price swings, today we are diving into the glitz and glamor of the accounting of bitcoin (all kidding aside, this is actually a very important topic).  

Today, there are no dedicated accounting rules for cryptoassets.  The existing rules were created long before Satoshi mined the first bitcoin in 2009 and as a result, cryptoassets simply do not fit into the current GAAP framework.

A rational person would think the answer is obvious, bitcoin should simply be treated as another currency and accounted for in the same way as any foreign currency typically is. In theory, this would be a straightforward solution as bitcoin would be recorded in the “cash and cash equivalents” portion of the cash flow statement and changes in the value of bitcoin would simply appear as currency gains or losses. However, bitcoin is not recognized as legal tender in the US, not issued or backed by a government or state, and not directly related to setting prices for goods and services.  Thus, bitcoin and other cryptoassets cannot be regarded as cash for accounting purposes.

Nor does bitcoin meet the definition of “cash equivalent.” In order to qualify as a cash equivalent, bitcoin must also have “insignificant risk of changes in value” (aka low volatility, not exactly what cryptoassets are known for). 

Which means under GAAP accounting standards, bitcoin falls under the intangible asset classification. Intangible assets are defined as “identifiable non-monetary assets without physical substance.” This broad definition is the best we got within the current accounting rules which is unfortunate because when an intangible asset’s value is impaired it must be written down below its purchase price.  But here is the kicker, while companies are forced to write down the value of their intangible holdings, the rules do not permit any write ups should that intangible asset increase in value.

Yup, that’s right.  If you are a company holding bitcoin on your balance sheet today, you have to mark down the value of your holdings if the price drops and are forbidden from showing the increase in value should the price rise. Don’t ask me why this makes any sense, I hated my accounting classes during school for reasons just like this.

However, there is some good news.  After more than a year of urging from accountants, CEOs and politicians, the Financial Accounting Standards Board (FASB) recently voted unanimously to begin reviewing the accounting rules for exchange-traded digital assets and commodities. This decision is a stark reversal from FASB’s historical position on cryptoassets in which it has declined to address the issue for years.  FASB’s most recent statement prior to this one, which came in October 2020, said that investments in cryptoassets weren’t widespread enough among companies to warrant a review. However, now several board members are realizing the growing adoption of cryptoassets and are changing their tune.

A clearer, more rational framework for how to account for cryptoassets should hopefully pave the way for many more public companies to hold bitcoin on their balance sheet.  And given the amount of cash this group has; this is potentially a huge deal. The companies in the S&P 500 currently hold nearly $2 trillion (yes with a “t”) in cash and cash equivalents on their books.  That’s 4x the market cap of bitcoin and nearly double the size of the entire crypto market today. Removing the largest obstacle facing companies from allocating a percent of their cash position to bitcoin could result in a significant influx of capital into the asset class.

Over a year ago, I made the prediction that in time it will not only be common to hold bitcoin on a corporate balance sheet, it will be considered best practice to do so.  Getting the proper accounting rules in place is a major step in that becoming a reality.

World Bank Crypto Report

The World Bank hasn’t exactly been a supporter of cryptoassets in the past.  They have called for tougher regulations designed to prevent the growth of cryptoassets, which they have said could lead to financial instability and funding of terrorism despite the fact they have never provided a shred of evidence to support any of these claims.  When El Salvador made bitcoin legal tender in the country, the World Bank rejected El Salvador’s request for assistance with the rollout because of “environmental and transparency shortcomings.” Never mind the fact that bitcoin is far more transparent than our current financial system and as we have covered in previous newsletters, the myth that bitcoin mining has a negative impact on the environment is a lot more nuanced than blanket statements like this lead people to believe.

Which is why the latest report on cryptoasset adoption from the World Bank caught me by total surprise.  Just read this paragraph from the introduction and see if you notice a change in tone.

“The ascent of crypto-assets has put a welcome spotlight on various well-known weaknesses in the traditional financial and monetary system. Some of these deficiencies are related to: financial inclusion, since 1.7 billion people around the world remain “unbanked” and have limited or no access to financial services (Demirgüç-Kunt et al (2017)); (cross-border) payments and remittances, which can be slow, costly, and opaque; citizen’s trust in and efficiency of traditional financial intermediaries, as in some countries competition is limited and memories of banking sector stress are still fresh; and macroeconomic policies, given that some countries experience regular bouts of excessive inflation and currency depreciation or volatility. Moreover, given their ease of storage and portability without the need for intermediaries, crypto-assets may also support people “living under the threat of harm by their families, people in their communities, or repressive governments” (Peirce (2021)). More broadly, crypto-assets typically operate on open platforms and open-source software protocols which are not controlled by a central entity which may be prone to failure, fraud or rent seeking and are accessible to anybody to use and build upon. Proponents argue that most of the value of open and decentralized systems accrues to participants and innovators, unlike centralized platform companies which tend to become extractive with users and competitive with developers and businesses as they reach scale (e.g., Dixon (2018)). Such conditions may therefore solicit more enduring innovation and network effects and give rise to a new wave of interoperable business models, products, and services.”

I couldn’t have said it better myself.  But that was just the introduction to a comprehensive, 60-page study that reported a number of other findings as well:

  • Bitcoin as an inflation hedge and substitute for gold:

“countries’ crypto volumes consistently rise when U.S. longer-term inflation expectations increase (based on breakeven inflation rates as embedded in U.S. Treasury securities yields). Moreover, crypto volumes move inversely with gold prices, suggesting that users may, to some extent, perceive crypto-assets as an alternative to gold, a traditional global macro hedge.”

  • Higher use where there is less financial infrastructure:

“we find tentative support that crypto activity is higher in less economically developed countries and in countries with stronger ICT penetration, broadband subscriptions in particular. We also find that crypto activity is higher in countries where personal remittances play a more important role.”

  • Improving cross border payments:

“results suggest that cryptoassets may be used as a response to overcome long-standing challenges in cross-border payments and remittances (including to evade capital controls). Nascent implementations of new promising technologies (e.g., the Lightning Network, see Poon and Dryja (2016)) that could address current transaction throughput challenges of crypto-assets may help accelerate adoption for (cross-border) payment transactions.”

This report is an impressive study that leverages on-chain data and is broken out by region, type, transaction size, and more. It is yet another example of how nearly anyone, even skeptics, who take the time to research the data and understand the facts, tend to draw much more favorable conclusions about the crypto industry.  Hopefully, this marks a change in rhetoric from an organization designed to “help developing countries achieve sustainable financial growth” because crypto is likely the best tool they have to achieve that mission.

Digital Preservation

A key characteristic of blockchain technology is immutability.  The fact that once something is stored on a decentralized blockchain it is nearly impossible for it to ever  be deleted or altered is one reason everyone can trust blockchains as single sources of truth.  While financial transactions and smart contracts are the predominant use case today, that doesn’t mean it’s the only thing that can be immutably stored on a blockchain.

Prior to computers and the internet, the only way to preserve information was to store physical documents.  If there was a fire or other natural disaster, those documents were likely to be destroyed forever.  Even if there was no disaster, time would eventually fade or erode pieces of paper and the information stored on them.  The advent of computers and the internet meant that we could now store documents electronically, preserve them longer and recover them if the computer was destroyed.  However, this advancement came with a reliance on centralized parties which increased the ability for censorship and ways malicious actors could acquire those documents.  Even storage of information on the internet isn’t permanent as evidenced by the phenomenon known as link rot as an investigation into hyperlinked citations on news stories published by The New York Times found last year.

Blockchains now give us an even better way to store critical information.  Decentralized storage solutions such as Filecoin, Arweave, Storj and Sia are blockchain based digital storage and data retrieval protocols. Rather than storing all files in a centralized cloud system, these networks distribute the encrypted data across many different nodes on a network thus security is not dependent upon any single server. By having many different “servers” in the network, each holding only a small fraction of the data, it becomes much more difficult for hackers or other malicious users to gain access to personal information. The increased reliability and redundancy also means there is no single point of failure nor is link rot an issue.

With the advent of blockchains, not only can the data be stored forever, but anyone can also rent out their hard drive space in exchange for tokens. Solutions such as Filecoin allow anyone to buy or contribute excess storage capacity using Filecoin’s native currency, FIL. 

This technology can be used to store key documents such as birth certificates, marriage licenses, and deeds to a house securely and permanently.  So much so that Ukrainans are currently leveraging Arweave to preserve key historic documents and cultural artifacts from being lost due to the destruction of Russian forces.  This includes important news articles, documents, videos, social media posts, and all sorts of digital forms of media. 

Which is why the recent grant provided by The Filecoin Foundation for the Decentralized Web (FFDW) to MuckRock is a development worth following.  MuckRock is a non-profit dedicated to helping journalists, researchers, activists, and regular citizens request, analyze, and share government documents.  It has a repository of over 8 million verified documents including important data sets such as The Panama Papers and the Facebook Papers. Now, MuckRock will store key public-interest documents on the Filecoin network in order to preserve some of humanity’s most important information.

Crypto’s first use cases revolved around finance but as projects such as Filecoin, Arweave, and many other projects continue to show, the technology is beginning to expand into new and novel applications.

In Other News

JPMorgan thinks bitcoin is below its “fair price” and now features among the bank’s preferred alternative investments.

Ukrainian President Volodymyr Zelenskyy has signed a virtual assets bill into law that will recognize cryptocurrency as an asset post-war. The country has received over $60M in crypto donations to date. 

According to a white paper published in the Journal of Marine Science and Engineering, bitcoin mining has the potential to unlock between 2 to 8 terawatts of clean and continuous power by harnessing the thermal energy of oceans.

Crypto executives and lobbyists have donated $30M to campaigns in favor of the crypto industry to create awareness. 

House Republicans seek more analysis on a possible US CBDC in letter to the Fed.

Robinhood is developing a standalone crypto wallet application compatible with NFTs so that users can store their digital assets, withdraw crypto, and link to NFT marketplaces.

Ethereum merge to Proof of Stake is scheduled for August “if everything goes to plan.”

Tether claims its stablecoin is now partially backed by non-U.S. government bonds.

The U.S. Commerce Department is requesting public comments about how to best ensure the country’s competitiveness in digital assets, following President Biden’s executive order on crypto in March.

At a recent gathering of the most powerful people in the sports business, attendees were more crypto-curious than ever.

A16z crypto released their inaugural 2022 State of Crypto report.

How charities can utilize NFTs to maximize fundraising.

Congress mulling stablecoin regulation after Terra crash.

Disclaimer:  This is not investment advice. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction. All Content is information of a general nature and does not address the circumstances of any particular individual or entity. Opinions expressed are solely my own and do not express the views or opinions of Blockforce Capital or Onramp Invest.

Disclaimer: This is not investment advice. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction. All Content is information of a general nature and does not address the circumstances of any particular individual or entity. Opinions expressed are solely my own and do not express the views or opinions of Blockforce Capital or Onramp Invest.


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