Crypto currency

Cryptocurrency is a digital “currency” designed to function as a medium of exchange.

It means that we can perform financial transactions with cryptocurrency (if our counterparty accepts
it) and we can make investments in cryptocurrency as well.

Cryptocurrencies usually have the following common characteristics:

 They are decentralized – i.e. not issued by any central bank or similar body;
 They are recorded on a distributed ledger – which means that all transactions in that
currency are recorded in one big ledger called “blockchain” and every participant has
his/her own copy of this ledger;
 The cryptography is used to ensure security and prevent fraud – to verify correctness of
the transactions, each valid transaction carries a sort of digital signature – or hash.

Cryptocurrency is NOT a financial instrument:

Many people are tempted to say that cryptocurrencies are financial instruments, because they
contain the term “currency” and thus they must be the same as cash.

Wrong.
The application guidance of IAS 32 (par. AG3) defines currency as a financial asset, because:

 It represents the medium of exchange; and

 It is the basis on which all transactions are measured and recognized in financial
statements; and
 The deposits if cash in banks represents the contractual right of the depositor to obtain
cash from the institution…etc.

However, the following applies for cryptocurrency:

 It can be used in exchange for particular goods or services, but it is not widely accepted.
 It is not used as the monetary unit in pricing goods or services – the pricing is usually
done in “normal” currency and then pricing in cryptocurrency is derived from regular
currencies.
 Cryptocurrencies are poor store of value due to their high volatility.
MOST IMPORTANT: There is NO contract whatsoever.

The basic definition of a financial instrument is that it a contract that gives rise to a financial
asset of one entity and a financial liability or equity instrument of another entity (see IAS 32).

In other words – if we hold some cryptocurrency, we do not have any contractual right to receive
cash or another financial asset, because there is no contract and there is NO counterparty.

So how should we classify and account for cryptocurrencies?

How to account for cryptocurrencies in line with IFRS?

Let’s discuss two types of entities that might be interested in accounting for cryptocurrencies:

1. Holders of cryptocurrencies: if we purchased cryptocurrencies to store value or to make

an investment return, but we are not involved in any “mining” activity;

2. Miners of cryptocurrencies: if we decided to invest in all that hardware (computers,

graphic cards and other stuff), electricity and other resources with the purpose of serving
the network and creating new cryptocurrency units. We will explain mining a bit later.

 Accounting for cryptocurrencies by the HOLDER:

Until recently, there was literally nothing official related to accounting for holding of cryptocurrency.

However, IFRS Interpretations Committee (IFRIC) met in June 2019 and discussed that and
issued their decision, so at least we have some official guidance for a part of the problem.

In accordance with IFRIC decision, cryptocurrency meets the definition of intangible asset in line
with the standard IAS 38 Intangible Assets.

Cryptocurrency is an asset for sure, because asset is a resource controlled by an entity as a

result of past event from which future economic benefits are expected to flow to the entity –
that is fully met.

Under IAS 38, intangible asset is an identifiable non-monetary asset without physical
substance.
Yes, cryptocurrency has no physical substance and is a non-monetary asset as I explained above.

Identifiable means either:

 Separable – i.e. we can separate or divide it from the entity and sell, transfer, rent, etc.; or

 Arising from contractual or other legal rights – not applicable here since there is neither
contract nor other legal rights.”

Since the cryptocurrency can be sold, it is separable and thus meets the definition of
the intangible asset

The accounting method depends on the purpose of our holding:

How to account cryptocurrency: for HOLDER

Held for Trading Held for Capital

(Cryptocurrency Dealers/Brokers) appreciation & Others

IAS-2 (Inventory) IAS-38 (Intangible Assets)

FV less cost to sell  Revaluation or Cost Model

 Indefinite life no amortisation
1. Cryptocurrency held for trading

If we are holding cryptocurrencies for sale in the ordinary course of business, we might need to
apply IAS 2 Inventories.

So, if our business is to act as a broker-trader of cryptocurrencies, then we should apply IAS 2,
more specifically IAS 2.3b for commodity brokers and traders.

As we might know well, commodity brokers and traders measure their inventories
(cryptocurrencies) at fair value less cost to sell.

2. Cryptocurrency not held for trading

If we acquired cryptocurrency units in order to hold them and store value over extended period of
time or for other purposes, then we need to apply the standard IAS 38 Intangible Assets.

Unfortunately, IFRIC did not state any recommendations or decisions on how to apply IAS 38 for
cryptocurrencies.

Here, the main consideration is which model permitted by IAS 38 to apply:

 Cost model – here, we would need to hold our cryptocurrency at cost less accumulated
amortization less impairment.

This is doable – especially when there will probably not be any amortization because
cryptocurrencies have indefinite useful life in general.

However, when there are declines in cryptocurrency’s fair value, we need to account for
any impairment.

Then there is another problem: if the fair value of cryptocurrency increases above our cost,
we would never recognize this increase under the cost model.

However it is not very intuitive when we hold cryptocurrency for capital appreciation
purposes.

 Revaluation model – if the active market exists, we can revalue cryptocurrencies to their
fair value and account for any increases directly in other comprehensive income, or for
decreases in profit or loss.

This is not very symmetric, but if we hold cryptocurrency for capital appreciation, it is
probably more appropriate than the cost model.
  Accounting for cryptocurrencies by miners

While holders received some guidance from IFRIC, there is literally no guidance on accounting for
cryptocurrencies by their miners.

And, the truth is that while we did not have to understand the full cryptocurrency process if we are
a holder, it would be great to understand it for miners.

The reason is that once we understand what in substance we do, then we can decide on how to
reflect it in our accounts.

Many people think that cryptocurrency miners are literally mining, and therefore the standard
IFRS 6 Exploration for and Evaluation of Mineral Resources applies.

Here, miners are NOT mining in this sense.

So, what are miners doing? This question brings us back to the basic characteristics of
cryptocurrencies that I described above.

One of them was that cryptography is used to ensure security and prevent fraud.

How?

In short – each transaction must be verified by adding a sort of digital signature and added to the
digital distributed ledger.

So, when somebody makes a transaction with cryptocurrency (e.g. pays for some service with
Bitcoin), then this transaction is broadcasted to the network of participants.

Then, a miner is responsible for:

1. Verifying the transaction and creating the new block of transactions.

Very simply speaking – they do so by collecting the transactions broadcasted by the

participants, organizing them to the block and then solving mathematical puzzle with
cryptographic hash function to add the proof of work of to that block.

It simply means that the miner must literally guess the correct authentification digital code
that meets the algorithm criteria.
 2. Update the distributed ledger to include newly verified transaction (or block of
transactions, to be precise).

Thus the miners communicate their “proof of work” to the network of participants and each
participant updates their ledger (blockchain; remember, blockchain is decentralized and
each participant has its own copy of it).

Just a side note: that huge decentralized ledger is called blockchain, because all transactions are
split into blocks. One block is created by a number of individual transactions.

if we want to know more technical details about proof of work, how it prevents fraud, how we can
be sure that everybody has the same version of decentralized ledger, etc

For their work, miners get two types of reward:

1. Block reward – earned for creating the block; which is generated by the system algorithm
2. Transaction fees – earned for validating an individual specific transaction and paid by the
transacting participant

Remember, there are many transactions in one block and when miner solves puzzle, he currently
earns both types of fees. Moreover, when miners “mine”, or do the computational work to verify
transactions and update the blockchain, they use huge resources, such as loads of computers,
graphic cards, high electricity bills, etc.
Therefore the question is: how to account for all these expenses spent in cryptocurrency mining?

And how to account for the rewards they earn for mining?

 Accounting for block rewards by miners

Every time when the miner guesses the digital code or hash, verifies the transactions and updates
the ledger with new block, he earns the small amount of cryptocurrency.

Where does this amount come from and who pays that?

Out of thin air: No one pays that – the system is set and programmed this way.

This is the first part of miner’s reward and is often referred to as block reward because it relates to
creating the new valid block (including more transactions).

However, it will not go infinitely – for example for Bitcoin, the blockchain reward decreases with
time as the total number of blocks increases. So after some time, block reward will be zero and
miners will earn only the transaction fees as described below.
Currently, it is set to 12.5 BTC (with about 612 000 blocks of transactions). When the number of
blocks in the ledger (blockchain) reaches 630 000, the block reward will decrease to 6.25 BTC.

This is all set in the blockchain algorithm programmed by its creators.

I don’t want to go deeper into technical details now, because that’s not really our main purpose.

However, how to account for this block reward?

First we have to know: what are miners doing here?

In fact, they are providing some service to the network. The block reward is a reward for solving
the puzzle, creating a new block with certain transactions and updating the ledger.

That implies that we should apply the revenue standard IFRS 15 to accounting for block rewards,
however there is one problem: There is no customer. No contract.

Miner is getting paid by the algorithm.

Some people argue that it is implied that the whole network is a customer, but I think there is a
problem with enforceable rights and obligations – there are none.

Thus, we cannot apply IFRS 15.

However, when the miner receives the block reward, it certainly represents the inflow of economic
benefits – thus it meets the definition of income as stipulated in Conceptual Framework.

The conclusion: Include it in our profit or loss at the moment of receiving the block reward,
measured at fair value.

The journal entry is:

 Debit Intangible assets – cryptocurrencies;

 Credit Other income in profit or loss.

(If the miner happens to be a trader with cryptocurrencies, then Debit is Inventories).
  Accounting for the transaction fees by the miners

The transaction fee is earned for validating the transaction and including it in the individual block of
transactions.

So, the fees are not earned by the system for the validating the block as a whole (block reward is
to compensate that), but they are earned for the individual transaction.

Also, while the block reward is created out of thin air and no one really pays it (because it is
created by the block algorithm, or the program underlying the cryptocurrency), the transaction fee
is paid by the specific network participant.

For example, Mr.X pays 5 BTC to Mr.Y and for that transaction, the fee of 0.005 BTC is sent to the
miner who includes this transaction to the block, manages to guess the hash and validates block
and includes it in the blockchain.

Technically speaking, here we have a customer – it is the originator of the transaction (Mr.X in the
above transaction).

And also, the contract is implied here because it is understood that Jane will have to pay the
transaction fee.

Conclusion: We can apply IFRS 15 in this case and recognize the transaction fee as revenue at
the point of time when the performance obligation is satisfied – i.e. when the miner validates the
transaction and becomes entitled to the fee.

 Accounting for expenses incurred by the miners

Well, we heard some arguments that since cryptocurrency is an intangible asset (as described
above), then the miners are developing intangible assets.

Therefore, they should capitalize all expenses incurred in mining (like hardware, electricity bills,
etc.) and when they earn block reward for the successful solving of the puzzle, then they have
completed the development and start the development of the new intangible asset (i.e. new block
reward for another transaction).

I am NOT in favor of this view.

The reason is that if we want to capitalize internal development of an intangible asset, we need to
meet 6 PIRATE criteria (as per IAS 38)

One of them is that we can reliably measure the expenditure attributable to the intangible asset
during its development. And in this case, we CANNOT.
Why?
In reality, there are many miners out there, trying to solve the puzzle and win the race.

Indeed, being able to validate the transaction is more like winning the lottery, rather than
systematic building of some asset.
Also, it is quite difficult to separate costs incurred for the successful guess from all previous
unsuccessful guesses.

Which is more important – what is the nature of miner’s activity?

They are validating transactions and updating the blockchain (ledger) – thus it seems
like providing the service to the network rather than building an asset.

Conclusion: Miners should account for the expenses incurred with “mining” in profit or loss as they
are incurred.

For those who like matching principle – here, we cannot really attribute the specific expenses to the
specific revenues because of a “lottery element” included in mining.

Single miner or pool?

Sometimes, more entities combine their computational power and create mining pool.

In this case, they mine together and have agreements on sharing the rewards and fees.

Let me mention that the accounting principles described for individual miners are the same for
pools.

The only difference is that they maybe create some joint arrangement and need to apply IFRS 11
as well.

Final word

Well, I tried to be as clear as possible and as I can. The number of digital transactions and their
variety increases and becomes more complex.

Also, please bear in mind, that I tried to think about these issues, make up my own opinion, cross-
check it with IFRIC’s decision and other available guidance – but indeed, we may need to develop
your own accounting policy if the terms of your cryptoassets are different.

I would give special thanks to my Teacher SILVIA FCCA.