Crypto Accounting Needs To Evolve – Unpacking The Recent SEC Bulletin

UNITED STATES – CIRCA 1960s: Office paper trays, In tray overflowing, Out tray with smaller pile. … [+] (Photo by H. Armstrong Roberts/Retrofile/Getty Images)

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Cryptoassets still have numerous accounting and financial reporting issues that need to be addressed, that goes almost without saying. By the same token, however, attempting to regulate or add clarity to regulatory actions through market edicts is neither sustainable nor likely to achieve the intended effect. Especially as hacks and breaches continue to dominate the headlines surrounding the cryptoasset sector, with the Axie Infinity hack – totaling over $600 million – simply being the most recent said event.

As cryptoassets continue to permeate the investing and financial services landscape, including investment by nations and financial institutions alike, the need for more applicable accounting standards cannot go overlooked. Accounting rules and standard-setting might not be the most scintillating or most exciting aspects of crypto conversation, but they are critically important. Marketplaces and asset classes that have achieved trillion dollar valuations simply cannot proceed without appropriate and well though-out valuation, accounting, and reporting standards.

Regulation, both in the United States and other jurisdictions has – to date – been a patchwork of comments, issuances, and opinions that are often ambiguous and sometimes conflicting. Worse yet, the enforcement mechanisms around these different regulations can be described as inconsistent at best. That is why that, despite looking like positive progress, regulation or even attempted regulation, by bulletin or edit is not the correct approach.

Let’s take a look at just what is contained in the recent Staff Accounting Bulletin (SAB), and why these implications are not as obvious as might initially appear.

Bulletins are not enforceable. The first thing that any market participant, investor, or business owners should keep in mind is that this SEC bulletin, or any bulletin for that matter, is not enforceable law. No matter how much discussion or debate a certain specific bulletin gets in the mainstream media, that does not change the fact that these bulletins are not binding law. Much like how the Internal Revenue Service (IRS) can issue frequently asked questions (FAQs) and opine publicly on crypto issues, the formalized IRS legal requirements are those passed into law via changes to the tax code.

That said, while not enforceable on its own, this bulletin does provide some insight into the current thinking regarding how crypto is to be treated moving forward.

Technical vagueness. Even though the bulletin itself is not enforceable as law, it is interesting to note how much specificity and focus has been included in this short document. Two primary components stand out when this bulletin is reviewed. First, there is a recommendation that organizations offering custodial services over crypto-assets that are traded by their owners should be listed on financial statements. This representation would take the form of setting up a liability on the balance sheet linked to the risks of offering custodial services, and having this liability offset by an asset as well.

While it is true that custodial firms, including those that offer said services in the crypto space, often already attempt to do this, the fact that valuations are featuring so prominently might indicate further clarification on this issue will be forthcoming. Secondly, this bulletin also recommends that organizations disclose and report risks and costs connected specifically to cryptoassets that include legal, regulatory, technical, and financial risks.

Such specific accounting recommendation, coupled with somewhat broad (some would say vague) risk categories makes this bulletin an interesting combination of specificity and vagueness for implementation purposes.

Narrow applicability. Whenever the SEC or other regulatory body issues any sort of pronouncement or even potential guidance around cryptoassets there are always headlines and discussion that follow. Despite this, and fully recognizing the fact that these regulatory agencies exercise formal enforcement power and informal power through influencing how organizations behave, this bulletin is relatively narrow in its applicability. Since the SEC only has jurisdiction, and enforcement power, over organizations that are publicly traded in the U.S. that means that it is relatively small number of firms that will be impacted by this bulletin in any way.

It is interesting to point out that the timing of this bulletin is almost as interesting as the content of the bulletin itself. Although the number of organizations directly overseen by the SEC, and subject to any forthcoming rules, is small, the growth of the cryptoasset sector has been quite rapid. Alongside the growth of centralized exchanges and platforms, the decentralized finance (DeFi) space has been in the middle of a rapid growth phase. With this growth, however, have also been a recent rash of hacks, leading to billions in investor losses.

This bulletin might be a warning to the DeFi sector that, while not directly under the oversight of the SEC, the Commission is watching the development of the sector.

Crypto regulation and policymaking is neither a simple nor a straightforward endeavor, with multiple stakeholders needing to be consulted to develop any comprehensive and logical outcome. That said, virtually every rule making body has been issuing pronouncements, opinion pieces, and other non-binding guidance as the sector continues to evolve rapidly, which can make navigating this space all the more complicated. Complicated, but not impossible, and every new pronouncement – binding or not – does actually make the space clearer for users, investors, and policymakers alike. As always, proactive individuals and firms who actively stay abreast of changes in space will be rewarded for their efforts.

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