accounting

US lawmakers argue SEC accounting policy places crypto customers at risk

While the bulletin was intended to provide clarity regarding the accounting treatment for digital assets, it has been criticized by both lawmakers and regulators.

Two United States lawmakers have criticized crypto accounting guidelines outlined by the national securities regulator, arguing they places crypto customers at greater risk of loss.

The guidelines came from the United States Securities and Exchange Commission and became effective in April last year.

The guidelines ask financial companies holding crypto for customers to recognize all digital assets they do not control as a liability. They also state that digital assets should be backed by a safeguarding asset.

Crypto companies must show liabilities equal to ALL customer crypto assets, according to SEC’s new rule SAB 121 issued in March 2022.@coinbase complied for their Q2 filing and now shows an $88B “customer crypto liabilities” item. https://t.co/59029Pr2LE

— Cory Swan.com #Bitcoin WORKS (@coryklippsten) August 15, 2022

However, Senator Cynthia Lummis and Representative Patrick McHenry argued on March 2 that these guidelines will “likely” discourage regulated entities from engaging in digital asset custody, which is the opposite effect of what the regulator should be doing.

In a letter to ranking individuals with the Federal Reserve System, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the National Credit Union Administration, the lawmakers argued that while Staff Accounting Bulletin (SAB) 121 was intended to provide clarity on accounting treatment for digital assets, it carried negative side effects. They wrote:

“SAB 121 places customer assets at greater risk of loss if a custodian becomes insolvent or enters receivership, violating the SEC’s fundamental mission to protect customers.”

The lawmakers argue the effect of SAB 121 will be to “deny millions of Americans access to safe and secure custodial arrangements for digital assets.”

“In sum, the effect of SAB 121 is to deny millions of Americans access to safe and secure custodial arrangements for digital assets.”

⬇️⬇️ My letter with @PatrickMcHenry here:https://t.co/kEQKJMg4tC

— Senator Cynthia Lummis (@SenLummis) March 2, 2023

The lawmakers also disagreed with the “breadth of the ‘digital asset’ definition in SAB 121,” arguing that “a more nuanced hierarchy for this asset class which considers the opportunities and risks of digital assets with different functions is necessary.”

Lawmakers including Lummis have kicked up a fuss over the SEC accounting bulletin in the past.

Last year, five Republican senators, including Lummis, sent a letter to the SEC on June 16, sharing their concern that the bulletin amounted to “regulation disguised as staff guidance” and did not adhere to the Administrative Procedure Act.

SEC commissioner Hester Peirce shared similar concerns on March 31, soon after the bulletin was released, noting it was “the way the change is being made” rather than the accounting determination itself she took issue with. She characterized the change as:

“Yet another manifestation of the Securities and Exchange Commission’s scattershot and inefficient approach to crypto.”

USDC transfer volume hit 5X USDT’s in fallout from FTX collapse

Although it has a much smaller market cap, on-chain data shows that USDC has a much greater transfer volume than its main competitor USDT.

Stablecoin USD Coin (USDC) has grown in popularity since the collapse of FTX. It now frequently reaches daily transfer volumes four to five times that recorded by major competitor Tether (USDT) according to data from blockchain analytics firm Glassnode.

That’s despite the market cap of USDT being $23 billion greater than USDC. As of Jan. 10, the difference was in USDC’s favor by a margin of four and a half times.

Both stablecoins recorded surges in transfer volumes following an infamous tweet from Binance CEO Changpeng Zhao on Nov. 6 announcing Binance would liquidate its entire FTX Token (FTT) holdings. FTX went into bankruptcy soon after.

Since then, USDC has been the preferred choice for crypto users, averaging over $12.5 billion more in transfer volume per day than USDT, according to Glassnode data.

*Total transfer volumes for USDC (In blue) and USDT (In green) from Oct. 8, 2022, to Jan. 10, 2023. Source: Glassnode.*

While each stablecoin is designed to trade as close to one U.S. dollar as possible and is backed by reserves held by its issuers, USDC is regarded by some in the crypto community as a potentially safer option.

Supporters point to USDC’s assets, which are backed by cash or short-term United States treasuries and its monthly audits by global accounting firm Grant Thornton.

Tether has faced criticism over several years for not providing a proper audit and being less transparent about its reserves.

The company behind USDT was fined $41 million in October 2021 by the Commodity Futures Trading Commission, which accused it of only holding sufficient reserves 27.6% of the time between 2016 and 2018 despite claiming its tokens were fully backed by fiat currencies.

Tether has been reducing the commercial paper backing its issued tokens in favor of safer alternatives, with the latest asset breakdown on Nov. 10 shows that nearly $46 billion of its reserves consist of cash, bank deposits and U.S. treasuries.

USDT briefly lost its peg to the U.S. dollar following the FTX collapse amid fears of exposure to Alameda Research and FTX, which Tether denied.

On-chain evidence suggests the two firms were attempting to short the stablecoin.

USDT had been recording transfer volumes much higher than USDCs up until May 2021, after Tether had increased the supply of the token from $8.79 billion to $61.82 billion in the previous year, representing an increase of 603%.

*Market cap of USDT from May 2018 to January 2022. Source: TradingView*

Despite the subsequent change in consumer preferences, Tether had referred to the growth in market capitalization as an indication of “the market’s continued trust and confidence in Tether.” It noted every token could be redeemed for U.S. dollars on a 1:1 basis.

Russia’s Central Bank report examines crypto’s place in the financial system

Russia’s Central Bank has released a report on digital assets which looks at how the technology could be integrated into its traditional financial system.

The Central Bank of Russia (CBR) is looking at ways to integrate crypto assets and blockchain technology into its local financial system amid a pile-on of global financial sanctions.

In a Telegram post by the CBR on Nov. 7, the central bank shared a public consultation report titled “Digital Assets in Russian Federation.”

It considers how the sanction-hit state may possibly open up its domestic market to foreign issuers of digital assets — particularly those from “friendly countries.”

Other areas of focus in the report are digital asset regulation, retail investor protections, digital property rights related to smart contracts and tokenization, as well as reformed accounting and taxation proposals.

The CBR stated that it strongly supports the “further development of digital technologies” provided they don’t create “uncontrollable” financial or cybersecurity risks for consumers.

Despite the nascency of blockchain technology, CBR said the same regulatory rules concerning the issuance and circulation of traditional financial instruments should also extend to digital assets.

The CBR said regulation over the short term should focus on protecting investor rights, strengthen rules for admitting a digital asset into circulation, ensuring the issuer is accredited and ensuring the issuer discloses all relevant information to investors.

The Central Bank’s message on Telegram, originally written in Russian, said while the legal framework for digital assets has been created, improved regulation is required for its continued development.

“Russia has created the necessary legal framework for the issuance and circulation of digital assets […] But so far the market is at the initial stage of its development […] and is many times inferior to the market of traditional financial instruments. Its further development requires improved regulation.”

As for smart contract regulation, the central bank acknowledged that a legislative framework was already in effect — however, it proposes that Russian-created smart contracts be independently audited before being deployed.

CBR was also positive about the potential for tokenized off-chain assets. However, the bank noted that legislation would need to be put in place to ensure a “legal connection” exists between the token holder and the token itself.

The report comes as the Russian Ministry of Finance recently approved the use of cryptocurrencies as a cross-border payment method by Russian residents on Sept. 22.

However, the CBR’s 33-page report made no reference to the increase in sanctions that have been imposed on Russia and the crippling effect it has had on its economy — nor did it discuss the Russia-Ukraine War that is currently taking place in Ukraine.

It however mentions a separate report it is working on, which focuses on Russia’s new central bank digital currency (CBDC) — the digital ruble —which is expected to be piloted in early 2023.

In Aug. 2022, The CBR stated that they plan on rolling out the digital ruble to all Russian-based banks in 2024.

Russia’s Central Bank report examines crypto’s place in the financial system

Russia’s central bank has released a report on digital assets which looks at how the technology could be integrated into its traditional financial system.

The Central Bank of Russia (CBR) is looking at ways to integrate crypto assets and blockchain technology into its local financial system amid a pile-on of global financial sanctions.

In a Telegram post by the CBR on Nov. 7, the central bank shared a public consultation report titled “Digital Assets in Russian Federation.”

It considers how the sanction-hit state may possibly open up its domestic market to foreign issuers of digital assets — particularly those from “friendly countries.”

The CBR stated that it strongly supports the “further development of digital technologies” provided they don’t create “uncontrollable” financial or cybersecurity risks for consumers.

Despite the nascency of blockchain technology, CBR said the same regulatory rules concerning the issuance and circulation of traditional financial instruments should also extend to digital assets.

The CBR said regulation over the short term should focus on protecting investor rights, strengthening rules for admitting a digital asset into circulation, ensuring the issuer is accredited and ensuring the issuer discloses all relevant information to investors.

The central bank’s message on Telegram, originally written in Russian, said while the legal framework for digital assets has been created, improved regulation is required for its continued development:

“Russia has created the necessary legal framework for the issuance and circulation of digital assets […] But so far the market is at the initial stage of its development […] and is many times inferior to the market of traditional financial instruments. Its further development requires improved regulation.”

As for smart contract regulation, the central bank acknowledged that a legislative framework was already in effect. However, it proposes that Russian-created smart contracts be independently audited before being deployed.

The report comes as the Russian Ministry of Finance recently approved the use of cryptocurrencies as a cross-border payment method by Russian residents on Sept. 22.

It, however, mentions a separate report it is working on, which focuses on Russia’s new central bank digital currency (CBDC) — the digital ruble —which is expected to be piloted in early 2023.

In Aug. 2022, The CBR stated that they plan on rolling out the digital ruble to all Russian-based banks in 2024.

Crypto notches a win among professional accountants

The Financial Accounting Standards Board made a change in October to help public companies that hold cryptocurrencies on their balance sheets.

In his regular column, J.W. Verret, a law professor, attorney, CPA, and head of the Crypto Freedom Lab covers law and regulation of cryptocurrency with a focus on decentralized finance (DeFi) and financial privacy.

Institutional adoption is an exciting yet frustrating topic in crypto. The true modern-day crypto inheritors of the 90s cypherpunk legacy have a vision for crypto as human empowerment through decentralization. That vision includes breaking down the intermediaries that charge rents and threaten human freedom and privacy. On the other hand, Crypto Twitter becomes abuzz when a large financial institution makes new moves into crypto.

Dogecoin (DOGE) mooned on the hopes that Elon Musk would use Twitter to help the cryptocurrency’s adoption. The cognitive dissonance extends to the institutions themselves, as banks start crypto projects without considering how a crypto payment system built on the Bitcoin Lightning Network or an Ethereum layer 2 is intended to make that very bank obsolete.

Those broader philosophical questions aside, the United States-based Financial Accounting Standards Board, or FASB, instituted a change to accounting standards in October that will help public companies hold digital assets on their balance sheet. For now, that’s good for both institutions and crypto.

The old method of accounting for crypto on company books was to account for it as software. It went on the balance sheet at its historical cost and then was written down as a value impairment on every price drop (but not written up again when prices went up). This was a deterrent to public company holdings for anyone but the die-hard Michael Saylors of the world. It’s hard to hold an asset that might remain recorded on your books at the bottomed-out price of the last bear market.

The new rules take a more reasonable approach and implement the same fair value accounting rules that apply to company holdings of publicly traded stock. Crypto covered by the rule will simply be valued at the publicly listed price.

This shouldn’t be the end of accounting standard deliberation over crypto, however, and there are still many questions left to consider. For one, stablecoins backed by other assets are not included in the new accounting methodology.

Many public companies that are willing to accept crypto from customers do so to humor the customer and immediately convert that crypto into fiat dollars. That may not always be the case, and if companies start using crypto as currency themselves, then inclusion in some kind of new balance sheet quasi-case or digital cash category would be appropriate.

Another thing to consider is the differences in asset-backed stablecoins. USD Coin (USDC) is basically just a cash equivalent and would readily fit the standard cash equivalent category in generally accepted accounting principles, or GAAP. Tether (USDT) is a closer case and was historically backed by riskier commercial paper, though that is changing. Maker’s Dai (DAI) is a very different form of stablecoin, partially backed by USDC and partially by other cryptocurrencies. Dai seems like it would need a novel quasi-cash or quasi-currency category.

And what about cryptocurrencies such as Bitcoin (BTC) or Ether (ETH) that a company holds for the purposes of using it to pay for things, like cash, and not for investment purposes? Will Bitcoin used as a means of payment be accounted for in a new quasi-currency category, or will it remain in an investment category despite its partial payment use case? While it is designed for payments, it is highly volatile, unlike stablecoins.

Fair valuation methods will be relatively straightforward to apply to liquid, highly traded currencies like Bitcoin and Ether, which is most of what companies are holding. But as companies start holding and using other types of cryptocurrencies, there will be a wealth of questions to consider.

For those digital assets not in actively traded markets, it will be a challenge to apply classic financial valuation models to their valuation. Existing financial valuation methods for assets like stock in public companies may not entirely carry over to cryptocurrencies because of the unique design of the asset class.

The FASB should be saluted for its thoughtful adaption of accounting principles to this new technology, an approach the Securities and Exchange Commission and other financial regulators might learn from. The FASB hired crypto-native experts and adapted their rules to the reality of this new technology in a short period of time, ensuring that in the crypto revolution, GAAP is going to make it.

Many questions remain in GAAP accounting for crypto. Crypto natives will need to continue to develop their own accounting methods once we decentralize finance. For now, it’s a helpful change to encourage institutional crypto holding.

J.W. Verret is an associate professor at the George Mason Law School. He is a practicing crypto forensic accountant and also practices securities law at Lawrence Law LLC. He is a member of the Financial Accounting Standards Board’s Advisory Council and a former member of the SEC Investor Advisory Committee. He also leads the Crypto Freedom Lab, a think tank fighting for policy change to preserve freedom and privacy for crypto developers and users.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

Portfolio in the red? How tax-loss harvesting can help stem the pain

“If you’ve made a sale during the tax year, and you’ve sold at a loss, there’s basically a benefit there,” says Koinly’s head of tax.

Crypto investors — particularly those that bought in toward the top of the market in 2021 — may be able to find some salvation through a tax-saving strategy called “loss harvesting,” according to Koinly’s head of tax in Australia.

Koinly is one of the most widely-used crypto tax accounting firms online. Australian head of tax Danny Talwar told Cointelegraph that while most retail investors are aware of their obligation to pay capital gain taxes (CGT) when they make profits, many are unaware that the opposite holds true and that losses can be used to reduce their overall tax bill by offsetting capital gains elsewhere:

“Most people are familiar with the concept of tax on gains. But, what they’re not doing is realizing that they can recognize that loss on their tax return to then offset against gains.”

Loss harvesting

Loss harvesting, also known as tax-loss harvesting or tax-loss selling is an investment strategy where investors either sell, swap, spend or even gift an asset that has fallen into the red — also known as making a “disposal” — allowing them to “realize a loss.” Investors typically do it in the final weeks of the tax year — which in Australia is right now. Talwar notes the strategy works in many jurisdictions with similar CGT laws, including the United States.

“Countries like the U.K., U.S. and Canada follow very similar capital gains tax regimes to Australia or have a kind of loss harvesting,” he said.

The concept is also embraced by traditional investors in stocks, bonds and other financial instruments. In the crypto world, a loss can be realized by converting it to fiat or just trading for another crypto token on the exchange.

Talwar believes that the surge of new crypto investors over the last few years will likely have produced quite a number of loss-making portfolios, given the current bear market:

“A lot of crypto investors got into the market around 2020 and 2021. What that means is that the majority of these people are actually going to be sitting on losses, so their portfolios are in the red.”

Will it work?

Talwar noted there are specific nuances in each country’s tax regime, such as the treatment of “wash-sales,” which could impact an investor’s ability to benefit from tax-loss harvesting, and suggested that investors reach out to their accountants to see how to best execute this strategy.

“A wash sale basically means you’re selling the same asset and reacquiring it in the same space of time, just to recognize a loss for your tax return.”

This is illegal in some countries or the tax authority could deny the claimant from realizing a tax loss.

Koinly has published guidance explaining how the rules regarding wash sales can differ from country to country.

As a general rule, Talwar suggests that anyone that has a portfolio in the red should be thinking about loss-harvesting:

“The more relevant point is if you’ve made a sale during the tax year and you’ve sold at a loss, there’s basically a benefit there that people might miss out on if they don’t put it in their tax return.”

One “extreme exception” to the case would be if an investor’s portfolio only contains loss-making crypto and nothing else. In that case, they won’t have any gains to offset.

“They should talk to their accountant. Do they have other assets that they can offset a lot against? You know, there’s no point recognizing a loss if crypto is your only investment, you have 99.8% of your savings in the bank and you’re never going to invest again.”

Tax authorities playing catch up

Talwar believes that while global tax authorities have made huge strides over the last three years to keep up with the rapidly evolving crypto industry, there’s still a lot to catch up on as more retail investors pile into the market and crypto accessibility continues to rise:

“Three years ago, it was rare for a tax authority to actually have some type of guidance on crypto out there. And, the crypto space three years ago is a completely different beast from what it is now. It’s become a lot easier to buy and sell crypto for everyday investors.”

However, Talwar noted that “not many” tax authorities have yet released guidance on how investors can record and report the use of decentralized finance (DeFi) protocols despite it gaining strong adoption in 2020.

“The UK is probably leading the way in some respects because they’ve just released guidance on decentralized finance. Not many tax authorities have released guidance on DeFi.”