Cryptographic assets under IFRS

There are no shortcuts in the crypto world

PwC’s In depth series takes a close look at current financial reporting issues, and topics are regularly updated to include the latest regulations and standards of practice. This is particularly necessary for cryptographic assets, where accounting principles and questions – and how IFRS should be applied – are still being discussed. The newly updated version of the PwC publication «Cryptographic assets and related transactions: accounting considerations under IFRS» deals with such debates.

Given their rapid increases in value and volatility, cryptographic assets, including cryptocurrencies such as Bitcoin, have generated a significant amount of interest and have attracted regulatory scrutiny across multiple jurisdictions. One of the key issues is the fact that there is no legal definition of cryptographic assets, as there is for securities in various jurisdictions. There are no easy solutions or shortcuts and no «one size fits all» guidelines. However, some cryptographic assets can legally be considered securities by local regulators. The two key characteristics for classifying cryptographic assets for accounting purposes are:

• the primary purpose of the cryptographic asset, and
• how the cryptographic asset derives its inherent value.

Accordingly, four specific subsets of cryptographic assets can be defined:

• Cryptocurrencies are valued based on supply and demand.
• Asset-backed tokens derive their value from the underlying asset.
• Utility tokens derive their value from the demand for the issuer’s service or product.
• Security tokens derive their value from the success of the entity, since the holder of the token participates in future profits or receives cash or a different financial asset.

In June 2019, the IFRS Interpretations Committee (‘IC’) published its agenda decision on ‘Holdings of Cryptocurrencies’, and it considered a subset of cryptographic assets with the following characteristics:

• 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.

The IFRS IC concluded that IAS 2, ‘Inventories’, applies to such assets where they are held for sale in the ordinary course of business. If IAS 2 is not applicable, an entity applies IAS 38, ‘Intangible Assets’, to holdings of cryptocurrencies.

There are many judgemental areas that will require further investigation as entities determine the applicable accounting treatment and as the technologies and markets continue to develop. For some topics, no uniform or definitive answers currently exist.

How to determine if an active market exists

The suggested approach to determining the fair value of a cryptographic asset was expanded in the December 2019 update of the publication. The corresponding section focuses on evaluating if an active market exists, including considerations around the reliability of data and trading pairs.

IFRS 13 contains a three-level fair value hierarchy: If quoted prices in active markets for identical assets or liabilities that the entity can access at the valuation date are available a cryptographic asset can likely be considered level 1. Level 2 assets are based on observable inputs other than level 1 inputs, and cryptographic assets without observable inputs will likely be considered level 3 assets.

The first step in considering the fair value of a cryptographic asset is to determine if an active market exists for that cryptographic asset at the measurement date (in other words, whether a level 1 valuation can be performed). Appendix A to IFRS 13 defines an active market as one “in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis”. A benchmark for evaluating the depth of a market could include active trading days within a given time period. The average daily turnover ratio, which is calculated by dividing the average daily trading volume by the total amount of cryptographic assets outstanding, is a metric for volume that could also be considered. In addition to that, qualitative factors such as the reliability of data and trading pairs should be taken into consideration.

When obtaining trading data used for an assessment of frequency and volume, it is crucial to consider the source of the data. Data from regulated exchanges is generally considered more reliable than from an unregulated exchange, but it is necessary to consider the regulation criteria and if there is any surveillance over the trading data.

In addition, cryptographic assets are often exchanged for other cryptographic assets (‘crypto to crypto’), instead of being exchanged into a traditional currency (‘fiat’) (‘crypto to fiat’). In our view, an active market for a certain cryptographic asset exists only when crypto to fiat exchanges published by reliable sources exist. Crypto to crypto exchanges should not be considered when determining if there is an active market.

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