In the ever-changing technological landscape, having a fundamental understanding of what blockchain and digital assets (sometimes referred to as crypto assets) are is essential. While computer scientists and the more technical professionals should be concerned with how these new technologies are developed and deployed, audit and tax professionals must focus on understanding the regulatory landscape and how blockchain and digital assets should be treated under both existing and future regulatory frameworks. Understanding what digital assets are, how each unique digital asset could be categorized and what auditors should be thinking about when working with them will help companies make decisions when digital asset-specific guidance is issued.
Digital assets are a digital record or representation of value stored and tracked on a distributed ledger called a blockchain. Digital assets can represent traditional forms of value like stocks, real estate or patents, and they can also represent new forms of intangible value (e.g. the right to access an online platform or the value of someone’s time spent viewing an advertisement). Regardless of the type of value a digital asset represents, in order to be classified as a digital asset, it must be recorded on a blockchain. Due to the creation of digital assets, both traditional and new forms of value can be represented and tracked in a secure, verifiable and transferable form.
Accounting professionals should treat each digital asset uniquely based on the value and rights that particular digital asset represents. To help determine how digital assets with similar characteristics should be treated, various regulatory bodies have attempted to classify digital assets into four categories:
- Asset tokens
- Utility tokens
- Payment tokens
- Hybrid tokens
The term token is used to signify a unit of value represented in the form of a digital asset, similar to how share signifies ownership in a company or unit signifies ownership of a partnership.
- Asset tokens can be broadly defined as digital assets representing ownership of a physical or intangible asset. These types of tokens can represent physical assets such as gold bullion, real estate, and inventory or paper assets such as stock, bonds and profit rights. An asset token could provide its owner with the same rights as a traditional stockholder who owns a paper stock certificate. These rights include the ability to vote at meetings or receive dividend payouts. Similar to a traditional stock, ownership of asset tokens can also be transferred or sold. The advantage of using a digital asset to represent equity ownership or ownership of other assets, as opposed to relying on centralized administrators to track and uphold ownership, is the security, transparency, compliance automation and optional self-custody a blockchain record-keeping system can provide.
- Utility tokens are a more abstract category of digital asset. To be considered a utility token, a digital asset must be designed with the intention of being used to pay for the right to access a good or service. Utility tokens can represent all kinds of rights from the right to be first in line to buy the latest phone to the right to be given prereleased access to an online game or platform. A book publisher could potentially issue a token that will permit the holders to purchase the first edition of a book before it is released to the public. It is important to remember that utility tokens do not represent a product or service, but rather the right to purchase or use a product or service. Utility tokens can be a superior method to traditional ways individuals or companies grant customers special rights. They enhance the utility token issuer’s ability to quantify the value of the right being sold, help the issuer to engage more directly with their customer base, and allow the issuer to create a customized economic model for rights to access a digital or physical service. Never before has there been an easier way to efficiently transfer access rights.
- Payment tokens are digital assets that are designed to operate in the same manner as a dollar, euro or other form of fiat money. Money is defined as anything that is a store of value, medium of exchange or unit of account. Payment tokens are designed and developed to be used in a similar way as sovereign money. Unlike the tokens discussed above, payment tokens do not represent an asset or a specific right, but rather create value through their scarcity, their ability to be transferred near instantly between parties, or by some other value proposition. Bitcoin is the first and most well-known example of a payment token. Bitcoin is designed to be scarce and thereby derives value through limitation of supply. Since bitcoin was introduced, other payment tokens such as litecoin and Facebook’s Libra have been undergoing development. Payment tokens have become popular due to their ease of use and the ability for users to send money almost instantaneously without the involvement of a central bank.
- Hybrid tokens are digital assets that share characteristics of multiple digital asset categories. The most common hybrid tokens are those that have characteristics found in both asset and utility tokens. An example of a hybrid token would be a digital asset that represents both a share of company ownership and the right to receive the first product the company manufactures. Having both the ownership and future right characteristic makes this type of digital asset unique and unlike any kind of traditional asset. The advantage that can be gained from using a hybrid token is that issuers and purchasers alike can use a hybrid token to easily encompass all desired characteristics they wish to convey to an individual.
The novelty of digital assets, coupled with the lack of definitive accounting, auditing and regulatory guidance from authoritative bodies, makes advising clients about them a challenging task. The treatment of digital assets that represent nontraditional forms of value can become especially complex. To date, very little guidance has been issued by the Financial Accounting Standards Board (FASB) or the International Accounting Standards Board (IASB) on how accountants should treat digital assets. With that said, regulatory and governing bodies have started looking more closely at issues involving digital assets. The American Institute of Certified Public Accountants (AICPA), for example, recently published a practice aid Accounting for and Auditing of Digital Assets which outlines a number of factors that accountants should consider when accounting for digital assets purchased or received in the normal course of business.
According to the AICPA guide, digital assets (regardless of categorization) purchased with cash would “meet the definition of intangible assets and would generally be accounted for under the FASB ASC 350, Intangibles–Goodwill and Other.” When digital assets are received in exchange for a good or service and the digital asset is accounted for as an indefinite-lived intangible asset, and there is a contract with a customer within the scope of FASB ASC 606, Revenue from Contracts with Customers, the party receiving the digital assets “would treat the receipt of the digital asset[s] as a form of noncash consideration under FASB ASC 606 when determining the transaction price.” As with any indefinite-lived intangible asset, the digital assets “should be tested for impairment annually or more frequently if events or changes in circumstances indicate it is more likely than not that the asset is impaired.”
Although the AICPA’s guidance focuses more broadly on digital asset accounting as a whole, for digital assets with characteristics that clearly place them in one of the four categories above, accounting professionals could consider a more tailored approach based on the nature of each digital asset as further guidance is published. Asset tokens could be treated similarly to the traditional asset they represent (i.e., a digital asset representing ownership of a stock could be treated as a financial instrument). Utility tokens are a more unique form of digital asset that can have various characteristics that may require a professional assessment of their accounting considerations. The accounting treatment for payment tokens appears to fit into the existing guidance from the AICPA above, but for payment tokens that are pegged to fiat currencies, there may be additional considerations for whether those types of payment tokens could represent cash equivalents. Finally, the very nature of a hybrid token means that each should be assessed on a case-by-case basis as it relates to each of the classifications described above.
The AICPA practice aid is nonauthoritative and does not provide guidance on all the complexities surrounding accounting for digital assets; however, in combination with this article, it does give accountants a place to start when looking to determine the various accounting treatments for a digital asset. Over time, regulatory bodies are expected to pull alongside the advances in technology and more definitive guidance should be forthcoming. Until then, using these four categories when assessing the nature of a digital asset can help business professionals understand how they might treat those digital assets under current and future regulatory frameworks.