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Corporates investing in crypto Considerations regarding allocations to digital assets
The terrain of digital assets is a new frontier of possibilities, so it requires that each corporate department, and its external party, rethink the application of the rules and policies of its core competency.
Table of contents Introduction 4 The high-level view from treasury 6 Accounting and tax: Potential opportunities for alignment, challenges of divergence 7 Controls 11 Conclusion: The need for cross-organization collaboration 13 Get in touch 14
Corporates investing in crypto | Considerations regarding allocations to digital assets Introduction In 2020, more operating companies began allocating cash to digital assets and cryptocurrencies. This is a new dynamic and a departure from more conventional investing by funds and others in this space. One telling example is MicroStrategy Inc., which announced, last December, that it had made more than $1B in total Bitcoin purchases in 2020, a move that it characterized as an investment that would “provide the opportunity for better returns and preserve the value of our capital over time compared to holding cash.”1 Some companies have followed suit, and others may now be wondering how to invest in Bitcoin and other digital assets. There are a variety of reasons for adding digital assets to a company’s balance sheet, whether it’s seeking asymmetric risk return observed over previous years or as a natural hedge against fluctuating fiat currencies; whether it’s part of a corporate strategy to embrace modern, open technologies; or as a complement to an operational strategy that includes accepting digital assets as payments. This paper focuses largely on Bitcoin rights on a protocol, or they may provide Before proceeding, we want to make investments, considering recent a level of access for participation in one point absolutely clear: There is increased investments in Bitcoin, a decentralized application. These no playbook or foolproof approach and its common reference as a store may provide some commercial or for these kinds of bold moves. There of value. It should be noted that economic benefit to the holder. Prior is only painstaking effort, disciplined there are numerous types of digital to investing in any digital asset, it is analysis, fresh thinking and rethinking, assets, each having their own unique important to understand the specific dedicated collaboration across characteristics. Ethereum is also viewed terms, conditions, and characteristics competencies, and, above all, rigorous as a store of value, with the added use of the investment since those will affect execution. What follows, then, is not a of enabling transactions on Ethereum- accounting, tax, risk, controls, and legal step-by-step prescription, but instead based decentralized applications. These considerations, among others. a high-level guided tour of the wide contrast with central bank digital terrain companies should cover when currencies (CBDCs) and stablecoins, What follows here, then, is some they are considering investing in Bitcoin. which are digital representations of guidance on what undergirds any Additionally, note that what is stated fiat currency. Their value is derived corporate decision to invest in digital here cannot necessarily be extrapolated from an actual currency in circulation, assets like Bitcoin. In addition, we set to all digital assets, given that they have and they are issued by a central out the ongoing actions that teams many different characteristics. bank. Equity and derivative tokens across a company should undertake are digital assets whose value may to monitor and go forward with a represent actual corporate stock or a long-term investment. In other words, legal right to another asset or financial our goal is to answer the question instrument. Some digital assets have “How would you do that?” rather than additional attributes, such as voting “Why do it?” 1. https://www.microstrategy.com/en/company/company-videos/microstrategy-announces-over-1b-in-total-bitcoin-purchases-in-2020. 4
Corporates investing in crypto | Considerations regarding allocations to digital assets
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Corporates investing in crypto | Considerations regarding allocations to digital assets
The high-level
view from treasury
The main purpose of the treasury Risk is a constantly moving target,
function is risk management and the and adjustments frequently need
Liquidity is not necessarily
preservation of capital. When deciding to be made within an agreed-upon
a major issue, especially if the
and executing on an investment in band of risk tolerance.
company is adopting a
digital assets, governance is key to all • With digital assets, treasury needs longer-term investment mindset.
activities. More than creating a policy, to consider not just the investment Nevertheless, there needs to be
governance begins with understanding side, but also how these assets may appropriate provision for extra
the types of investment the company figure into daily operations such as cash on hand. And assuming
is making and where this alternative payments, debt management, raising investments are layered in
investment vehicle—digital assets funds, IPOs, etc. progressively over time, liquidity
like Bitcoin—fits within the broader is likely to be less of an issue.
investment strategy. Leaders also • How can treasury be more
need to be comfortable with the strategic in using these assets
to advance efficiencies in payroll, Yet, in the event of the need to
characteristics and nature of the vehicle. liquidate assets, the company
(More on this below in the discussion vendor payment, trade, customer
interactions, and cross-border needs to know if the facility to
on controls.) Given that it’s a financial do so is available without a
investment, it’s imperative that the transactions with subsidiaries
and others? (More on this last premium penalty or if the
treasurer, CRO, CEO, CTO, and board of transaction can be executed
directors all have a clear assessment point when we discuss accounting
and tax implications, as well as without a depreciation of the
and understanding of the asset’s risk assets’ value.
profile, the company’s tolerance for controls, below.)
risk, and how these two may align or
diverge. Ultimately, governance is all Of course, the first and final refrain
about monitoring and assuring that the for treasury must always be that the
conditions and requirements set by the governance of digital assets is a living
organization are maintained. and adaptive process. It constantly
follows and must adjust to market
Tolerance for risk, depending on the and risk realities.
stake and type of digital asset, may well
have to be modified and periodically
“Global macroeconomic, monetary, and digital
adjusted. Risk tolerance takes several
forms and requires decisions on issues evolutions have converged, requiring all forward-
such as the following: thinking corporations to consider alternative assets on
• What percentage of the cash on their balance sheet. The ecosystem and the regulatory
hand, after accounting for operating environment for digital assets, especially Bitcoin, have
costs, will be assigned to alternative
investments in digital assets?
matured to the point that this strategy is becoming
• What range of risk is the company approachable and mainstream.”
comfortable with? Governing risk is
rarely a matter of “set it and forget it.” Phong Le, President and CFO, MicroStrategy, Inc.
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Corporates investing in crypto | Considerations regarding allocations to digital assets
Accounting and tax: Potential
opportunities for alignment,
challenges of divergence
Accounting for digital assets if, the price goes up or a previously
under US Generally Accepted written-down asset subsequently
Accounting Principles (US GAAP) recovers. As a consequence, for
US GAAP does not offer specific accounting purposes, it is virtually
guidance for the treatment of digital impossible to book any ROI on digital
assets, and, to date, the Financial assets held as investments. Clearly
Accounting Standards Board (FASB) then, the rules and framework for
has decided not to add a project on digital assets present certain important
accounting for cryptocurrencies.2 For constraints: It is not possible for the
those reasons, a company’s accounting company’s accounting function to reflect
function must draw on various pertinent the economics of how it may value its
sections of US GAAP to facilitate digital assets.
accounting for digital assets. First, the
accounting will be determined by what Absent the ability to mark up the value
the company is accounting for. What is of a company’s digital asset holdings,
it investing in? Practice has settled on if the company believes fair value to
accounting for certain digital assets, be more reflective of the economics
like Bitcoin, as an “indefinite-lived of its investment, it has the flexibility MicroStrategy’s 70,469 Bitcoins
intangible asset.”3 That means it does to provide disclosures that it believes held as of December 31, 2020
not meet the accounting definition of are meaningful to its investors. For were acquired for $1.125B and
cash or a cash equivalent, financial example, the company can provide reflected in its financial
instrument, or inventory. Needless to investors with information about the statements at $1.054B. If the
say, the accounting principles prevailing value of one digital asset (say, a Bitcoin), price of a Bitcoin on an exchange
today were largely established at a by flagging the price of one Bitcoin at was $29,000 at December 31,
time when digital assets were not yet a given time on a given exchange. But 2020, MicroStrategy may view its
even contemplated. then again, unlike equities, Bitcoins are 70,469 Bitcoins economically to
typically traded on multiple exchanges, be worth $2.044B, rather than
Now here’s the accounting challenge and around the clock, seven days a the $1.054B on its balance sheet.
with digital assets being reflected as week. Hence, any snapshot of the price
intangible assets: According to US GAAP, can only provide rough guidance. But Perhaps investors understand
acquired digital assets (intangibles) with the knowledge of the number MicroStrategy’s accounting
should be accounted for at cost, of coins or other digital assets held, treatment by looking at the
subject to subsequent impairment, as investors can arrive at an approximate company’s disclosures and
appropriate. That means that when the determination of the valuation of the (based on its stock price
asset is impaired, the company must company’s digital asset holdings. Note performance) appear to be
write down the value on its books. The that companies should be mindful of valuing a company’s digital
converse is not true. The value of the non-GAAP measures when preparing assets based on the current
asset cannot be written up when, and these disclosures. price rather than the book value.
2. The FASB decided at its October 21, 2020, meeting not to add a project on digital currencies to its agenda.
3. That assumes that the company is not required to apply specialized industry guidance, such as the
guidance in ASC 946 Financial Services – Investment Companies.
7Corporates investing in crypto | Considerations regarding allocations to digital assets
SEC reporting because of their treatment as intangible
As we’ve seen, absent standard-setting assets, that presentation may not be
Regarding partnerships: The
on specific accounting for digital assets, appropriate or allowed.
accounting and tax treatments for
the accounting function draws on digital assets may change if a
various rules and frameworks under Tax treatment and challenges from
company invests in these
the US GAAP rubric of intangible assets. an investment perspective
alternative vehicles using a fund
Similarly, the related disclosures need The rules governing tax treatment of
versus holding the assets outright.
to be drawn from various sections digital assets do not depend on US
within US GAAP to align with the GAAP accounting rules and frameworks.
accounting, resulting in a patchwork of One key difference: In accounting, digital and time each unit was acquired or
disclosures. For example, the disclosure assets can only be marked down when wallet created, basis cost and fair market
requirements within ASC 350, Intangibles impaired (impairment accounting) value of each unit at the time it was
– Goodwill and Other, apply to the and not marked up when their value acquired or wallet created; and finally
digital assets held as an investment. increases; but in tax, such a move only the fair market value of each unit when it
And additional disclosures under ASC results from an election that may be was sold or exchanged.
820, Fair Value Measurement, would available to dealers or traders whereby
be required for the nonrecurring fair the tax function can mark up or down Absent the use of the specific ID
value measurement used to determine to fair value. For tax purposes, gain or method and wallet structures, there
impairment of those digital assets. To loss is normally recognized only when a are very limited ways to distinguish the
the extent the company sells digital digital asset is sold or exchanged. different assets. Hence, taxpayers are
assets or uses them in its business likely bound to use a FIFO approach.
transactions, additional disclosures In the United States, there are two tax In other words, absent the specific ID
would be required. accounting methods or treatments that information (time, date, cost basis at
can help account for gains and losses: time of purchase) and an adequately
These disclosures, drawn from various specific identification (ID) and first in, first segregated and identified asset, each
areas of US GAAP, should articulate the out (FIFO). The specific ID method can be time a company disposes of a digital
accounting to an investor and explain used to determine the cost basis of each asset, the presumption is that the
why the digital assets, and related digital asset the company is selling or company is disposing of the oldest asset
transactions, are presented the way exchanging. That means that every time or coin(s) it holds. While complex and
they are in the financial statements. the company disposes of such an asset, sometimes messy, tracking the cost
A reader should be able to understand it is specifically identifying the exact units basis versus the current market price is
the company’s investment in digital it is selling or exchanging. So how does important for both tax and accounting.
assets. That includes where it is one specifically identify a digital asset like
presented on the financial statements Bitcoin that is deemed to be a fungible
and the overall investment strategy. asset? By segregating tranches into
When considering the presentation in distinct wallets. It’s common for investors
the financial statement, there are plenty to develop wallet structures to house
of potential pitfalls, and mere logic does different tranches of their digital assets
not suffice. For example, one may be with different cost bases and holding
tempted to conclude that write-downs periods. Hence, when it comes time to
on a digital asset are akin to a loss on sell, a given wallet or tranche is readily
an investment and hence should be distinguishable from another, and the
classified as nonoperating income. But relevant information is at hand—date
8Corporates investing in crypto | Considerations regarding allocations to digital assets
9Corporates investing in crypto | Considerations regarding allocations to digital assets
From a tax standpoint, digital assets umbrella of a barter transaction. That’s across borders—say, to a foreign
held for investment purposes are the case every time digital assets are subsidiary in Europe—it encounters
normally deemed a capital asset. In used in a business transaction. This complexities in other jurisdictions.
corporate solution, capital losses can has a related impact on accounting as
only be used to offset capital gains. So well, and the process can become very The transfer process may well involve
while a company may mark down to fair complex on both fronts. a number of steps: converting fiat to
value for accounting purposes, tax does a cryptocurrency, transferring the
not follow that methodology (except in Accounting for digital assets used cryptocurrency, then reconverting the
certain limited circumstances relating for business transactions cryptocurrency to fiat. The benefit,
to an election to mark to market as a When companies use digital assets that of course, is that such a process
dealer or trader in digital assets). Rather, are accounted for as intangibles for avoids bank transfer fees. Yet the act
it’s a matter of layering in a deferred business transactions, such as paying of transferring funds may well have
tax asset (DTA), which may require a vendors, these transactions will require triggered an unrealized gain or loss. And
valuation allowance if there are no other a different accounting treatment, which since the subsidiary may not be subject
sources of capital gains. is more complex. That is a consequence to the same tax and accounting rules as
of the intangible asset now being used the US parent company, there may be
So how does this play out in a set of as a tangible one—i.e., a financial implications in the following areas:
financial statements? Members of a versus nonfinancial asset. The resulting
company’s tax function must live and financial reporting oftentimes doesn’t • Gain recognition rules
abide by the rules and framework of align or “make sense.” Many have
• Cost basis tracking methods
US GAAP first, and then layer on the tax expressed concerns that the financial
treatment in terms of deferred taxes. reporting may be misleading, rather • Indirect taxes, such as VAT
than useful, to investors. That said, • Withholding taxes that may apply
Tax treatment and challenges from more and more mainstream financial upon transfer
a business transactions perspective services and fintech companies are now
Let’s move now from the investment offering customers the possibility of
The bottom line is this: The tax and
angle to consider the use of digital holding or exchanging Bitcoin.
accounting rules surrounding digital
assets in business transactions, such
assets are still evolving. This evolution
as fund transfers, paying vendors, Cross-border transactions
is occurring simultaneously around the
and as an accepted form of payment So far, we’ve applied a US-centric view to
world, but with inconsistent conclusions
from customers. When used for such digital assets from both an accounting
being reached across jurisdictions.
transactions, digital assets should be and tax perspective. Outside of the
segregated into separate wallets to United States, the treatment of digital
maintain a clear distinction between assets varies substantially. Accounting
digital assets used in the operation of under International Financial Reporting Wallets are typically structured
the business (ordinary assets) and digital Standards (IFRS) may similarly view according to the different cost
assets held for investment (capital digital assets, like Bitcoin, as intangible bases at which the digital assets
assets). Naturally, if digital assets are assets. However, the intangible asset were acquired. Differentials can
being used in place of fiat, such actions guidance under IFRS differs from be set by a range of dollar
will generate a gain/loss recognition US GAAP. When a company uses digital denominated cost basis (say, at
event for tax purposes under the assets like Bitcoin to transfer funds $100 or $1,000), or a new wallet
can be created every time a new
tranche is purchased.
10Corporates investing in crypto | Considerations regarding allocations to digital assets
Controls
It should be obvious from our discussion
that risk and controls are at the very assistance of third-party technical help in supporting new digital assets?
foundation of any investment project in and evaluation. • What occurs if private keys and
digital assets. Let’s quickly review the passwords are lost or stolen?
main areas that should be on the radar. Custody
Custody raises a number of important A great way to start addressing these
Risks unique to each digital asset questions. Will the company custody the potential issues would be to obtain and
The risks underlying digital assets, asset itself, or will it rely on third-party review the SOC 1 and/or SOC 2 reports
including cryptocurrencies, vary vendors? Self-custody may provide easy of any potential exchange or custodian.
considerably. Consequently, companies access to the assets, but it also presents
need to conduct rigorous due additional risk in terms of accidental Authorization risks
diligence about how the given asset loss, who conducts transactions, and Authorizing and executing transactions
or coin operates and related market how transactions are monitored and and transfers (such as the cross-border
vulnerabilities, as well as terms and recorded. Given the inherent complexity transfers to subsidiaries discussed
conditions. From a technical perspective, and risk associated with self-custody, above) may well create a host of risks.
companies need to understand the more and more companies are resorting That’s why it is vital for companies to
blockchain supporting each asset and to third-party custodians. Then, it’s segregate duties in such a way that
how the associated governance system a matter of evaluating the strengths there is a clear chain of command and
works, as this may have a direct bearing and weaknesses of different custody documentation regarding who has
on the resilience of the coin system. processes and procedures. access to the keys of the accounts and
This will also help to identify the types what transaction each person can or
of events for which companies should If the company chooses to rely on an cannot undertake. That effort includes
be monitoring. exchange or custodian to store its the timely monitoring of transactions
digital assets, careful consideration of that are committed to the blockchain
For example, the computer code that a large number of potential risk issues and ensuring, independently—there
enables the Bitcoin network to process and questions is in order. Some of are third-party tailored custodial
transactions is fundamentally different these include: solutions that employ, among other
from the Ethereum code base. Further, devices, automatic alerts—that those
as many blockchains enable extensibility • How does the third-party exchange transactions were, in fact, authorized.
in the form of smart contracts (e.g., or custodian secure private Given that there is no FDIC insurance
ERC-20 tokens), mechanisms that allow key material? for digital asset holdings, it’s important
for the taking of unilateral actions that a company ensure that its holdings
• Can the company trust the accuracy are segregated from other participants
can have a negative impact on the of account statements furnished by
holder of the assets. Other instances rather than being part of a commingled
the third-party vendor? account in an omnibus fashion; and that
where assets can be lost include
proof-of-stake blockchains, where • What plans are in place in the event of the custodian carry adequate insurance.
assets can be “slashed” for violating a liquidation of the custodial services? That becomes very important if an
network rules. That will result in a exchange or custodian suddenly goes
• How does the exchange handle
reduction of the amount of assets held offline for a time or ultimately fails.
market anomalies, such as
in a given address. A full appreciation flash crashes?
of the technical and business risks
associated with each digital asset, and
• What is the vendor’s hard-fork policy
their dimensions, may warrant the
11Corporates investing in crypto | Considerations regarding allocations to digital assets
Regulatory compliance
It’s critical that the company be able “What has pleasantly surprised us in the process is
to ascertain that the exchange or
custodian in question is abiding by how encouraging and welcoming the digital asset
all appropriate laws and regulations. community has been. Longtime Bitcoin enthusiasts,
Items on the regulatory radar for
exchanges and custodians include,
macroeconomists, and luminaries; blockchain and
among others, compliance with all technology fans; financial institutions, exchanges, and
anti-money laundering and know-your-
customer regulations, measures related
custodians; accounting, tax, and legal experts; and retail
to counterterrorism, and rules set by and institutional investors and shareholders have all
the Office of Foreign Assets Control.
emerged at scale to support and champion our efforts.
As with accounting and tax, the rules
and regulations vary by jurisdiction. The combination of these groups’ support, as well as
Hence, to ensure compliance, it our own internal vision, strategy, and teamwork have
would be wise to seek advice from
informed legal counsel. led to our initial successes.”
Phong Le, President and CFO, MicroStrategy, Inc.
12Corporates investing in crypto | Considerations regarding allocations to digital assets
Conclusion: The need for
cross-organization collaboration
Any sizable investment in digital that each corporate department, facing operating companies interested
assets presents more than just and its external party, rethink the in investing in such assets are complex
technical issues related to treasury, application of the rules and policies of and in flux. But they are navigable with
accounting, reporting, tax, and controls. its core competency. Few of the norms the right level of commitment from all
It also involves a significant cultural associated with legacy investments in departments and external parties. And
realignment—internal and external— securities, fiat currency, or treasuries with appropriate attention to issues of
among the many different groups may apply. Once each group gains a process, procedures, and risk all along
and departments, including, but not level of comfort with the application the decision spectrum, digital assets
limited to, the board of directors, of the rules to digital assets, they can offer innovative, bold, and dynamic
the audit committee, risk, corporate then need to actively listen to one alternatives to traditional investments.
reporting, finance, tax, internal audit, another, gain an understanding of the
operations, controls, technology, and sensitivities, evaluate any operational
investor relations. Since many of these or technical dependencies, and finally Our thanks go to Phong Le,
departments interact with external rethink how they collaborate and tackle President and CFO of
parties, such as the external auditor, challenges together. MicroStrategy Inc. and to Jeremy
tax and legal counsel, etc., it is vital that Blank, Deloitte lead client service
there be a corresponding realignment Many more operating companies are partner serving MicroStrategy Inc.,
in thinking when dealing with these beginning to evaluate the potential for their support in writing this
external groups. benefits of investing in digital assets paper. The authors bear sole
like Bitcoin. And as their cumulative responsibility for the content and
What does that realignment entail? experience grows and sparks further views expressed here.
Typically, the various functions and interest, the more likely strategic
departments of a company establish investments in digital assets are to
procedures and assumptions for become more routine realities. That
collaborating across and outside said, companies must have the right risk
the organization based on normal- measures in place, as well as the right
course, well-understood transactions. risk tolerance levels, for it to be
The terrain of digital assets is a new worthwhile pursuing this type of
frontier of possibilities, so it requires investment. For certain, the realities
13Corporates investing in crypto | Considerations regarding allocations to digital assets Get in touch Tim Davis Rob Massey Risk & Financial Advisory Global & US Tax Global Center of Excellence for Blockchain and Digital Blockchain Assurance leader Assets leader Deloitte & Touche LLP Deloitte Tax LLP timdavis@deloitte.com rmassey@deloitte.com Amy Park Carina Ruiz Singh US Audit & Assurance Blockchain Risk & Financial & Digital Assets specialist Advisory partner Deloitte & Touche LLP Deloitte & Touche LLP amyjpark@deloitte.com caruiz@deloitte.com Ella Bergmann Seth Connors Audit & Assurance Risk & Financial Advisory senior manager senior manager Deloitte & Touche LLP Deloitte & Touche LLP ebergmann@deloitte.com sconnors@deloitte.com 14
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