No one could have predicted the meteoric rise of cryptocurrencies. After all, who would have thought that a digital asset without any intrinsic value could achieve such traction? But as cryptocurrency becomes increasingly popular, the digital currency secured by cryptography has faced challenges. Some experts believe that regulation is necessary to safeguard investors and legitimise the currency. Others argue that regulation might stifle innovation and impede the growth of the cryptocurrency industry.

Following the collapse of stable coin TerraUSD and its sister token Luna in 2022, which sent shockwaves through crypto markets, Singapore Deputy Prime Minister Heng Swee Keat cautioned retail investors to steer clear of cryptocurrency speculation. But Mr Heng also conceded that crypto and blockchain technology has the potential to transform the future of finance, and revealed plans to enable the safe adoption of digital payment tokens in the financial sector through regulatory sandboxes.

“The extreme volatility and increasing popularity of cryptocurrencies raise an urgent question on whether accounting standards are robust in their requirements for timely recognition, measurement and disclosure of information on cryptocurrencies to external stakeholders,” notes SMU Associate Professor of Accounting (Education) Pearl Tan.

Moreover, cryptocurrency is becoming more widely accepted as a payment mode, particularly for online transactions. El Salvador accepted Bitcoin as legal tender in 2021, followed by the Central African Republic. And Prof Tan anticipates more governments worldwide will follow suit.

She posits: “Presently, cash by definition must be legal tender. However, cryptocurrencies pride themselves on being democratised units, completely devoid of government involvement. Would the accounting understanding of cash change with the shift in sentiments towards cryptocurrencies?”

Need for a new framework

In 2021, Prof Tan and SMU Assistant Professor of Accounting (education) Tracey Zhang wrote in the article Cryptocurrency Framework: “A framework is needed to classify cryptocurrencies by underlying attributes and requires the appropriate accounting treatment for each classification.”

An accounting framework is a set of principles and standards that ensures financial statements are relevant, reliable and comparable. However, cryptocurrencies are a new phenomenon and a corresponding accounting framework is needed to account for these  assets and their value and performance meaningfully.

“Preparers of financial information need clear guidelines in the classification and measurement process,” says Prof Tan.

“Given the proliferation of cryptocurrencies, understanding the economic characteristics of each cryptocurrency and its value drivers is challenging.”

Despite the growing global adoption of cryptocurrencies, an accounting standard dedicated to cryptocurrencies has not been established. Prof Tan notes that the  International Financial Reporting Standards Interpretations Committee (IFRIC), which ensures consistent accounting practices worldwide, decided not to add cryptocurrencies to its agenda on prospective accounting standards in 2019. In 2022, the International Accounting Standards Board (IASB) reaffirmed the decision not to place cryptocurrencies on its work plan projects.

“Hence, we should not expect to see a comprehensive, dedicated standard on cryptocurrencies anytime soon,” says Prof Zhang.

“The approach taken by IFRIC is that the existing standards are good enough to deal with the accounting for cryptocurrencies. Hence, cryptocurrencies are parked in the same asset class as patents, research and development, and trademarks.”

Challenges in determining crypto classification

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Regulators face multiple obstacles in achieving a consistent framework for cryptocurrencies. Most significantly, there lacks a consensus when it comes to classification, given the huge diversity in the attributes of cryptocurrencies and the holding intentions of their owners.

Prof Tan explains that international standard-setters view cryptocurrencies as an intangible asset, defined by IAS 38 as “an identifiable non-monetary asset without physical substance”. In other words, they are things that hold value but do not have a physical form, such as intellectual property, copyrights and patents.

Although the economic characteristics of these intangible assets are vastly different from cryptocurrencies, they share a common accounting standard. Under the criteria for recognising and measuring intangible assets, cryptocurrencies are carried at either the cost or revaluation model. However, if the holder’s intention is mainly to sell or speculate in cryptocurrencies, IAS 2 Inventories apply. It is currently an eclectic mix of approaches.

“However, it appears counterintuitive that cryptocurrencies are carried at cost, given their sharp volatility,” states Prof Tan.

“Further, the choice of cost or revaluation for intangible assets is discretionary, and there is nothing to prevent a holder from opting for the cost model.”

Instead, Prof Tan and Prof Zhang observe a greater economic similarity between cryptocurrencies and financial instruments than other conventional intangible assets. Consequently, they suggest expanding the definition of financial instruments to accommodate new instruments that do not fall into the conventional categories of cash, bonds, equity, receivables and payables in both primary and derivative forms.

“Financial instruments share similarities with cryptocurrencies concerning their exposure to market movements,” adds Prof Zhang.  

“Given the immense dynamism of their price movements, cryptocurrencies measured at fair value through profit or loss (a common basis in financial instruments) provides real-time information to stakeholders.”

Cryptocurrencies and the broader universe of digital assets rely on complex infrastructures that are tricky to navigate and regulate. The valuation of such assets — particularly lesser-known or newer cryptocurrencies that are not exchange-traded — is an uphill task as the markets for these currencies are not always transparent.

Beyond cryptocurrencies, different digital assets also possess multiple underlying attributes, and require an appropriate accounting treatment for each class.

“We think that fair value remains an important metric that captures the inherent volatility of most digital assets,” asserts Prof Tan.

Despite many obstacles, establishing a framework to standardise cryptocurrency information will benefit capital markets. A robust accounting architecture provides access to more timely data that could make all aspects of financial performance analysis more efficient and meaningful.

Moreover, relevant and reliable information can enable stakeholders to better assess the financial performance, financial position and cash flows of entities holding cryptocurrencies. With greater consistency and transparency, financial professionals can be empowered to make more precise economic decisions, especially as digital assets become more commonplace.