Since the first Bitcoin transaction in 2009, the cryptocurrency market has exploded. Over a decade later for more detail reputation guards, the cryptocurrency market is valued at more than $2 trillion, with around 4,000 different cryptocurrencies. Industries such as healthcare and government have adopted blockchain, the computing technology that validates and secures cryptocurrency, to secure their data.
As cryptocurrency becomes a common option for transactions and investments, the accounting profession needs to understand cryptocurrency and how these assets are classified under generally accepted accounting principles (GAAP).
Consider these cryptocurrency accounting examples: A certified public accountant (CPA) is filing a client’s taxes and must accurately account for cryptocurrency valuations — how does the CPA determine if a holding is a tangible or an intangible asset? An auditor is validating a corporation’s financial statements — does the auditor understand the digital ledger? A bookkeeper has to reconcile bank statements and the general ledger — has the client kept proper records of buy and sell prices? The rise of cryptocurrency brings a new layer of complexity to accounting.
What is cryptocurrency?
The founding of Bitcoin, the first cryptocurrency, is shrouded in mystery. Computer cryptographer Satoshi Nakamoto coinvented the currency, and then disappeared three years later. No one knows who Nakamoto is — a man, a woman, or a group — but Bitcoin established the principles that all cryptocurrencies are based on today.
Exactly what is cryptocurrency? If it can be invested in or used to buy stuff, then why doesn’t it behave like money? Here’s how it works.
Cryptocurrency explained
- Cryptocurrency is a digital form of money. As such, it can be used to buy and sell any kind of good or service. Each transaction is anonymous. Cryptocurrency is secured by a digital ledger, which uses cryptography to make sure that the crypto, as it’s sometimes called, has been legitimately bought or used in a transaction.
- The digital ledger exists across a network of computers, each called a node. As a crypto transaction occurs, it’s recorded, given an identifier called a hash, and put into a block with other transactions (the block is attached to the existing chain of transactions). This cryptography is called blockchain.
- Blockchain cryptography is a highly secure method of safeguarding data. It’s hard to hack because hackers would have to break into every block in the chain to change transaction data. The network is decentralized, so it can’t be physically broken into or have data stolen from a single location.
- Bookkeeper, “Breaking Down Blockchain for Accountants in 2020 — and Beyond” — The advantages of blockchain technology for the accounting and auditing industry.
- Deloitte, The Rise of Using Cryptocurrency in Business — Accountants who understand how companies can benefit from cryptocurrencies can provide advisory services.
- Insightful Accountant, “Why Accountants Need to Learn about Bitcoin” — As cryptocurrency goes mainstream, accountants need to understand the risks as well as the rewards for their clients.
- Accounting Today, “Decrypting Crypto: Opportunities and Obstacles for Accountants” — An overview of cryptocurrency, crypt assets, and the challenges that accountants face when providing clients with tax compliance and consulting services.
- Association of Chartered Certified Accountants, “Accounting for Cryptocurrencies” — An overview of the International Financial Reporting Standards (IFRS) that pertain to accounting for Bitcoin and other cryptocurrencies.
- Current Issues in Accounting, “Challenges When Auditing Cryptocurrencies” — Audit concerns stemming from cryptocurrencies and how to identify these challenges when planning for a new client audit.
- RSM US, “Digital Assets: Challenges for Audit, Accounting and Taxation” — Issues and concerns around the lack of regulation, leading to tax evasion cases and other issues for accountants and investors.The World Financial Review, “7 Benefits of Blockchain Technology for Accountants” — Blockchain technology has numerous benefits for accountants, including increased consulting opportunities.Most cryptocurrencies are digitally mined. Users run powerful computers that solve a complex computing puzzle that verifies a blockchain transaction. Bitcoin “miners” and others are rewarded with a percentage of a Bitcoin for every puzzle solved. The high energy use of Bitcoin mining is an environmental concern, and some cryptocurrencies have been developed that use less electricity.
Cryptocurrency risks
As cryptocurrency gains acceptance among users, governments that haven’t banned digital currency are looking for ways to regulate it. Although the appeal of cryptocurrency is precisely that it bypasses regulation, that lack of policing contributes to a wildly volatile market value, scams, and other illegal activity. The following are some of the concerns regarding cryptocurrencies:
Lack of regulation
The Federal Trade Commission (FTC) warns investors about cryptocurrency. In particular, cryptocurrency holdings lack U.S. government backing and protections against mismanagement and theft. The sheer number of cryptocurrencies can also lead to scams and fraud. Investors are responsible for identifying which initial coin offerings (ICOs) are legitimate, with no recourse if they get it wrong.
- See Also: Social Media’s Influence on Elections
Investment volatility
Investors need nerves of steel to stay in the volatile cryptocurrency market. Some of the reasons for this volatility are:
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- Bitcoin and other currencies are largely seen as investments. Speculation causes demand to swing wildly, causing prices to rise and fall dramatically.
- Public perception. Cryptocurrency is a novel concept, and investment news and other coverage can swing public perception and affect prices.
- Pending regulation. Governments are increasingly looking at regulating cryptocurrency. Rumors of pending regulations can cause investors to back out, leading prices to fall.
- High-profile scandals. The connection between Bitcoin and the Silk Road and various other incidents in the early history of cryptocurrency have tarnished the reputation of the market.
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Hacks and other losses
Despite the safeguards of blockchain, cryptocurrencies can still be hacked. Investors can lose their entire investment by forgetting a password or losing a laptop. A transaction mistake means that money is gone forever, never to be retrieved. In two high-profile cases, cryptocurrency investors Gerald Cotton and Mircea Popescu died unexpectedly, leaving behind digital wallets, but no passwords.
Benefits of blockchain
Despite all the risks, many industries are looking at distributed ledger and blockchain technology and have identified applications. Healthcare, government, and insurance, for example, have been investigating ways to put blockchain to work to increase security, save money, and automate transactions in a safe and private way, making cryptocurrency accounting knowledge all the more valuable.
Healthcare
Blockchain technology keeps healthcare and personal data secure, protecting patients’ personal information and healthcare data. It can be used to verify and authenticate participants, and it can identify use patterns that can prevent unauthorized access. However, since a feature of blockchain is that transactions can’t be reversed, the healthcare industry will have to be thoughtful about how it incorporates blockchain into its operations.
Election security
Blockchain can be used to keep voting data secure and relieve concerns over voting fraud. By ensuring that voters’ choices can’t be reversed or altered, blockchain secures election integrity. While few governments currently use blockchain to secure their voting systems, the concept has its proponents.
Other government uses
Advocates also see a place for blockchain technology in other government operations. Blockchain can secure records, such as birth certificates and Social Security numbers. It can be used in intergovernmental transfers, validating and securing transactions. It can also potentially restore citizens’ faith in government by keeping data safe.
Insurance
Blockchain has applications in the insurance industry. Besides securing health records, it can be used to detect and prevent fraud. It can be used in digitally signed contracts: smart contracts can that be signed digitally and computer automated, making compliance simple and automatic.
The rapid evolution of cryptocurrency
Nakamoto laid the groundwork for Bitcoin and blockchain in 2008, with a white paper laying out the theory and practice behind the world’s first cryptocurrency. In 2014, Bitcoin developers made changes to the blockchain protocols.
This break, called a “fork,” is common in the cryptocurrency sphere, and it often results in an entirely new currency. Bitcoin cash, Bitcoin gold, and Bitcoin XT are all the products of forks.
Developers create new cryptocurrencies all the time, usually to take advantage of a different blockchain protocol, improve on an existing technology, or create a crypto asset that does something even more cutting edge. This rapid evolution means that some cryptocurrencies are launched to great fanfare, but burn out just as spectacularly.
Cryptocurrencies set up their own rules in their own white papers, which investors read (or should read) before investing. Developers can create cryptocurrencies for specific industries or markets. For example, healthcare cryptocurrencies include SOLVE and Doc.com. Theta, discussed below, is an online cryptocurrency platform for the video industry.
Some of the best-known cryptocurrencies besides Bitcoin are as follows:
Ethereum
The Ethereum white paper was published in 2013. Ethereum has forked multiple times in its history, leading to Ethereum 2.0. As one of the earliest altcoins, Ethereum has some For instance, Ethereum’s blockchain stores computer code for financial contracts, unlike Bitcoin’s platform. Ethereum also provides the additional capability of producing smart contracts, or self-executing agreements.
Binance Coin
Binance Coin (BNB) started in 2017 with 100 million BNB tokens and regularly buys back and “burns” BNBs, keeping the supply of coins finite and their value high.
Tether
Founded in 2014 as Realcoin, Tether is a stablecoin. It’s tied to the U.S. dollar, helping to reduce volatility. Some financial experts are concerned that Tether doesn’t have enough dollar reserves to justify being tied to the U.S. dollar and therefore risks causing a market crash.
Cardano
Launched by an Ethereum cofounder in 2017, Cardano stands on a proof of stake platform, which is seen as less risky than a proof of work platform, which is the classic Bitcoin platform. Proof of stake also requires less electricity to power Bitcoin mining.
Polkadot
Polkadot is an example of the way new coins are founded to solve shortcomings in the previous generations of cryptocurrencies. This currency promises cross-platform interoperability and no forks. Features include the ability to connect multiple blockchains, increasing transaction processing capacity.
XRP
Ripple Labs created XRP for its global transaction platforms. The Ripple platform can transfer fiat currencies and intangible assets, such as air miles, as well as digital XRP currency. In this case, the value lies in the ability of the Ripple network to quickly transfer assets around the world.
Uniswap
Founded in 2018 on the Ethereum blockchain, Uniswap is open source and completely decentralized and uses an automated liquidity protocol, which allows trades to happen instantly.
Litecoin
Litecoin was launched in 2011. It was based on Bitcoin’s source code, making it one of the earliest successors to Bitcoin’s splashy introduction. It’s often considered a less-expensive investment than Bitcoin.
Theta
Theta was launched in 2018 to solve a problem in video streaming networks: lack of bandwidth. Theta’s blockchain rewards users who contribute their excess bandwidth and computing resources to deliver video with Theta tokens.
