Six Things to Beware of in Digital Asset Accounting

Introduction

These are six things to look out for  before jumping into Digital Asset accounting. A big misconception among accountants that start looking into accounting practices for digital assets is the assumption that the data would be as readily available as in the traditional financial system. While the cryptocurrency ecosystem is growing rapidly and revolutionizing the world of finance, fitting this new emerging technology or asset class into the financial and regulatory mold we have today presents unique challenges.

Blockchain technology was originally developed to supply a tamper-resistant decentralized distributed ledger thereby creating a trustless environment, with several exchanges having been created to offer access to this new market. This means that we need to aggregate information for a portfolio invested over multiple exchanges and in a variety of coins, because the information is disbursed in different locations. In theory, each exchange would be able to supply a ledger of information for the activities on that specific exchange, but none of the exchanges follow the same rules. This leads to differences in data formats and tickers as well as vastly diverse availability of data in relation to what the exchange offers. As such, the decentralized nature of the blockchain, and inevitably the nature of digital assets, brings us to some of the major roadblocks in accounting for the asset class.

If we look at a mutual fund as an example, accounting would be performed from the information obtained from the broker or bank statements. The price of the stock would be easily obtained from the exchange that investment is listed on. Unfortunately, digital assets do not currently have the same infrastructure: as there is no broker, and no closing price on an exchange as the cryptocurrency exchanges run 24/7.

Further major barriers in this sector also include: the collection and standardization of data; ensuring the data is complete, accurately assigning a cost basis to an asset; and calculation of fair value.
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1. HOW AND WHERE DO WE OBTAIN DIGITAL ASSET INFORMATION

Allow me to answer the million-dollar question: how do you obtain the information to accurately account for digital assets?

Well my friends, for cryptocurrency trading, an API allows you to connect with your exchange giving you access to real-time market data and the ability to manage your account. You will either need to connect all the APIs yourself (and that can eat up your resources), or you can use a data aggregation service provider. This is where Hash Data comes in.

Hash has API connections to a variety of centralized and decentralized exchanges, Blockchains and DeFi protocols. We work with you and your clients to ensure that you are provided with one source of normalized data that is categorized to facilitate accurate accounting.
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2. TRADITIONAL ACCOUNTING PACKAGES DO NOT SUPPORT THE DIGITAL ASSET CLASS

Traditionally accounting packages were developed without taking digital assets into consideration. The majority of cryptocurrency transactions are traded in currency pairs. You can buy Ethereum for Bitcoin and vice versa. Other DeFi and lending protocols have terms and deal structures unlike any traditional asset type. Accounting packages are unable to process these types of transactions. The way transactions are executed and structured on the blockchain makes fitting the digital asset transactions into a certain accounting standard an even bigger feat. Workarounds are possible in the traditional accounting systems such as by processing a buy and a sell transaction for a currency pair or accounting for it as a spot transaction.
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3. COMPLETENESS OF INFORMATION

The decentralized nature of blockchain technology carries an inherent risk of incomplete information. For example, when staking a coin some protocols would not reflect the accrued reward on-chain until it is harvested, and only when harvested will it reflect in your wallet and accordingly on the blockchain. There is no centralized authority like a bank that would be able to give you a bank confirmation, reflecting all the accounts that the client holds with them. Unfortunately, the onus will be on your client to declare all their cryptocurrency wallets and exchange accounts held in their name. Cryptocurrency wallets are anonymous and there is no way to know how many accounts your client have if they don’t disclose the information. Other completeness risks involve hard forks, timestamp cut-off risk and complete accounting for wallets supporting a variety of blockchains. However, if you have a good data provider they will be able to inform you when an event has occurred that leaves you vulnerable to incomplete information.
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4. TIMESTAMP MANAGEMENT FOR DIGITAL ASSET ACCOUNTING

The crypto market never closes, therefore each company or fund should have a pricing policy where they identify a valuation timestamp. This is the official closing time when the books and records of the company or fund will be closed, for instance 23:59:59 UTC.

It is crucial to realize that not all data providers provide information for trades and prices at all timestamps and in a timely manner. Therefore, when deciding on service providers, this is a very important aspect to consider.

5. PRICES AND FAIR VALUE

Tokens and coins trade on multiple exchanges and the price of crypto currencies are notoriously volatile. The concept of a closing price does not exist, as crypto markets never shut down. I believe that pricing necessitates a three-fold consideration:

 5.1) TIMESTAMP

The timestamp at which the coin will be priced at should be agreed upon. For Mutual Funds, we would expect to see this in the Memorandum of Incorporation or Pricing Policy. Careful consideration should be made to the availability of information from your chosen pricing source at that specific timestamp.

 5.2) PRICING METHODOLOGY

This could be challenging if the company needs to identify what their principal markets are, and the value on the principal market may differ from the value they need to report for a tax perspective. From a datapoints perspective, ensuring that your data provider has connectivity to the most likely principal markets for the coins and tokens that you are trading is of critical importance.

 This comes into play when calculating profit and loss. The fair value for a trading pair should be priced from the exchange the trade is executed on at the execution timestamp. Gathering this information as well as processing it in current accounting packages available is extremely challenging.

 5.3) PRICING SOURCE

There are a couple of free pricing sources such as Coinmarketcap and CoinGecko available.

These options use an average price over a basket of sources and each have their own pricing methodologies. Prices can be obtained via API from specific exchanges, or data providers can be otherwise consulted with to provide prices from exchanges. Obtaining prices for non-vanilla asset types such as Futures and Options could be trickier as the free sources above do not price these asset types. It is also noteworthy to point out that these pricing sources are also not infallible, such as There are also specific data providers that calculate their own price for these instruments such as Coinmetrics, Kaiko, and ICE.
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6. UNAVAILABLE INFORMATION

Hedge Funds invest where the yield is high and a lot of the time that is in new and upcoming protocols. Data aggregators take a while to support new chains as the protocols are usually quite small, can be highly specific and somewhat obscure, and not required by a big client base. You can benefit from using a data provider that is willing to work with you to develop connectivity to these chains and protocols.

TAKEAWAY

Do not assume that your traditional technology or infrastructure will meet your needs when it comes to handling of crypto assets. Take this opportunity to upgrade all of those processes and technology stacks by assessing new solutions.

The growth in the crypto landscape brings both opportunities and challenges. It’s still early days in the industry and the services providers filling the gaps are growing. Partnering with the correct service providers with the expertise and vision that agrees with your firm is cardinal to your success.

While we are seeing that service providers have limited access to new and high yielding protocols, the good news is that we at Hash are increasingly developing software that is intelligent and automated and directly intended to serve these specific needs.