Crypto assets – Accounting for stablecoins, staking, and lending

Thought Leadership from PWC's National Office Welcome to PWC's Accounting Podcast. I'm Heather Horn. Today we're back with the second episode in our two-part series on crypto assets. In part one, we focus on the fundamentals to crypto asset accounting. In today's episode, we're turning our attention to specific considerations for common crypto transactions, including stablecoins, stake-in, and lending. For today's episode, I'm happy to welcome back to the podcast, our guest host, Diana Stoltzviz, a partner in PWC's National Office. She's joined again for today's episode by Beth Paul and John Van Austol, also partners in our National Office. In addition, Ryan Blacker, a director in our National Office, is a special guest for today's episode. Together, they bring deep expertise in this area. With that, let's listen in on our conversation. Beth and John, thanks so much for joining me again for part two of our crypto asset mini-series. And Ryan, welcome or so nice to have you joining us as well. Thank you. Okay, so in part one of this discussion, we talked about the fundamentals of crypto asset accounting. And now today for part two, we want to dive into the specific considerations around some of the common types of crypto transactions. Beth, can you tell our listeners which transactions we plan to focus on today? And also, I think it would be helpful to level set on what we mean by transactions because I feel like it's a broad term and there are all sorts of transactions happening in the crypto space that we potentially would want to cover. Yes, nice to be here again with you, Diana. You're absolutely right. There's all sorts of transactions happening in the crypto ecosystem. You know, from simple buy and hold strategies to companies beginning to consider accepting certain crypto assets as a form of payment, exchange for goods, or services they offer customers. That being said, there are a few key themes that we see on a recurring basis and that are getting a lot of recent attention that we thought would be particularly important to cover today. And that is stablecoins, staking, and lending. Okay, great. Well, let's dive in. I think we'll take each of these topics in order. So we'll start with stablecoins. Ryan, can you give us an overview of what a stablecoin is and why we're talking about it today? Great. Yeah, thanks, thanks, Diana. You know, stablecoins certainly are getting a lot of attention. I've even heard it referred to as a stablecoin summer. So certainly a lot of press on the topic. And you know, it's kind of interesting because stablecoins are, you know, a little bit different than other forms of crypto that we might typically think of. Certainly, the crypto-intangible assets that Beth and John talked about on the previous part. But on the previous podcast episode, you know, the primary purpose of a stablecoin really is to represent the value of an asset that is not generally subject to significant volatility. And so often a stablecoin is peg to a fiat currency, most commonly that's the US dollar, but it could be other currencies. It could be commodities like gold. And so this is usually achieved by collateralizing the asset whose value the stablecoin is aimed to peg against. Maybe just to illustrate. So if a stablecoin is designed to represent the value of one US dollar, then the issue of the stablecoin would accept, you know, an equivalent amount of that fiat currency. And you know, they'd make sure to keep adequate reserves for each stablecoin in circulation. Okay. I think most of the time when we think about crypto assets, we think about changes in value over time. So it sounds like is the name suggests stablecoins are designed to maintain a stable value for the holder over time. Yeah. So maybe to jump in here, Diana, that's exactly right. So stablecoins came into use to provide value stability in the crypto ecosystem and what we've historically seen as a volatile environment. So that's one of the reasons they're probably becoming increasingly used for making payments or transferring funds. Okay. That makes sense. Ryan, you also mentioned that there's been a lot of press recently on stablecoins. Can you share some perspective on why that is? Right. Yeah. So in July, the president signed into law a new act. It's the guiding and establishing national innovation for US stablecoins. So maybe we'll just call it the genus act. I think, you know, it's a catchy acronym. And they love the acronym. Right. Exactly. Exactly. So what the act does is for the first time, you know, it's establishing a regulatory framework for issuers of stablecoins in the US. Okay. Got it. So does the genus act cover all stablecoins? No. And I think that's an important point. It's not broadly all stablecoins. The framework covers a specific subset of stablecoins and they have to meet certain requirements. If they do, you know, the act refers to those as payment stablecoins. And so, you know, maybe just to illustrate that they need to meet all of the following criteria. So they need to be used for payment or settlement. They need to be, you know, pegged to a traditional asset, like a Fiat currency. And again, that's designed to minimize price volatility. And then it can't pay, you know, a yield or interest. So if the stablecoin meets all of those criteria, then the stablecoin does meet the definition of a payment stablecoin. And why that matters is then it would not be considered a security under securities law. So we talked about the definition for a payment stablecoin. You know, there's certainly a lot of elements in the act in terms of what's required of the issuers of those payment stablecoins. So maybe I can just talk about that for a moment. You know, the first thing is that there's certainly regulatory oversight. You know, let's say for example, you're an insured depository institution, then the company would be required to be regulated by its primary federal regulator. You know, so think the Fed or the FDIC or OCC. But ultimately that regulatory oversight depends on the type of institution. Another requirement for the issuers that they need to maintain reserves. We talked about reserves a little bit earlier. Those reserves would need to be maintained on a one to one basis. And that would have to be with high quality liquid assets. So think, you know, cash, treasuries, the like. Along with that in terms of the reserves, they would have to be disclosed on a monthly basis. So of required monthly examination, it would have to be performed by an independent accounting firm. And you know, along with that, they're also now would be a required annual attestation by the independent accounting firm. And that would be over the design of the issuers internal control. So not a full list, but just to give listeners sort of an idea of the requirements that relate to the Genius Act. And then ultimately those are there to promote consumer protectionism and financial stability. Okay, that's really helpful, Ryan. Beth, is there anything else you want to add or that we should think about before we jump into the accounting? Yeah, I think if there's one thing to remember about crypto assets from these two podcasts, it's that the details matter. You have to understand the underlying rights of the holder and the obligations of the issuer because they do vary from stablecoin to stablecoin. So it's critical as a holder to review the terms and conditions to determine the nature and classification of the assets that you hold. For example, some stablecoins contemplate the idea that the stablecoin may be transferred to another third party in a future transaction. So that is the terms and conditions include language like the right to redeem with the issuer will automatically transfer and be assigned to the subsequent holder. So long as those other holders are, you know, eligible to meet fairly basic minimum requirements, like setting up an account and not engaging in inappropriate activities, right? Not being a bad actor. On the other hand, some stablecoins have terms and conditions that indicate that the right to redeem is contractually the right solely to you as the original purchaser. So those are very different, right? The redemption rights also may limit who can open an account based on geography or they may impose a floor like a minimum, like you have to have, you know, 100,000, 500,000, some number to be able to redeem. And in more extreme cases, the rights may not entitle the holder to a right to the underlying asset at all. So rather, it may say something like you can redeem for redemption in kind, but that's not really defined. So it's important again that you understand whether your company has these rights. And then not just the generic rights that you can find sort of on the generic T's and C's that exist on the website. But then we are finding some companies enter into specific agreements. Maybe they have a large volume with the issue. And so they're entering into a separate contractual arrangement with the issue that entitles them to specific rights and privileges. And those would be important when you're thinking about your classification and the things we've talked about earlier. Okay. Well, these seem very important points, Beth. So thank you. Now let's turn to the accounting for stable coins. Ryan, you mentioned there are that they differ from crypto and tangible assets like Bitcoin and ether. And I think this means the accounting will also differ as well. Can you share some perspectives on that? Great. Yeah. There's no one universal answer on how the holder of a stable coin should account for them. I think that's fundamentally for the reasons that Beth just described right. There's a wide range of underlying rights in the terms and conditions for each stable coin. So maybe what I can do is give a few indications of things that the companies would look for when they're sort of figuring out the accounting for their specific stable coin. So the first one, I think it's fairly straightforward, but it's the purpose of the stable coin. Probably something simple like maintain a peg to the US dollar. Obviously, if you're holding that, you'd expect that that's a pretty straightforward analysis. The second one though is the contractual redemption rights of the holder. So. Are there minimum thresholds like Beth talked about? Are there limitations on the frequency of how often you can redeem? Are there restrictions on who can hold the stable coin like based on geography? So that's number two. And then the third one is, companies should also think about the collateralization of the stable coin. So not only what's being held and reserved by the issue, but also how are they able to invest those funds in the reserves? - Okay, that's really helpful on the types of things that you need to consider when you're determining the accounting. So after you thought about those, what's the next step in accounting for stable coins? - Yeah, I think certainly determining the classification is critical. And I think the way it makes sense to go through the classification analysis is as the first determine whether it meets the definition of a financial asset. So the thing we're most focused on in that part of the analysis is, does the holder have a contractual right to cash from the issuer? Something to be mindful of is that there are conditions that if they're going to limit the redemption, particularly if that's at the discretion of the issuer, that would likely adversely impact the ability of the company to classify the stable coin as a financial asset. So something for listeners to just be mindful of there. And if that were the case, it would result in the stable coin being accounted for as another type of asset, often that would be an intangible asset. So certainly, we've been saying it a couple times, but just to re-emphasize analysis of the underlying contract terms certainly matters. Now let's say for example that the company does in fact determine that a certain stable coin meets the definition of a financial asset. So this is the critical part. The primary question that we've been receiving is should the stable coin be classified as a cash equivalent? And the answer to that question is, well, it depends. I hate to say that, but first the company needs to evaluate, does the asset meet the definition of a cash equivalent under US gap? So is it short term? Is it highly liquid? Is it readily convertible to a known amount of cash? And ultimately, is it so close to maturity that there is basically an insignificant risk of a change in value as it relates to changes in interest rates? I mean, I think there's really a lot to unpack in that definition. So maybe I'm just going to jump in here. Right? The creation of stable coins has resulted in the profession. And myself, I feel like I cannot believe how much time we have spent recently thinking about the definition of cash equivalents and cash. I think something that back in accounting 101, you thought was pretty solid. And it's so important that the FASB is started a research project to consider the definition of cash equivalents. And so I think that just shows this is really a new world. But maybe just to highlight a few key elements. The definition of cash equivalents has to be short term. So this is generally understood to having a maturity of three months or less. I was going to ask that Beth, I was thinking. I was like, I haven't thought about cash equivalents in a while and it used to be 90 days or less. I didn't know with things are changing so quickly, you know, makes sense of the FASB thinking about it. Right. Right. Yeah. So it is still what's in there. But I think for stable coins, we generally think they're going to meet that characteristic. Because they typically are redeemable with the issuer immediately or within a day or two. The second element of the definition is that a cash equivalent has to be highly liquid. So this means the asset needs to be convertible to a known amount of cash and should be redeemable on demand without incurring a significant penalty. So if you do have that one-for-one redemption, that's your terms and condition, this is likely met. But we also do typically look at what the underlying reserves are comprised of to understand whether those maturities don't exceed 90 days, sort of on an average basis. And whether the stable coin issuer has that ability to redeem the stable coin stale. OK. I think that's really helpful to help bring that thought process to life. So let's say a company has a stable coin that meets the definition of a financial asset and is now evaluating whether it further meets the definition of a cash equivalent. Ryan, what else do they need to consider? Well, we still aren't quite done yet. So not only does the stable coin need to meet the gap definition of a cash equivalent, but it also must then meet the company's accounting policy of a cash equivalent. So this is something that already exists in GAP and ASC 230, the cash flow standard. And what it says is, well, not all investments that qualify as a cash equivalent are required to be treated as cash equivalents. A company needs to establish a policy in terms of which short term highly liquid investments that satisfy the GAP definition of cash equivalents are treated as cash equivalents. And so why does that matter? Right. Well, if a company does determine that a stable coin meets its accounting policy of being presented as a cash equivalent, then it would need to be reflected in the statement of cash flow as just like cash or cash equivalents or restrict a cash. OK. So to recap, even if a company has a stable coin that meets the definition of a financial asset, that doesn't automatically make it a cash equivalent. The underlying terms are important in making that determination. But any final thoughts before we go on, Beth? Yeah, I mean, maybe just one other point I'd make is that the classification of the asset from an accounting perspective not only drives the presentation, that cash flow discussion, that Ryan just mentioned, but it also drives the subsequent accounting for the stable coin. And that's particularly relevant when we think about derecognition, which we haven't yet really spent a lot of time on. But if we're in a financial asset model, then we're in the financial asset derecognition model. So for those that love the references, that's ASE 860. OK. Well, I think we've touched at least unstable coins. I'm sure there's more to unpack. But we'll move on to our next topic, which is staking. So I've heard terms, proof of work, for bitcoins, and proof of stake, for other crypto assets like Ether. Now, in this case, we're talking about the latter. So I'm going to turn to you now, John. Can you explain what we mean? We're talking about proof of stake for staking. Yeah, Diana, it's a great question. So a proof of stake consensus mechanism is one of the ways that blockchain networks validate transactions. The other common one being proof of work, as you mentioned. But instead of using energy intensive mining like proof of work systems for Bitcoin, proof of stake allows holders of the blockchain's native token to stake their crypto assets. So what that means is that the company can post its crypto assets as collateral on the blockchain network to assist in the validation. So in the most simple examples, there's often two parties involved with the blockchain protocol to perform the validation. Holders of the crypto assets may use their crypto assets, their technology, and equipment to validate transactions by operating the node directly on the blockchain. And we often refer to this party as the validator. It's the one verifying transactions on the blockchain. Alternatively, holders may simply provide access to their crypto assets or delegate them to a validator. And so we often refer to this party as the delegator. And most of the questions we're receiving are with respect to the delegator's accounting. And so we'll focus on that probably for the rest of this discussion. OK, so we'll focus on the accounting for the delegator. But before we get there, maybe taking one step back, some listeners may be wondering, why would a company want to stake its crypto assets in the first place? Can you explain that, Testion? Yeah, so thank you for re-grounding us there. So in exchange for staking its crypto assets, companies participating in invalidation transactions can earn transaction fees or staking rewards. And those are usually provided in the native crypto assets. So if you're staking ether, then in return, you'll often receive a reward in the form of ether. There are different terms used for and different types of these rewards, depending on the blockchain protocol. We won't go into all the nuances and the complexities there of how that can play out. But fundamentally, if a company has a hold strategy on a crypto assets that's on a blockchain that uses a proof of state consensus mechanism, it's a way for the holder to generate an incremental return. OK, I think that's super helpful. Thank you, John. So let's turn to the accounting now. What are some of the common questions you're hearing about staking when companies are acting as the delegator? Yeah, so the first one is, do I need to do anything with the crypto assets that I'm staking? Or in other words, should I de-recognize the crypto assets from my books? In the most common scenarios we see, the crypto assets that are being staked or classified as intangible assets. And so the de-recognition question comes down to whether control has been transferred. And that means applying in the guidance in ASC 610-20. And that's tied to the control principles and the revenue standard in ASC 606. So kind of weaving away through. We've got to go to a lot of different standards here. And so because of that and applying that guidance, the conclusion is often that the delegator does not de-recognize the asset. And that's because the delegator often maintains control of the assets. And so you might say, well, how do we think about that? What drives that? Well, some of the indicators that we think about in terms of whether the delegator has control or are focused on risk and rewards of ownership and things like, does the validator have the right to direct the use of the crypto asset? Can the validator somehow use the crypto asset to do any activities other than performing the validation transactions. Can you? the delegator unstake, the crypto assets at any time or within a short period of time, whose wallet, the crypto assets remain, did they remain in the delegator's wallet, and then does the delegator remain responsible for the cryptographic keys to access the wallet? So maybe I'll jump in here. When we consider these indicators, we have seen instances where the crypto asset remains in the entity's digital wallet. The validator can't sell or pledge them, and the delegator can un-stake them pretty frequently, because no other party gains the right to use the crypto or receive the economic benefits from those crypto assets, then the validator is not obtaining control. And so the state assets remain with the delegator and on their balance sheet. But that's just one way we've seen it. I mean, and probably a pretty common way, but as this is developing, we are seeing new and evolving ways. So that's something people have to again know their specific facts and circumstances. An important thing we keep coming back to. So when accounting for crypto staking as the delegator, the first step is to consider deregognition, and then to your point, often the conclusion is that control has not transferred. If that's the case, the company does not de-recognize the state crypto assets. So I would imagine the next step is to evaluate how to recognize the rewards earned from staking. So John, can you talk us through that? Yeah, exactly, Diana. So that's the other sort of primary question we're receiving on this topic. And so, okay, I figured out I can't take the assets, the crypto assets off my books. How do I record those rewards that I'm earning in the income statement? And so we often say the first thing the delegator should think about is whether the transaction is a contract within the customer, within the scope of the revenue standard. And so essentially is that that part of the entities ongoing major or central operations, again, in the scope of the revenue standard. And I think even if staking is not part of central operations, you know, in the absence of other authoritative guidance on the topic, you know, in practice, we often look to ASC 606 by analogy. But I think it's still an important question to consider and think through as it could also guide presentation on the PNL. So under the revenue guidance, the delegator would evaluate the principal versus agent framework to think about which entities is the principal in performing the validation activities for the blockchain. And and here again, I can't can't overstate that this is the most common fact patterns. There are nuances to these fact patterns and others. But what we've generally seen is the validator is determined to be the principal for performing the validation activities. And that's because the validator is primarily responsible for fulfilling the validation activities. It's the one operating the node and executing the validations. And so what that means is that the delegators performance obligation is is to provide access to its crypto assets for the validators validation activities. And so if you follow that through the delegator, would recognize that the staking rewards that it earns, net of the amount retained by the validator as revenue. Okay. So oftentimes the delegator is not the principal and recognizes the rewards on a net basis. John, are there any other considerations companies should keep in mind with staking? Yes. So maybe to round this out, there's a question of measurement. And so when you measure the rewards that the delegator recognize, the staking rewards as we previously mentioned are usually in the native crypto asset. And so that means it's non-cash consideration as contemplated by the revenue standard. And that guidance on for non-cash consideration tells us that the measurement date for the staking rewards is contract inception. And so practically speaking, that can be challenging because as we talked about that the delegator often has the ability to un-stake the crypto assets at any point in time. Wow. Okay. Well, that's certainly really helpful and a lot to thinking about from a staking perspective. But we'll shift to our last topic now lending. At first glance, it seems like there are some similarities between staking and lending, but the accounting conclusions could differ. Seems like that has been our conclusion with each of these. But Beth, maybe can you start us off with the basics on accounting for lending? Yeah, you're right. I think some of the analysis is the same. But as you might see in a minute here, the accounting conclusion often ends up different. We do often end up in a dereconition. But maybe just to clarify in level set, we are talking now from the perspective of the lender. Okay. Good point. And we're loaning crypto assets that meet the definition of an intangible asset. So not financial assets. And I think the best way is to illustrate with an example. So let's say the lender is holding a crypto asset for appreciation and decides it wants to loan it out to earn a return on that asset while they have this whole strategy. So the lender loans 500 units of the crypto asset out. Again, it's an intangible and it has a fixed term of two years. At the end of two years, the borrower is going to pay back the lender in the same crypto, along with paying a fee of, you know, let's call it one unit a month per month of the lending period. Now, this is important. Control of the loaned crypto asset is transferred upon giving the loaned crypto asset to the borrower. And that's because the borrower has the right to deploy those assets at its discretion. For example, the borrower can transfer them to another counterparty. They can pledge a must collateral. They can sell them. The key part here is that borrower can do what they want with those crypto while they have them. They're just going to need to return a crypto in two years. So we have that recognition of the control going away and going to the borrower. Therefore, the lender would de-recognize the crypto assets lent and would recognize an asset that represents the lender's right to receive the crypto asset at the end of 24 months. That crypto asset loan receivable would be measured at fair value at the time. The crypto assets are transferred to the borrower. The lender would also need to consider recognizing an allowance for any expected credit loss related to the crypto asset loan receivable. And that's because the crypto asset loan receivable exposes the lender to the credit risk of the borrower. This model that I've just described is consistent with what's known as Q&A 25 of the AICPA's Digital Asset Cryptoguyde and is also consistent with remarks made by SEC staff at the AICPA conference from a few years ago. So that's places along with our own crypto guide where people can find more on this. Okay, so the lender does de-recognize the crypto asset, records are receivable, and then considers if there's any credit loss reserve that needs to be recognized related to that receivable. And then one thing I was wondering is, could there be a difference between the value of the crypto assets previously on the company's book and the value of the crypto asset loan receivable that it's now putting on its books? And if so, how do we think about that difference? Yeah, so in theory, any difference between the fair value of the crypto asset loan receivable at the time of transfer and the carrying amount of the crypto asset would be recognized as a gain or loss in the ink of statement. But as we covered on our first podcast, certain of these crypto assets do fall the scope of the new guidance, what we call 35060 or the new intangible guidance for certain cryptos. And those cryptos are measured at fair value on a market basis. And so oftentimes there's not going to be a gain or loss, right? I guess the other thing to remember for the recognition of that crypto asset loan receivable is that the lender is going to continue to remeasure that crypto asset loan receivable to fair value at each reporting date. And in addition to the AICBA guide, I mentioned we've got our guide. Now we've got these podcasts. So I would suggest people maybe go to PWC's viewpoint because they can access all of that content in one place there. Okay, thanks for highlighting those additional resources because I know that's always really helpful to our listeners. Before we close this section, are there any final thoughts on lending? Yeah, I guess the only other point I'd make is that we've been referencing the crypto asset loans to the borough meets the definition of an intangible asset. Want to be very clear in our fact pattern. And this was very intentional because had the loan crypto asset met the definition of a financial asset. Then we believe the lender should follow the related de-recognition guidance for financial assets, which I mentioned earlier, is ASC860. So in a way, it's bringing things full circle because you might remember when we were talking earlier, we were saying, you know, stablecoins might be financial assets, and you'd have to think about 860. So we're bringing it full circle, got to know the nature of the asset, and then you'll know the measurement and recognition model and de-recognition model will follow accordingly. I think from all these crypto discussions, there's lots of different places that these different types of assets could fall in lots of criteria that you need to look at to see which model you're in. So I think, you know, back to I think the point that many of you have made multiple times is that it's really important to understand the specific contractual details and circumstance of the different types of assets. So we've covered a lot of topics today from stablecoins to staking and lending, but as we wrap up today, maybe I'll ask each of you what the key takeaways you'd like for listeners to keep in mind when they're thinking about crypto assets. So maybe Ryan, I'll start with you. Yeah, great. I mean, one thing I'd emphasize is this is a journey, right? There's a reason we're doing these podcasts now. We're trying to be timely in terms of, you know, the latest developments on these topics, but the reality is that our thinking is probably going to evolve the related accounting guidance is likely going to continue to evolve. So just keep in current, staying apprised of new developments in the space will be important. How about BAS? Yeah, I think we covered a lot today, but sort of just scratching the surface on those topics. And we tried to give examples of common fact patterns we've heard. But as I kept saying, it's really facts and circumstance-based. And so I think if you're really planning on getting into this space as a company or as an individual, read your terms and conditions, understand the contract your company has with us, counter parties, and then follow the applicable accounting that comes from there. Okay, John. Yes, so Diana, we said it on the last podcast, but maybe I'll say it again. Here is, leverage your resources, talk to your advisors, talk to your accountant, accountants, other market participants. This is really a don't go it alone. Sort of landscape. And these fact patterns, as we talked about, and these transactions can be very challenging to navigate. Okay, well, this has been a great discussion today. Thank all three of you for joining me today and sharing your perspectives on this topic. I'm sure we'll have you back to talk about it again soon as this is such an evolving space. But thank you so much. Thank you. Thanks. That's our show for today. Tune in next week for more fresh episodes so that you never miss any of our audio content. Follow the PwC County podcast wherever you listen to your podcasts and to stay up to date on all our latest accounting and reporting news. Sign up for our newsletter at viewpoint.pwc.com. From Thought Leadership at PwC, I am Heather Horn. Thanks for tuning in. This podcast is brought to you by PwC, all rights reserved. PwC refers to the U.S. member firm or one of its subsidiaries or affiliates and they sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This podcast is for general information purposes only and should not be used as a substitute for consultation with professional advisors, including accountants and lawyers.