With the growth in the crypto market also comes volatility and uncertainty. The latest FTX scandal highlights the fact that more government regulation and accounting transparency are needed for the evolving digital asset industry. Let’s look at the implications of FTX’s collapse on the accounting profession and how the current accounting for cryptocurrency has evolved.

FTX Collapse and Implications

Prior to its downfall, FTX was the second largest cryptocurrency exchange, backed by blue chip investors. The collapse of FTX is reminiscent of Enron in many ways due to the lack of transparency, fraud, and related party transactions. Specifically, FTX was responsible for the following:

• Misappropriation of customer assets– FTX transferred customer assets to its sister company, Alameda Research (a trading firm also founded by FTX’s CEO), without the customer’s consent.
• Inflated asset valuation– FTX inflated its balance sheet with concentrations of FTX tokens (FTT) created and issued by FTX. FTX created FTT as a way to give investors a discount on trading fees. The market value of FTT is essentially tied to public sentiment on FTX performance. The problem is that FTT are so intertwined with FTX, that they would have very little value in a liquidation/financial duress scenario. Alameda Research also used FTT as collateral for leveraged trading.
• Lack of governance and internal controls– FTX did not have a traditional board of directors that included third-party investors. The CEO and his inner circle did what they wanted without any accountability and had little experience. There was no separate accounting function. Therefore, the accounting records were likely incomplete and untrustworthy.

The catalyst for the FTX collapse was when CoinDesk, a cryptocurrency news site, revealed that Alameda Research’s assets were highly concentrated in FTT, and its balance sheet was highly leveraged. This discovery raised doubts about the separation between FTX and Alameda Research and FTX’s solvency, which then triggered a market run where investors started dumping their FTX holdings and demanding withdrawals. FTX could not secure enough funds to pay out the investors, and the value of FTT plummeted. FTX went on to file for bankruptcy.

The collapse of FTX raises the question of what role accounting and the auditors played. FTX had its financial statements audited by two different third-party U.S. audit firms. You might wonder why two different firms were used to issue an opinion on FTX’s financial statements. One might assume that it prevented one firm from having the full picture of all the transactions. It is unclear how these firms signed off on the financial statements, but without knowing more, it calls into question if they were fully independent. In an extreme case, Enron led to the collapse of Arthur Andersen as investor confidence in the public accounting giant was permanently destroyed. It will be interesting to see what the repercussions are from the FTX scandal. Some accounting firms have elevated the risk profile of their crypto clients due to the FTX scandal, or are staying away from crypto clients. Those firms with crypto clients must ensure they have the right resources to deal with the continuous innovation in crypto activities.

The fact is that the nature of cryptocurrency is different from other assets and continues to evolve. There currently is no authoritative guidance around cryptocurrency assets, so the accounting and reporting for cryptocurrency activities are not clear. The AICPA’s Practice Aid on Bitcoin and Other Cryptocurrencies issued in 2018 helped provide clarity but did not provide definitive guidance. By default, crypto assets were treated as indefinite-lived intangibles as they didn’t meet the criteria to be cash or financial instruments.

The FASB is currently working on an accounting and reporting model just for crypto assets. Once the FASB issues final guidance, the regulators need to enforce compliance with the accounting rules. To prevent another FTX scandal, the measurement and recognition of exchange-created tokens like FTT coins should also be subject to the accounting rules.

Current Accounting for Cryptocurrency

The FASB has included accounting and reporting for crypto assets in its technical agenda. While the project is still in initial deliberations, the FASB made two key tentative conclusions at its meetings on October 12, 2022, and December 14, 2022:

• Crypto assets should be measured at fair value under ASC 820. Subsequent changes in fair value should be recorded in other comprehensive income each period. Previously, crypto assets were accounted for as indefinite-lived intangibles recorded at cost and subject to impairment.
• All companies are required to disclose the following (separate from other intangibles):
  • The aggregate amount of crypto assets
  • Gains and losses on crypto assets recorded in net income
  • Crypto assets that are noncash consideration and are converted immediately to cash should be classified as operating cash flows
  • Information about significant crypto asset holdings for annual periods and interim (fair value, units held, cost basis)
  • A rollforward of crypto assets for annual periods only
  • Restricted crypto assets for annual periods and interim

These tentative conclusions are an important step to creating the much-needed transparency that investors are looking for.