On October 12, 2022, the Financial Accounting Standards Board (FASB) announced a crypto asset accounting and disclosure project update. Any FASB guidance for reporting the fair value of crypto and crypto derivatives will become the global standard or at least the standard which others base their standard upon. The clarity FASB’s position provides will impact many aspects of the crypto-verse, because by codifying how and when value is reported, extant oracles and other methods may become unreliable or obsolete in the eyes of large, institutional players and retail hodlers; this is true even in the case of thinly traded cryptos where observed price action may not be indicative of a true fair value.
As with any guidance, nothing is coming out that entirely answers questions around what tools can be used to derive value nor the facts and circumstances that must be considered for fair value reporting purposes. Some considerations will likely not apply in the ‘real world.’ An example of such variance to ‘real world’ values is the use of blockage discounts. We know from using swap tools that price slippage when transacting large amounts is real. Fair value reporting under Accounting Standards Codification (ASC) 820 — Fair Value Measurement excludes considering the impact of large trades on the price of an asset, so right away, any value reporting under this new guidance will not encapsulate the factors that go into the real worth of an asset.
However, public information around acquired digital assets, positions held by public companies and other data points used by industry professionals to make decisions about how to allocate capital or manage portfolios will reflect the guidance as it is made available. And, even if the reported values do not align perfectly with the ‘real world’ definition of value, the results will certainly be useful for trending and comparing one crypto with another (or its own history.)
This change in status, from having little guidance to some guidance, does somewhat de-risk the digital asset industry, because it affirms the notion that this asset class is not going anywhere. Furthermore, the willingness of a quasi-regulatory agency to take a definitive stance on a controversial aspect of crypto informs us that more clarification is to follow. So in a lot of ways, the implication of a decision at all is a positive indication of things to come.
Let’s take a look at who the FASB is, what they most recently published, and its impact on Degen planning.
The FASB was established in 1973 as the independent, non-governmental, not-for-profit organization charged with establishing financial accounting and reporting standards for public and private companies.
From their own materials, “(t)he FASB is recognized by the U.S. Securities and Exchange Commission as the designated accounting standard setter for public companies. FASB standards are recognized as authoritative by many other organizations, including state Boards of Accountancy and the American Institute of CPAs (AICPA). The FASB develops and issues financial accounting standards through a transparent and inclusive process intended to promote financial reporting that provides useful information to investors and others who use financial reports.”
FASB’s mission is to establish and improve financial accounting and reporting standards to provide useful information to investors and other users of financial reports and educate stakeholders on how to most effectively understand and implement those standards.
Decisions Reached at August 31, 2022 Meeting
The following text is directly from the FASB’s website explaining what occurred back in August related to its crypto project kick-off.
“The Board decided that crypto assets that are held by an entity must meet the following criteria to be within the project’s scope:
Meet the definition of intangible asset as defined in the Codification Master Glossary
Do not provide the asset holder with enforceable rights to, or claims on, underlying goods, services, or other assets
Are created or reside on a distributed ledger or “blockchain”
Are secured through cryptography
The Board also discussed the different entity types that would be within the scope of the guidance. The Board decided that all entities would be within the scope of the project and that as decisions are made, the Board will consider the applicability of those provisions to those entities.” — FASB
The quick and dirty translation is that FASB is limiting its judgment regarding how digital assets’ value will be reported to only those crypto, as indicated by its second declaration, that are NOT securities. A security would come with enforceable rights. The other interesting note is that its guidance will only apply to fungible tokens, so SBTs (soul-bound tokens) or NFTs are excluded.
Decisions Reached at October 12, 2022 Meeting
For this section, we have pulled chapter and verse from the meeting’s minutes, and the below each section, provided a plain English impact on degens and non-degens alike.
“Accounting for and disclosure of crypto assets. The Board discussed how entities that hold crypto assets within the scope of this project should measure those assets.
The Board decided to require an entity to:
Measure crypto assets at fair value, using the guidance in Topic 820, Fair Value Measurement.
Recognize increases and decreases in fair value in comprehensive income each reporting period.
Recognize certain costs incurred to acquire crypto assets, such as commissions, as an expense (unless the entity follows specialized industry measurement guidance that requires otherwise).” — FASB
ASC 820 has been the beginning and end of all financial reporting guidance for the past 25+ years and is centered around the valuation of intangible assets. The definition of fair value according to ASC 820 is: “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”
It’s important to note that the fair value described here involves two market participants with contrarian (opposite) interests in arm’s-length transactions. The definition also assumes perfect information symmetry between the parties and that neither party has a compulsion to buy or sell.
The three approaches used to estimate a fair value under this definition are cost, market and income. The “cost approach” is generally discarded because the cost to make an intangible asset does not generally predict its value under the rules just mentioned. The income approach can work in this case if the token has a benefit stream associated with it. But, if the only assets under consideration by this project are those that do not contain a security interest, it would be difficult to rely on any sort of forecast to then ascribe a value. Therefore, it’s our educated guess that most practitioners are going to rely on market approaches to estimate a value. Perhaps some discounts will be applied to more thinly traded tokens, but that gets hairy for the practitioner. Specialists do not like to put themselves in between the data and the conclusion. Lifting something publicly available and coating information found on CEXes/DEXes in discounts and premiums is not a great look.
The Role of Market Makers and Fair Value
Market maker volume creates another challenge. As you may or may not know, not only do exchanges require token listers to hire market makers to churn volume (under the guise of ‘managing spreads’, lol), but the exchanges themselves use their revenue to pay market makers for artificial volume. The incentive to do so is clear; the higher the volume on the exchange, the more prestigious, the more they can charge for listing fees. As a result, a valuation professional will be challenged to find clean data on a specific token from which to draw conclusions. Even the comparison tokens will have noise baked in, but that’s their issue to document how they will handle it.
The second point around the reporting period is interesting. Reporting periods are generally quarterly for other intangible assets whose value needs to be updated periodically with a particular focus on getting year-end numbers right. Because these values will be largely market approach driven, the valuation practitioner or in-house valuation specialists can likely create a matrix of like tokens across multiple exchanges, and base a conclusion off of some triangulation of the same. The FASB is not there to tell you if you have done something right or wrong, but through the course of back-and-forth between auditors and third-party specialists/clients, some best practices will develop with time (and at the expense of the large public players basically paying third parties to solve this issue for the entire market!)
Lastly, the recognition of costs associated with acquisition of the digital asset is consistent with its treatment of costs associated with acquiring other intangible assets. So, the punchline is that public and private companies will be required to report a fair value on a regular basis, where the fair value is defined by the existing ASC 820 framework and is, generally, applied to all other types of intangible assets.
“The Board also considered:
Various measurement alternatives for crypto assets with inactive markets and decided not to pursue those alternatives.
Whether to provide implementation guidance relative to the application of fair value measurement of crypto assets and decided not to provide additional measurement guidance as part of this project.
Whether there should be a difference for private companies for the measurement of crypto assets and decided that the measurement and recognition requirements should be the same for all entities.
The Board will consider presentation, disclosure, and transition at a future meeting.” — FASB
The third bullet item is actually the most impactful. Typically, private companies are given some reprieve from new guidance or reporting requirements because the scale and nature of the audience is so different from publicly traded companies. By compelling private companies to report the fair value of crypto alongside their public counterparts, the FASB is admitting that the fungible nature of crypto makes informing private company investors of their holding’s fair value as important for them as it is for public company investors. Reporting requirements like these pose a challenge for private companies, because private companies do not tend to have the resources to retain vendors for such a specific, compliance-related task. As a result, since the Board considered but has not concluded on the matter, one would expect private company advocates to pushback on whatever draft formal guidance comes to the forefront here.
The other points raised about measurement alternatives for illiquid tokens and providing implementation guidance is not entirely unexpected. Here, the FASB is making the audience aware that it knows other critical discussion points exist, but are deferring specific recommendations for future working groups or through thought-leadership pieces published by the large accounting firms.
With December 31 around the corner, it would not be surprising to see the Controller groups at large, U.S. companies holding crypto having to incorporate this guidance into their planning now. The accounting firms charged with auditing these values will be engaging specialists who, themselves, will be cobbling together vendors, practitioners and tools to commoditize these new data points. Analysts will review these figures by mid-April 2023; likely, the first time the public will see public reporting of value for various digital assets, and then baselines established so that the intrinsic value of any alt-coin will have something to be measured against.
Even the modest clarity provided by FASB results in useful information beyond the specific decisions mentioned. As the leading body for prescribing fair value reporting rules, we expect to see this direction cascade through the varying public and private entities now beholden to such guidance. Stay tuned for more details as other regulatory bodies that provide valuation guidance for tax purposes or other measurement purposes jump into the fray.