Companies that hold cryptocurrency assets for clients should account for them on their balance sheets and warn investors of risks associated with safeguarding the digital assets, according to a new accounting bulletin published by the Securities and Exchange Commission on Thursday.
The agency’s views may auger changes in the balance sheets of companies like
Robinhood Markets (ticker: HOOD) that aren’t currently accounting for crypto the way the SEC staff would like.
“There are significantly fewer regulatory requirements for holding crypto-assets,” compared to traditional financial assets,” the SEC said. Companies that custody crypto “may not be complying with regulatory requirements that do apply, which results in increased risks to investors in these entities,” the agency added.
Crypto theft is a growing problem–more than $600 million stolen in tokens was recently stolen from the Axie Infinity blockchain-based game, for instance. The SEC views wouldn’t apply to those types of “DeFi” platforms, since they aren’t registered with the SEC.
However, a wide swath of U.S.-based corporations may face regulatory pressure to disclose more details about their customers’ crypto holdings, including potential vulnerabilities to hacks or other security breaches, and how the firms accounts for the fair market value of the holdings.
The SEC will apply its new thinking to all public companies registered with the agency, starting in each company’s next fiscal year that ends after June 15. The SEC’s accounting bulletins don’t create new enforceable law, rules or guidance; rather, they convey the views of the SEC’s accounting staff.
“It’s interesting that the timing of this accounting bulletin comes right after the recent rash of hacks,” says Sean Stein Smith, an assistant professor of economics and business at New York City’s Lehman College, am author of a handbook on cryptocurrency accounting. “That’s good,” he says, “because the risks connected to crypto-asset custody are different from other financial assets.”
The agency’s bulletin is part of a larger, unfinished task of setting standards for determining the fair market value of crypto assets, says Smith. Neither the SEC, nor the Financial Accounting Standards Board, has developed comprehensive rules, he says.
A growing number of public companies allow customers to transact in crypto-assets, noted the SEC. These companies often hold the security keys to safeguard those assets for customers. Moreover, crypto holdings carry unique technological and legal risks, which must be reported to shareholders, the SEC said.
Prominent companies that hold cryptocurrencies for their customers include
PayPal Holdings (ticker: PYPL),
Block (SQ), and Robinhood.
At the end of December 2021, for example, Robinhood reported holding over $22 billion worth of cryptocurrency out of the $98 billion of customer assets in the broker’s custody. That’s up from just $3.5 billion in customer crypto in 2020.
But those amounts aren’t included in Robinhood’s balance sheet, because the broker says that it’s an “agent” for customers that own the crypto. “[We] are not exposed to risks arising from fluctuations of the market price of cryptocurrency before delivery to the customer,” says Robinhood’s latest 10-K filing.
In correspondence with the SEC before Robinhood’s initial public offering in 2021, the company’s lawyers argued that the crypto that Robinhood held for its customers was not “an asset of the company.”
Using the same reasoning, PayPal also excludes its customers’ crypto holdings from its balance sheet, arguing it’s acting as an agent.
PayPal and Robinhood did not immediately respond to requests for comment.
Coinbase Global (COIN), the major crypto exchange and brokerage, holds even more customer crypto, and Coinbase does include those holdings on its balance sheet. There were $278 billion in its customers’ digital wallets at the end of 2021, up from $90 billion in 2020, according to the latest Coinbase 10-K filing. Some 96% of the 2021 customer holdings was cryptocurrency, with 40% Bitcoin, 25% Ethereum.
A spokesperson for Coinbase said the company is reviewing the SEC bulletin.
One other major firm that could be impacted by new disclosure requirements is crypto banking pioneer
Silvergate Capital (SI). The company makes loans secured by crypto assets that are held by third-party custodians. In Silvergate’s last 10-K filing, it warned: “Custodians of digital currency present additional risks because they are frequent targets and victims of cyberattacks, which could impact the custodian’s timely delivery of digital currency collateral to us.”
The new rules will require balance sheet notes that disclosure the nature and amount of crypto-assets that a company is holding for its users, with separate disclosure for each significant crypto-asset and any vulnerabilities the business has due to any concentration in its users’ crypto holdings. An estimate of potential liabilities from safeguarding failures may need to be included with the initial recognition of those crypto holdings, said the SEC, as well as later accounting of their fair value.
In addition to the new balance sheet reporting guidance, SEC-reporting companies may need to highlight any material risks of crypto safeguarding in other disclosures. Those include:
- litigation, reputational harm, and regulatory enforcement actions and additional restrictions
- whether customer holdings would be available to satisfy general creditor claims in the event of a bankruptcy
- the potential impact that the destruction, loss, theft, or compromise or unavailability of the cryptographic key information
“These risks can have a significant impact on the entity’s operations and financial condition,” said the SEC bulletin. Disclosing these risks should enhance investor information, “thereby assisting them in making investment and other capital allocation decisions.”
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