The regulation and taxation of cryptocurrencies is a hot topic.
Crypto markets are rising in popularity but investors have very little protection.
Governments are faced with the difficult task of implementing regulations and taxes that will provide consumer protection without discouraging investment and innovation.
When it comes to taxation and regulation, it is very important to separate Blockchain technology from cryptocurrency exchange platforms.
Blockchain technology is incredibly secure and has the potential to revolutionize our vision of transactions and data management but crypto exchanges are largely unregulated and vulnerable to theft, fraud and manipulation of volume and value.
Crypto exchanges function in the same way traditional stock markets do in that investors buy and sell assets according to the laws of supply and demand.
However, the digital and decentralized nature of Bitcoin differentiates it from stocks, bonds, and gold/silver which are tied to physical businesses, governments and minerals, respectively.
When you buy a stock you are purchasing a share of a business; buying a bond is essentially loaning money to government; and buying gold/silver is investing in a physical rare-earth mineral.
Bitcoin, however, is a virtual unit of account with nothing backing it up physically except the computer power necessary to mine it.
Is Bitcoin a tangible or an intangible asset?
The answer to this question will determine their accounting and tax status.
The International Financial Reporting Interpretations Committee (IFRIC) defines an intangible asset as an “identifiable non-monetary asset without physical substance”.
Bitcoin doesn’t have physical substance but is it a non-monetary asset?
IFRIC recently published a report stating that crypto holdings should be considered intangible asset as they are “(a) capable of being separated from the holder and sold or transferred individually; and (b) do not give the holder a right to receive a fixed or determinable number of units of currency“.
From an accounting point of view, intangible assets have no intrinsic value but are expected to produce income in the future. Think of such things as logos, patents and brand recognition: although they have no standalone value, they can potentially lead to immense returns if the business succeeds.
Bitcoin is intangible because owning one does not give you the “right to receive a determinable number of units of currency.”
Indeed, although I purchase one Bitcoin today with the intention of selling it tomorrow for profit, buying one at a determined price does not guarantee that its value will reach a determined price point.
OK, so Bitcoin is intangible. But is it a financial asset?
Well, IFRIC states that cryptocurrencies are not financial assets because “cryptocurrency is not cash […] nor is it an equity instrument of another entity. It does not give rise to a contractual right for the holder and it is not a contract that will or may be settled in the holder’s own equity instruments“.
To understand what the Committee means by “equity instrument of another entity” you must remember the aforementioned paragraph on stocks, bonds and minerals: Buying a stock is a buying a share of a company – the stock is a financial instrument issued by the company to raise funds. It is a contract that grants specific rights – such as voting in general assemblies – and can be settled – in cash or other forms.
Since Bitcoin is decentralized, it is not issued by anybody and does not grant the holder any contractual rights. Thus, it cannot be considered a financial asset in the traditional sense of the word.
Can Bitcoin be considered cash?
The Committee concludes that cryptocurrencies are not cash because they are not “used as a medium of exchange and as the monetary unit in pricing goods or services to such an extent that it would be the basis on which all transactions are measured and recognized in financial statements“.
This does not mean cryptos can’t be used as cash. It means that their use as currency is not widespread enough for all economic agents to recognize them as such in their accounting. Since it is not issued by a central bank, the value is not fixed and cannot be guaranteed.
Bitcoin is inventory?
Interestingly, the Committee also states that cryptocurrencies can be accounted as inventory in the case they are are “held for sale in the ordinary course of business“.
Logically, this means that professional traders could classify their holdings as inventory rather than cash or financial assets.
Why is IFRIC’s recommendation important?
IFRIC defines the International Financial Reporting Standard (IFRS) which is widely used around the world. Only the USA uses separate accounting standards, laid out in the Generally Accepted Accounting Principles (GAAP).
Hopefully, countries will adopt the IFRIC’s position that cryptos are intangible assets and will follow Germany, Portugal, Switzerland and Singapore’s lead of exempting long-term crypto holders of capital gains taxes.
Is IFRIC’s recommendation reasonable?
Bitcoin seemingly meets the criteria of an intangible asset in that it is a digital currency.
However, I find it difficult to argue that it is a non-monetary asset as it can be:
-> Used as currency to purchase goods and services
-> Valued and exchanged, as it is easy to buy and sell on exchange platforms,
-> Used as a store of value (“digital gold” theory)
I can understand classifying Bitcoin as inventory in certain circumstances but considering it a comparable asset to logos and patents is certainly puzzling.
Does IFRIC truly understand Bitcoin? Will their position evolve as they gain a deeper understanding of this technology?
Perhaps Bitcoin should be regarded as neither a tangible or an intangible asset. Surely, such technology could be classified in a league of its own – it is, after all, a decentralized digital asset the likes of which the world has never seen before.
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