Is Accounting the Missing Piece in Your Crypto Journey?
Aug 16, 2023
Welcome to the first article in our educational series on the world of cryptocurrencies and accounting. Brought to you by Mest, we aim to demystify the complexities of this intersection and guide you through its intricacies.
The crypto world is a vast expanse of innovation, promise, and potential pitfalls. As many embark on this digital odyssey, there's one aspect frequently overlooked: accounting. But why is this traditional field relevant in a futuristic landscape? Let's dive in!
The Rise of Cryptocurrencies
Cryptocurrencies have exploded onto the global stage. With over 20,000 coins and tokens in existence and a total market cap surpassing trillions, the digital asset industry is no longer the domain of tech enthusiasts alone. From individual investors to corporations, everyone's joining the crypto parade.
The Crypto Ecosystem: More Than Just Bitcoin
While heavyweights like Bitcoin or Ethereum often steal the limelight, the crypto universe is vast and varied:
- Utility Tokens: Assets that represent a value and can be traded, often related to a specific project.
- Stablecoins: Cryptocurrencies pegged to stable assets like gold or USD.
- NFTs (Non-Fungible Tokens): Unique digital assets representing ownership of a specific item or piece of content on the blockchain.
- Tokenized RWAs (Real-World Assets): These represent tangible assets, such as real estate, art, or commodities, that have been digitally tokenized on the blockchain.
From ICOs to DeFi: The Evolving Landscape
The variety of crypto assets is due to an industry that's always innovating and evolving:
- ICOs (Initial Coin Offerings): Earlier, startups in the crypto space raised capital through ICOs, where tokens were sold to investors. According to Cointelegraph, crypto teams raised over 20 billion US dollars through ICOs in 2017 and 2018.
- DeFi (Decentralized Finance): Today, the shift is towards DeFi platforms that aim to recreate traditional financial systems without intermediaries, using smart contracts. Notable examples include the decentralized exchange Uniswap and the decentralized lending platform Aave.
What Is Accounting, and Why Is It Overlooked?
While accounting is universally recognized as the "language of business"—a systematic method of recording, categorizing, and analyzing financial transactions—it serves as an indispensable link between business operations and their financial implications. It articulates the financial story of both businesses and individuals by detailing sources of income and expenditure patterns.
Yet, when it comes to emerging financial landscapes like that of cryptocurrencies, accounting often takes a back seat. Here's why:
- Distracting Novelty: The fast pace and unique terminology of the crypto landscape can overshadow essential financial practices.
- Misconception about Decentralization: While cryptocurrencies operate outside mainstream systems, it doesn't mean traditional financial practices aren't necessary.
- "Wild West" Perception: The crypto world's untamed nature can mislead individuals into believing it's free from rules. But as this frontier evolves, structure and practices will be essential.
- Responsibility with Wallets: In the world of un-custodian crypto wallets, you shoulder the accounting responsibility. Unlike traditional finance, where platforms track transactions, here you are in charge of your assets and their accounting.
The points mentioned above are not drawbacks. In fact, they endow cryptocurrencies with their unique magic. However, their distinctiveness makes people overlook accounting, an indispensable component in traditional finance.
Accounting in Traditional Finance
The prominence of accounting in the traditional financial world is undeniable. As Warren Buffett aptly stated, “Accounting is the language of business, and you have to be as comfortable with that as you are with your own native language.” Both for businesses and individuals, the contributions of accounting are indispensable:
- Guiding Personal Finance: Accounting not only sheds light on an individual's consumption patterns, savings, and investment results, but it also provides clear financial planning advice for various life stages, whether buying a home, funding education, or planning retirement.
- The Barometer for Businesses: For corporations, accounting acts as a barometer, transparently reflecting the company's financial health and thereby guiding strategic shifts in business expansion, investment choices, or cost-cutting measures.
- A Bridge of Trust: Whether it's individuals applying for loans or businesses aiming to attract investors, transparent and accurate financial reports serve as a solid foundation for building and maintaining trust.
- Guardian of Compliance: Every taxpayer and every business has tax and legal obligations. By adhering strictly to accounting standards and methodologies, they can ensure tax compliance, avoid legal disputes, and reduce the risks and losses due to negligence.
Moreover, the global investment in accounting underscores its value. The demand for accounting, both from businesses and individuals, continues to grow, with many willing to pay hefty fees to ensure financial transparency and compliance. According to the latest survey by The Business Research, the global accounting services market was valued at approximately $1.17 trillion in 2021.
The Importance of Crypto Accounting
Transitioning to the realm of cryptocurrencies, the tenets of accounting remain unchanged in their significance. In the dynamic world of cryptocurrencies, maintaining precise financial records isn't just an administrative task—it's foundational to success and security.
- Regulatory Compliance: With increasing crypto adoption comes increasing regulation. Tax authorities worldwide are focusing on crypto, and proper accounting ensures you're on the right side of the law.
- Informed Decision-making: Knowing your crypto assets' exact worth, realized gains or losses, and tax implications empowers you to make smarter investment choices.
- Security and Oversight: A regular accounting check provides another layer of oversight, potentially spotting unauthorized transactions or discrepancies.
The collapse of FTX in 2022 is a prime example of why accounting is just as important in the crypto industry as it is in traditional finance. The company's lack of accounting controls and transparency made it difficult for investors and creditors to understand its financial position, and even for its own management team. For example, FTX had been inflating its assets by counting illiquid assets as if they were liquid. This led to many terrible decisions and ultimately the collapse of the company. More alarmingly, there was no clear distinction in the accounting of assets belonging to FTX, Alameda, and even their founders. FTX's bankruptcy filing notably stated “FTX and Alameda Research didn't have their own accounting department - and it's impossible to rely on any of their financials.”
Accounting Challenges in Crypto
Cryptocurrency, by its very nature, presents unique accounting challenges:
- Scattered Transactions: Financial activities in crypto are spread across multiple platforms such as exchanges, wallets, and blockchains, making their consolidation challenging.
- Transaction Complexity: The range of transaction types, encompassing everything from trades to staking rewards, complicates record-keeping.
- Regulatory Uncertainty: The legal classification and tax ramifications of cryptocurrencies can differ dramatically among jurisdictions and are subject to regular changes.
Consider this address associated with the now-defunct Alameda Research/FTX.This address holds assets across over 14 separate chains, has engaged in numerous DeFi protocols with intricate operations such as liquidity provision, and has executed a vast array of asset purchases and sales at varied intervals. Pinpointing the exact cost basis for these trades and understanding the tax consequences of the associated DeFi maneuvers prove to be particularly challenging.
Navigating the Crypto Accounting Maze
Now, acknowledging the importance and the challenges is one thing. Navigating them is another. So, how do you ensure your crypto journey isn't derailed by accounting woes?
- Use Specialized Tools: Opt for emerging crypto accounting related software, like Mest. Our tool not only enables you to track wallet transactions seamlessly in a list format and provides real-time updates on blockchain activities, but it's also designed to offer financial insights and generate tailored tax reports in the future.
- Stay Updated: The crypto landscape and its regulations are always shifting. It's crucial to stay informed to prevent unforeseen challenges, particularly concerning tax updates.
- Consult Professionals: Consider seeking advice from a crypto-savvy accountant to ensure your financial records are spotless.
The crypto journey is exciting, filled with potential highs and lows. However, like any journey, preparation is key. Accounting, often seen as a traditional and perhaps mundane task, might just be the unsung hero of your crypto adventure. Embracing it not only provides peace of mind but ensures your digital voyage is smooth sailing.
Join the Conversation!
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