Since cryptocurrencies came into existence in 2009, regulators and financial bodies have been in a constant battle on how best to regulate this newfound innovation. Due to blockchain’s basic nature of cash finality, permissionless and borderless access to its use cases, it has become imperative for financial watchdogs to protect its citizens from possible rug pulls that are rather rampant in the industry and to also ensure that bad actors do not use the industry for their own selfish benefits.
Since 2020, we have seen a lot of big institutional names add cryptocurrencies to their balance sheet. Big names like MicroStrategy, Tesla, Galaxy Digital, The Block (Square), and others, have all added cryptocurrencies, especially Bitcoin, to their balance sheet and have all made a pledge to be ‘hodlers’, a term used to describe long term holders who do not plan to sell their cryptocurrencies in the foreseeable future.
There has been a lot of chatter about how best to account for holding digital assets on the balance sheet. This got more intense in 2021, which saw a lot of adoption of cryptocurrencies by institutions. MicroStrategy for one is one of the biggest institutional Bitcoin holders with over 125,000 BTC in its treasury that it began accumulating in 2020.
Although the adoption of cryptocurrencies by institutions has been praised by the cryptocurrency community, with many stating that it has somewhat brought a form of legality to the asset class, it does however come with pain to these institutions, in the form of the impairment charge, which affects their overall performance and has made other institutions, who might have been considering adding the asset class to its balance sheet, become somewhat hesitant.
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What is Impairment Charge?
Since cryptocurrencies are notoriously known for their volatility, a company’s financial statement and reporting for tax don’t always align. Impairment is intended to measure and account for the reduction of the cryptocurrency’s value. For cryptocurrencies, impairment analysis is tied to the price fluctuations of the asset.
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A brief history
Asset impairment was first addressed by the International Accounting Standards Board (IASB) in IAS 16, which became effective in 1983. It was then replaced by IAS 36, effective July 1999.
In United States GAAP, the Financial Accounting Standards Board (FASB) introduced the concept in 1995 with the release of SFAS 121. This was then replaced by SFAS 144 in August 2001.
The issue of impairment of financial assets exposed deficiencies in the IAS 36 framework during the 2008 financial crisis, and the IASB issued an exposure draft in November 2009 that proposed an impairment model based on expected losses rather than incurred losses for all financial assets recorded at amortized cost.
Because of this, the IASB and FASB came together to devise a common impairment model, but the FASB eventually decided to propose an alternative scheme in January 2011. The IASB issued a new exposure draft in January 2013, which later led to the adoption of IFRS 9 in July 2014, effective for annual periods beginning on or after January 1, 2018. The FASB is still considering the matter.
In simple terms, impairment charge is a term used to account for an asset that is no longer as valuable as may have once been. In the case of digital assets, an impairment charge is written when the price of Bitcoin for example, goes lower than the purchasing price of the entity.
Its effect on institutions holding cryptocurrencies
Due to the volatile nature of cryptocurrencies, it is almost impossible to not record impairment charges on them. Also, depending on the amount of money allocated to cryptocurrencies by companies, the impairment charge could be costly to an institution’s profitability in the long run.
Let’s look at the two biggest companies holding Bitcoin in their balance sheet, MicroStrategy and Tesla. MicroStrategy, in its full year financial report, revealed an impairment charge of approximately $147 million in the fourth quarter of 2021. MicroStrategy, a company that owns 125,051 BTC which at today’s price puts its dollar value at approximately $5.5 billion, has written a total of $830.6 million in impairment charges for 2021.
This effectively pushed the company’s profit before tax to the negative, for the second consecutive year. In a world where MicroStrategy did not have to account for impairment charges, the company would have a profit before tax of $19.2 million. This speaks volumes to how impairment charges have affected the profitability of MicroStrategy. This also impacted its share price as the NASDAQ listed stock is down over 27% Year-to-Date (YtD) as of the time of this writing.
Tesla is also no stranger to digital asset impairment charges as the company started acquiring Bitcoin in the first quarter of 2021. Tesla initially acquired a total of 42,902 BTC for $1.5 billion at the time. The firm later announced the sale of $272 million worth of BTC in the same quarter which led to the company gaining $128 million. Elon stated that the reason for the sale was to prove the liquidity and fluidity of the asset class.
In an SEC filing, Tesla revealed that the firm charged approximately $101 million in impairment charges for its Bitcoin holdings in 2021. The expense item in Tesla’s balance sheet, Depreciation, amortization and impairment, amounted to $2.91 billion and Tesla’s Bitcoin impairment charge accounted for 3.47% of the total charge. Although this did not stop Tesla from making $5.6 billion in Profit After Tax, the company could have made much more if it did not have Bitcoin holdings.
Tesla, in the SEC filing, explained how cryptocurrencies could affect its profitability. It read, “For any digital assets held now or in the future, these charges (impairment) may negatively impact our profitability in the periods in which such impairments occur even if the overall market values of these assets increase.”
What experts say about holding digital assets
Ajibola Lawal, a DeFi Analyst at Kaicho Digital Assets explained that it isn’t the time for institutions to hold cryptocurrencies in their balance sheet. He stated, “Honestly unless they are directly involved in the cryptocurrency space, I don’t not believe that it is a good time for institutions to hold BTC. It’s not just the volatility but the financial head winds. Look at the MVRV (Market Value to Realized Value).
“There are ways that Corporates can add Crypto to their balance Sheets, without being exposed to the volatility of the markets — and being subject to unfavourable financial accounting rules. They can do this, while observing and learning about the space enough to partake in the upside when the financial headwinds resolve themselves.”
Opeoluwa Dapo-Thomas, an international financial analyst also shared his thoughts on whether or not institutions should hold digital assets on their balance sheet. He stated, “Well the debate on institutional investments in cryptocurrencies is one that is saddled with risk. The risk appetite of the company determines if cryptocurrency is worth investing in. For example, Tim Cook, the CEO of Apple last year said he was not looking to expose Apple’s business to crypto offerings despite personally having a portfolio exposed to Cryptocurrency.
“What this illustrates is – the risk is still very out there with crypto and you cannot justify to your shareholders why you invested in cryptocurrency. You would argue there are use-cases that would improve an institution’s business model if it invested in cryptocurrency but the jury is still out there. KPMG just released a report signaling an increase in blockchain and cryptocurrency investments so there’s more adoption.
“But there’s more to wider adoption, Institutions should also evaluate the costs, the risk-reward ratio, their respective cash flow before taking this decision as it would essentially estimate the threshold a company can apply towards digital assets. Remember the essence of investment management is managing risks before managing returns.”
With so much weight of impairment charge on the financials of institutions who are heavily invested in cryptocurrencies like MicroStrategy, it begs the question as to whether or not institutions should have a big investment in digital assets.