Before we had paper money, developed countries like the U.S., Canada, Japan, etc. used commodity money; finite goods with intrinsic value like gold, salt, and cocoa beans, as mediums of exchange.
Even today, developing countries use commodity money as currency.
In 2005, a brewery in Cameroon promoted the sale of their beer by placing prizes under bottle caps. Winners could walk away with prizes ranging from a free bottle of beer to luxury cars. And because winning bottle caps were valued as much as $1 each, bottle caps were being used as a form of currency in place of money.
So what makes currency money?
Money doesn’t need to have intrinsic value to be considered valuable; it only needs to facilitate exchange.
What is cryptocurrency?
Cryptocurrency (Bitcoin, Litecoin, Ripple, etc.) is an electronic medium of exchange which typically utilizes blockchain technology. Cryptocurrency is not a “fiat currency,” meaning that unlike paper money issued by developed governments, cryptocurrency hasn’t been declared a legal tender.
How does cryptocurrency affect accounting?
When trying to account for cryptocurrency, one of the biggest issues is trying to recognize the true value of the asset. Accountants try hard to portray a company’s assets and liabilities as accurately and truthfully as possible, but when an asset’s inherent value fluctuates wildly and is not backed by something more concrete, such as a physical asset, it becomes difficult to definitively say “one unit of this cryptocurrency is worth X.”
However, because cryptocurrencies are still a medium of exchange, the accounting treatment of an asset remains fairly constant over time.
Downsides of cryptocurrency
In 2009, North Korea informed citizens that the won (its national currency) would be redenominated. Not only was their currency changing, almost overnight, but citizens were only allowed to exchange a limited amount of old currency, rendering many people’s life savings worthless.
Government-issued currencies have an inherent protection of the value by the backing organization’s credit (in the case of the U.S. dollar, the Federal government guarantees the value). Unfortunately, without being a government-backed coin, cryptocurrency has the potential of being just as volatile. Volatility typically arises from the fact that there is no underlying asset from which the cryptocurrency derives its value.
How businesses can leverage cryptocurrency
There are plenty of risk-averse companies performing services in exchange for cryptocurrency or similar related obligations (i.e. call options, warrants, etc). This obviously depends on your risk appetite and ability to withstand a negative outcome from the investment.
Depending on the cash needs of the business and the speculative volatility of the cryptocurrency, it may be an alternative means of fundraising, even if supplemental to the typical means of currency such as bank loans, angel investors, or private equity.
Another option is to undertake what is called an Initial Coin Offering, or ICO. This is similar to an IPO (Initial Public Offering) whereby a company has a set amount of cryptocurrency coins they sell to the public in order to raise capital. Although the concept is still relatively new and the regulatory bodies are grappling with how to treat ICOs, popularity will increase over time particularly because they aren’t usually tied to specific assets. Instead, they are akin to corporate paper in that they are backed only by the reputation of the issuing entity but are not a debt instrument.
Cryptocurrency has the potential to make a lot of money from fluctuations. Accountants should know how to help their clients understand the tax ramifications of electronic money or how it can affect reporting. If your business needs assistance with reporting, accepting cryptocurrency for payment, or leveraging cryptocurrency, contact us today.