CFOs need to start thinking about digital currencies

It is hard to go more than a few minutes without reading an article on the current state of Cryptocurrencies. Business icons like Bill Gates and Jamie Diamond have publicly dismissed them as “based on greater fool theory” and “worthless” respectively, while Twitter founder, Jack Dorsey, just announced he will use Bitcoin to build a new, decentralized web platform (DWP). (source) 

When cryptocurrencies first emerged, CFOs, regulators, and accounting standards boards asked relatively few questions. However, as the number of cryptocurrencies increased and their valuations sky-rocketed, associated issues were put into sharp contrast. Regardless of where the crypto market stands in the court of public opinion on any given day, CFOs and finance leaders must begin to look at how they engage with this new asset class in a way that supports business growth and agility. A March article from Gartner noted, “CFOs must be ready to add cryptocurrencies to their balance sheet and asset strategy as crypto becomes more efficient and trusted.” (source) If CFOs ignore this for too long, they risk being left behind by competitors at best or exposed to unmanaged risks at worst.  At the same time, regulators are beginning to righten the definitions and accounting standards (source).

Defining digital currencies 

For hundreds of years, when someone referred to currency they likely meant either commodity currency or fiat currency. Commodity currency, a gold coin for example, has intrinsic value as well as purchasing power. Fiat currency is not backed by any commodity such as gold or silver but holds value because individuals agree on its implicit value and trust that it will be accepted by merchants and other people. Today’s fiat currencies – the US Dollar, Euro, and Pound Sterling, for example - are backed by central banks. 

The term digital currency is an umbrella term representing different types of currencies that only exist in electronic form. Transactions involving digital currencies are made using digital platforms or electronic wallets connected to the internet or designated networks. Digital currencies can be centralized or decentralized. Generally speaking, there are three types of digital currencies: 

Cryptocurrencies 

Cryptocurrencies, like Bitcoin and Ethereum, are digital currencies that use cryptography to secure and verify transactions in a network. Depending on the jurisdiction, cryptocurrencies may or may not be regulated. Stablecoins are cryptocurrencies for which the value is pegged, or tied, to that of another currency, commodity, or financial instrument. Stablecoins aim to provide an alternative to the high volatility of the most popular cryptocurrencies. 

Virtual Currencies 

Virtual currencies are unregulated digital currencies controlled by developers or a founding organization consisting of various stakeholders involved in the process. Virtual currencies can also be algorithmically controlled by a defined network protocol. An example of a virtual currency is a gaming network token whose economics is defined and controlled by developers. 

Central Bank Digital Currencies 

Central bank digital currencies (CBDCs) are regulated digital currencies issued by the central bank of a country. A CBDC can be a supplement or a replacement to traditional fiat currency. Unlike fiat currency, which exists in both physical and digital form, a CBDC exists purely in digital form. Central Banks around the world are developing digital versions of their national currencies, backed by government commitment, promising to bring many of the advantages of crypto but with the reassurance of low volatility. (source) 

The business complexity of cryptocurrencies  

At Aptitude, we look at business complexity and opportunity across three areas: compliance, finance digitalization, and subscription & revenue management. Each of these three lenses bring a different perspective to the challenges of crypto in business. 

Compliance 

The market will always move faster than the regulators, but that won’t last forever. Regulators and auditors are beginning to think about capital restrictions, liquidity requirements, fraud prevention, accounting, and reporting for cryptocurrencies. Right now, there is not a universally consistent standard for crypto and this could introduce significant complexities for organizations - and their auditors - operating in multiple regions. As regulators coalesce around common standards, companies will need to implement data models, accounting technologies, and compliance solutions to meet regulatory requirements.  

Of course, one of the big advantages of cryptocurrencies should be that blockchain technology makes it easy to audit. While this is certainly true, there will be a learning curve for auditors and companies alike as they tackle the complexities of a completely new asset class. Henri Arslanian, PwC’s global crypto leader, summarized the important role auditors have to play in the advancement of the cryptocurrency ecosystem, saying: “Although Bitcoin was designed with a trustless ideology, the reality is that the industry still requires trusted entities to catalyze the development of the ecosystem.” (source) CFOs should be working closely with auditors to understand and plan for future cryptocurrency regulations. 

Finance Digitalization 

At its core, cryptocurrencies are just another asset class that will require the finance function to determine how to account, report and disclose them. The challenges will be different for organizations that accept cryptocurrencies as payments or clearing vehicles versus those that only hold them on their balance sheet in the form of assets or liabilities. Regardless, CFOs need to be thinking about the inherent accounting complexities and their risk on the balance sheet in addition to the impact crypto will have on systems and reporting. And while blockchain technology will likely help address some of the complexities in certain areas - around intercompany transactions for example – it will likely add challenges around areas like cost allocations and financial planning. 

The inherent risk of crypto (as a volatile asset class) will require a standard approach for banks to ensure they hold enough capital to protect themselves as determined by the standard risk management approaches dictated by prudential regulators. Non-financial services institutions will also need to ensure they have carefully understood the risk of crypto to their balance sheet. At the other end of the complexity spectrum, one of the idiosyncrasies of crypto is that data models and systems will need to be able to account for more than ten decimal places as any approach to rounding can rapidly misstate the holding. All of this is a great leap for a Finance department.  

Subscription & Revenue Management 

Subscription business models have exploded in recent years. As the use of digital currencies as payment methods increases, businesses will need to look at how they are going to meet the variety of customer payment desires – include cryptocurrencies. This is more complex than just adding a new payment type due to the fundamental nature of cryptocurrencies. Cryptocurrency transactions occur when a user sends a message to ledger managers to transfer a payment to another user. Each time a transaction occurs, the ledger database is updated, so that everyone can see it, and the transaction is completed. Therefore, to trigger a recurring payment initiated by the payee, organizations must use a wallet platform that can set up smart contracts to regulate recurring billing which introduces additional steps and complexity like new smart contracts required with every price change. 

On the revenue side, making a payment in digital assets triggers gain or loss recognition. On the financial accounting side, receipt of virtual currency from a customer falls under revenue recognition rules for digital assets. The use of cryptocurrency as payment for company expenses has two components—the sale of the currency and the receipt of a good or service for a noncash consideration. On the financial statements, the related revenue accounting policies must be addressed. (source) 

CFOs need to start thinking about digital currencies 

The above areas are just a primer on some of the considerations CFOs and their teams need to consider as digital currencies – specifically cryptocurrencies – become more widespread and the financial and regulatory response to its use takes shape.  

Current surveys show that the likelihood that most CFOs will need to create a strategy to incorporate them into their organizations in some way is high. In a February 2021 survey 84% of finance leaders said they would never hold bitcoin as a corporate assets. Just over 9 months later, in early 2022, half of CFOs planned to assess it for business use this year. Additionally, 2022 research from blockchain data platform Chainalysis, showed cryptocurrency usage is growing faster than ever before, with total transaction volume reaching $15.8 trillion in 2021, up 567% from 2020. There are now around 300 million people holding crypto world-wide, with 75% of users saying they would like to use cryptocurrency to pay for goods and services.  

CFOs and their boards need to start talking about the potential areas of competitive value and the infrastructure the organization will need to support it.