How to manage Crypto Accounting: Selecting Software – Part 2

How to Manage Accounting Crypto?

Here is the second part of our ultimate guide to crypto accounting for businesses. Last time, we introduced the topic and discussed the reasons why businesses should (or shouldn’t) use crypto. Now, it’s time to explain the intricacies of managing crypto accounting, including the best crypto accounting software.

So, let’s say your company is thinking of opening the doors for crypto assets. The next question is: how to document cryptocurrency transactions for accounting?

Treating digital assets in your account books is possible, just like with any other type of asset. However, in certain aspects, crypto is special. Let’s go a bit deeper into it.

To begin with, businesses usually record trading in crypto just like they record stock trading. When you spend fiat currency to buy crypto, you will credit your cash account and debit the crypto account.

Also, if impairments occur, you will account for this by debiting the loss account and crediting the asset account. 

In case you wish to eliminate your investment in crypto, you will credit the asset account at its book value, and debit the account that represents the consideration received in exchange for trading your digital asset away.

If crypto is traded for fiat, the cash account will be debited. On the other hand, if one digital asset is traded for another digital asset, the crypto account is the one being debited.

Adding Crypto to the Account Books: Two Approaches

There is one thing that should be made clear from the very beginning. There are many business owners who accept crypto payments, which is one thing. Holding crypto on a balance sheet, on the other hand, is a completely different thing.

The difference between these options is important, and choosing between the two should be a careful decision. Such a decision should be made in consistency with your business objectives, resources, drawbacks, risks, etc.

Now, let’s carefully elaborate on the two paths your business can take when it comes to accepting crypto.

1) “Hands-Off” Approach: Enabling Payments

Enabling payments is something like a light version of using crypto. A hands-off approach means that you will simply allow your customers to buy your products or services using digital currencies, i.e. bitcoin. Your payment processor will merely convert the crypto from your customer’s account to fiat currency. That means your account actually won’t get in touch with crypto, and will only receive fiat. 

In a way, this is a win-win combination if you would like to attract customers willing to spend crypto while saving yourself the trouble of complicated crypto accounting. Also, adopting a hands-off approach won’t require many adjustments in terms of corporate functions and risk management. It is the easiest and fastest way to get involved if your company is new to crypto.

This kind of approach is particularly convenient for companies that rely on agents and third-party vendors.

Third-Party Vendors

Third-party vendors help a company make the sales and they manage a great deal of risk. However, remember that third-party vendors can’t really manage all risks. Even though they resolve many technical questions and ensure compliance, it is not always their job to make sure your business is compliant with anti-money laundering laws and KYC requirements.

In case you employ third-party vendors, their activities should be controlled so that they comply with any regulation imposed by the governmental economic and trade institutions.

Therefore, if your company is working with third-party vendors, make sure to think through the following: how does accepting crypto payments affect their position? Do they have efficient internal controls, such as cybersecurity, that are particularly important for processing crypto payments? Preferably, vendors should be able to provide some assurance about the ability to follow the introduction of crypto. For example, they should be able to provide a SOC1 or SOC2 report.

Also, another issue to keep in mind when it comes to third-party vendors is the connection between the innate volatility of crypto assets and your vendors’ conversion pricing.

Additionally, if you’re running an international business, keep in mind that international licensing and regulation of crypto transactions are constantly changing. In such a context, you should be clear on how will your agents guarantee appropriate licensing and compliances across the national jurisdictions.

2) “Hands-On” Approach

Once a company is ready to incorporate crypto more deeply into its financial system, it will adopt a hands-on approach. While major changes in operations and treasury functions might be required, the company will be able to enjoy many additional benefits.

In the case of a hands-on approach, the corporate treasury is the major player that carries out the task of incorporating crypto into the company’s financial operation. It is the treasury that maintains the company’s financial relationships with investment partners, capital providers, and banking groups. Additionally, the treasury is the one determining which types of financial services a company needs, considering the broader DeFi context.

Usually, before embarking on this journey, the treasury has to prepare the company for integrating this entirely new financial dimension. 

First of all, the company needs to define the goals as precisely as possible. What should be achieved by adopting an entirely new asset class? 

Furthermore, the treasury should be clear on what is necessary to efficiently and effectively process, monitor, and manage payments in digital money. That means, your company should make sure that the staff fully understands the way crypto works, with all of its benefits and risks.

If not, your company should consider outsourcing the custody of the crypto to a third party.

Finally, as the likelihood of national central banks issuing digital currencies is growing, your treasury should be prepared for such an opportunity.

Deep Crypto Integration: Key Aspects

Here are several major aspects of deep crypto integration your company should pay close attention to. 

• Crypto Wallets

There is no way to process crypto without crypto wallets. They are necessary in order to hold and manage crypto. 

Every company needs to choose a wallet structure that suits its needs and business model. 

In general, there are two major types of crypto wallets: “cold” and “hot” wallets.

Cold wallets refer to accounts that store value, while hot wallets perform as operational accounts. Also, cold wallets are better for long term storage. On the other hand, hot wallets are used for current operations. They are able to record essential data, and facilitate forecasting, rapid payments, and more transparent transfers and investments. Thus, hot wallets are of indispensable value to the treasury department.

Being able to track the details of transactions is essential for businesses and global companies with high volumes of transactions. By tracking, businesses usually take the following into account: 

• Date and time of crypto acquisition
• Value
• Assigning of basis
• Etc.

In order to tackle the issue of volatility, companies often convert crypto assets to stablecoins. Once a cryptocurrency (i.e. bitcoin) is converted into USDC (USD Coin), it becomes much easier to process this digital asset. Except as a life hack for fighting the volatility issue, conversion to stablecoins is especially valuable because it makes the transactions much easier for traditional banks and the treasury. 

• Anti-Money Laundering Laws and Know Your Customer

The AML and KYC regulations provide a legal framework for any crypto operating business. Therefore, they have important implications for every stakeholder within a crypto ecosystem.

The main purpose of AML and KYC regulations is to make sure companies aren’t being used by criminal foreign vendors, in order to cover up the evidence of money made through illicit activities. Especially for companies working in the international milieu, this is an important issue that needs to be assessed very carefully, in order to avoid serious legal complications.

• Second-Layer Protocols

In order to record a particular transaction on a blockchain, a series of aggregate transactions need to be performed as well. These additional transactions need time to be aggregated, and during this period, the process is vulnerable and prone to malicious manipulation. 

In the corporate context, the second-layer protocol is a scaling app that sits on top of blockchain systems. They are used to speed up the recording process and reduce fees.

Second-layer protocols are promising innovations, whose benefits are currently recognized by only a handful of companies. Most likely, second-layer protocols will become much more effective in the future. Some even believe they will outrun the traditional payment systems we currently use.

Two Versions of the “Hands-On” Approach

There are two ways your company can perform a deep integration of crypto. You can either:

• Employ a third party to maintain the blockchain and provide wallet management services, or 
• Do it in-house, relying on your internal team and resources. 

The latter approach might be a more difficult one, and at the moment, most companies opt for third-parties to perform this task. In case you want your team to perform the adoption of crypto, you will need to consult your legal advisories to make sure your company has all the licenses required. On the other hand, with the in-house performed hands-on approach, the company will have greater control over the transactions.

Best Accounting Software for Crypto

We are living in an era of automation. Just like budgeting can be handed over to YNAB app or trading with crypto to CEX and DEX arbitrage bots, crypto accounting can partially be automated as well.

Accounting software for cryptocurrency is able to speed up and simplify the way your taxes are calculated and filed. Firstly, the software will keep track of crypto gains and losses. Then, it will automatically fill in the taxation documents required.

Although not omnipotent, apps can be of great help. The primary benefit of investing in such software is saving time and energy for your team, that will now be able to dedicate to something else. At the same time, the app will perform the required tasks for you, for free. 

The basic function of crypto accounting software for businesses is to allow you to integrate various exchanges and wallets, and obtaining important transaction details, such as dates, amounts, values, names, statistics, etc. On the other hand, these apps will require some information, such as: 

• Gross income for the last year
• 1099-INT forms showing interest paid
• 1099-G forms showing refunds, offsets of state, credits, and local taxes
• Receipts and other income documentation

The usual features of the best accounting software for cryptocurrency include, but are not limited to:

• IRS wizard 
• Audit assistance from a crypto accountant
• Support for various exchanges
• Integration with the exchanges and collecting data
• Calculation of crypto profits and losses
• Import and export of transaction reports
• Long-term data storage
• Filing the state returns along with the taxes
• Etc.

The following apps have proven to be among the best accounting software for cryptocurrency business so far:

1. Koinly
2. Accointing
3. Cointracking
4. ZenLedger
5. TaxBit
6. CoinTracker
7. BitcoinTaxes
8. Bear.Tax

Easiest Way to Do Accounting for Crypto

There still aren’t general accounting standards for cryptocurrencies. This is partially so because various legal systems still can’t agree on what cryptocurrencies even are, let alone how to pay taxes for them.

Still, cryptocurrencies have real value so most basic accounting principles can be applied. Digital assets received as payment from a customer are subject to regular revenue recognition rules. Still, they aren’t treated as cash, but rather as assets with a certain value.

The recorded value of the asset is determined at the moment the transaction was processed or the contract was concluded.

Although the value of crypto often changes, it is impossible to change the balance sheet by and by. In order to properly account for changes in value, crypto might require special treatment and additional accounting as an embedded derivative.

Accounting for crypto expenditures

If a company decides to use crypto for expenses, each transaction will have two important dimensions:

1. The sale of the crypto asset
2. The receipt of a good or service for a noncash consideration.

The receipt is accounted for as a non-monetary consideration, meaning that the company will need to treat the other party in the transaction as either a customer or a noncustomer. In turn, this will affect the way items are defined in the financial statement.

Keep in mind that the value of the crypto asset and the transaction prices are determined at the same moment. That moment is usually when the contract became legally enforceable.

Furthermore, if the value of a digital asset used in a transaction is different from its initial value, the realization of the value differential may come up.

Implications of using intangible assets for monetary purposes

To begin with, the specific way in which crypto assets are usually treated by the law will probably require closer collaboration among the departments. This is especially true for the treasury, accounting, and tax departments. Any realization of gain or loss caused by the use of crypto needs to be reported to the tax department.

Furthermore, the company will need to find a proper way to adapt its financial statements. Introducing crypto will require additional disclosures, which will keep a detailed record of all the crypto transactions.

In case of companies adopting the hands-on approach, these adaptations are usually more complex. It is not enough only to adjust financial statements, but to make sure they are adequate and detailed enough. If not, the company is at risk of legal complications and, potentially, a lawsuit. 

Also, using crypto will irrevocably change the company’s financial system. Cash flows, balance sheets, and operations will have to be modified so as to accommodate crypto transactions.

Finally, accepting crypto payments requires diligent and careful risk management. The impacts on the company’s financial presence and future need to be assessed and properly mitigated.

The Implementation Plan 

Before doing any accounting and implementing crypto payments, you need a thorough implementation plan. This plan should contain the overall strategy of crypto implementation and define the short-term and long-term goals. Furthermore, the plan needs to be clear on who is going to carry out the crypto innovation. Which departments will be affected and does the company have the suitable human resources to perform the implementation?

Cybersecurity is one of the most important issues to consider. Any cyber-attacks or data safety breaches can be fatal for the company’s cash flow and reputation.

Furthermore, is the company able to afford the introduction of crypto? Crypto is an exciting, but costly innovation. You will probably need to hire new employees, train the existing ones, buy new equipment, pay for the software, do regular audits, etc.

Also, a company needs an exhaustive implementation roadmap. Every step of the way needs to be elaborated in as much detail as possible. 

Finally, the company needs to be clear on KPIs and the ways the progress and the result of the innovation will be evaluated.

Since it can be a complicated and lengthy process, most companies opt for a pilot. For example, a certain amount of crypto can be purchased. Then, the treasury can redirect it into a couple of payments, just to see how the crypto is processed, received, and revalued.

That’s it for this part of our extensive guide. In Part 3, we wrap up the guide by examining the crypto mining accounting process, taxes associated with crypto accounting, as well as common accounting issues encountered by businesses working with crypto. Here, you can find Part 1.