Insights on the fair market valuation of crypto assets

Bitcoin is the new black.

More and more companies (Tesla, MicroStrategy, PayPal…) and funds (Fidelity, Tobam or Wisdom Tree for instance) purchase or use cryptocurrencies as a new way to diversify their cash flow (1) or investments portfolio, build financial products like ETFs, or simply offer an alternative payment method to their customers. Beyond their own purposes, these big players have one thing in common: they need to know the bitcoin price — its value. This value is essential, but not only for them. It is also for their accountant who needs a reference to determine the net asset value (NAV) of a fund or the estimated worth of a company’s assets and liabilities that are listed on its balance sheet.

However, we assume finding a perfect consensus in the determination of the value of this new asset class can be tough. The mainstream response used for a standard financial and non-financial asset is using a well-known accounting methodology that supposes to seek its “fair value”. But can this methodology be easily used for cryptocurrencies? In other words, can their particularity be a pain point for the application of accounting standards not initially designed for them?

The fair value concept is defined by accounting rules corpora. Under the IFRS 13 “Fair Value Measurement” — we chose the most widespread here –, the International Accounting Standards Board simply defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date”. This measurement requires to determine the following components:

*The asset (or liability) with its unit of account. This seems pretty logical, indeed… But determining the measured crypto asset can be hard sometimes. Especially when a fork of the blockchain on which the asset is registered and transferred occurs, it can happen that the exchange platform where the entity purchased its asset can list a token that doesn’t belong to the main chain but to the derivative one.

*Whether the entity is a normal market participant under the IFRS definition. For this, the entity must ensure its independence from the asset price determination and the other market participants, that it can conclude a transaction, and other criteria…

*The “principal” (or “most advantageous”) market, on which the transaction occurs.

*The most appropriate valuation technique by which the aggregation of level 1 observable inputs (“quoted prices in active markets” according to the fair value hierarchy (2)) is possible and sufficient to measure the fair value of the asset with the best representativeness. IFRS 13 distinguishes three approaches of valuation: the market approach, the income approach, and the cost approach. Proceeding by elimination, we think the market approach is the most suited to the fair value measurement of crypto assets. Indeed, the costs approach would logically take into account the mining or staking costs of a cryptocurrency; this case does not concern an entity that only had purchased crypto on an OTC or exchanges platform, nor seems to fit the definition of “quoted price” according to the hierarchy of inputs. Furthermore, we think the income approach is much too uncertain facing the current volatility of the crypto markets. Finally, the market approach seems to be appropriate, as it suggests observing day-to-day quoted prices on platforms where the asset is traded.

To conclude: the fair market value of a crypto asset would be the price to sell a crypto or paid to transfer a liability in an orderly transaction between market participants at the measurement date and which would be determined by current quoted prices observable on a spot exchanges platform that handle crypto trading.

IFRS and other accounting standards first requires determining if there’s an “active market” for the asset at the measurement date. An active market is “a market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis”. To determine whether an active market exists for the measured asset, the entity must verify if level 1 inputs are available on this market and give them priority in that case. Several studies published by audit firms and associations (like PwC, Deloitte, AICPA, EFRAG…) (3) considers when the crypto asset quoted price published by the exchanges platform is the expression of its direct conversion into legal tenders (or “fiat money”), the transaction data related to this trading pair should be considered as level 1 inputs. The main reason is that a crypto-to-crypto trade then requires to convert the quote into fiat. More precisely, this quote may include transaction costs due to conversion and can highly fluctuate between the conversion date and the measurement date due to market volatility. The result is this conversion can misrepresent the price valuation of the quote.

When the active market is finally defined, IFRS suggests this active market is the principal market on which the asset’s fair value can be measured. But here’s the pain. Bitcoin and most other cryptocurrencies (altcoins) are traded on a plurality of exchanges platforms, so it seems tricky to determine a principal market. Even if a market on which the asset is traded has “the greatest volume and level of activity for the asset or liability”, the activity of this platform might not represent the fairest value of the crypto asset due to the atomicity of the crypto market in general. In that case, IFRS 13 invites the entity to choose the “most advantageous market” “that maximises the amount that would be received to sell the asset or minimises the amount that would be paid to transfer the liability, after taking into account transaction costs and transport costs”. Studies we mentioned above encourage this method and invite the entity to choose the most advantageous platform to measure the fair market value of an asset.

We think the issue would be the same: due to the atomic nature of the crypto market, we assume the crypto asset’s fair value calculation would be perfectly representative only if this calculation lies on an aggregation of the transaction data publicly delivered by the most significant exchanges platforms’ API. It seems inappropriate to resume the market and economic value of a crypto asset with the supply and demand expressed on one and only one platform. But it’s understandable: IFRS 13 prohibit the use of a weighted-average price for the fair value measurement, and an aggregation of multiple spot prices will surely be interpreted as it. However, this “economic representativeness” is a requirement of the EU 2016/1011 “Benchmark” regulation in the determination of reference rates used by funds and portfolio managers. Does that mean that a crypto reference rate like “BTC-USD” cannot be used for funds for their NAV calculation? Or that each crypto index should be calculated from a specific exchange platform data feed? Or should IFRS 13 be amended and accept weighted-median prices (which can exclude extreme values from the calculation)? Frictions between “BMR” and “IFRS” requirements may occur in a near future.

Unlike the audit firms’ point of view, we wonder if the most appropriate approach shall consist in considering the principal or most advantageous market not in the “platform” scale, but in the “trading pair” scale. In this hypothesis, the “BTC-USD” or “BTC-EUR” market could be the principal or the most advantageous market at the measurement date. On the one hand, it would be easier to take the particular nature of crypto assets market into consideration and reach a more exhaustive measurement of the asset’s fair value. On the other hand, does this mean that an exchanges platform which does not publish a quoted price of the crypto in the required trading pair should not be taken into account? Or should we reconsider the level 1 inputs definition and integrate crypto-to-crypto trading pairs? Last but not least, we assume this approach can fit with centralized exchanges analysis, but what about tokens only listed on DEXs (decentralized exchanges)?

This is a tricky point, that might need to be overcome and clarified. While we are all waiting for the EFRAG work results (4), what are your thoughts about this approach?

We would be pleased to share insights with you! You can leave a comment or chat with us on Twitter or Reddit!

(2) IFRS 13 categorizes inputs used for fair value measurement within three levels: “level 1 inputs” refers to non-adjusted quoted prices in active markets for identical assets or liabilities that an entity can access at a measurement date; “level 2 inputs” refers to other inputs than quoted prices according to level 1 definition and that are directly or indirectly observable; finally, “level 3” refers to unobservable inputs for the asset or liability.

(3) PwC, “Cryptographic assets and related transactions: accounting considerations under IFRS”, 2019; AICPA, “Accounting for and auditing of digital assets”, 2020; EY, “Applying IFRS — Accounting by holders of cryptoassets”, 2019; EFRAG, “Accounting for crypto-assets (liabilities): holder and issuer perspective”, Discussion Paper, 2020.

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