Bitcoin 101: A Brief Introduction for Accountants

Introduction

Over time cryptocurrencies have become more mainstream, and their importance to the accounting profession has continued to grow.

For accountants, understanding concepts relating to bitcoin and digital currency has become more important, given its likelihood to come up in conversations with clients, colleagues, and organizational leaders.

What is Bitcoin?

Bitcoin, invented by an anonymous person (or group) known as Satoshi Nakamoto, is a decentralized digital asset. Unlike traditional currencies issued by governments (fiat currencies), Bitcoin operates on a technology called blockchain—a distributed public ledger enabling transparency and immutability (un-alterability) of transactions.

The essence of Bitcoin lies in its decentralization, which means that no single entity or group controls it.

Why was Bitcoin Invented?

The Bitcoin whitepaper was published on October 31, 2008, following Lehman Brothers filing bankruptcy and Congress passing a $700B program to stabilize the economic system. The crisis exposed the vulnerabilities of the traditional banking system, leading to a loss of faith in financial institutions.

Bitcoin was presented as an alternative to existing financial systems, “a new electronic cash system that's fully peer-to-peer, with no trusted third party.” Importantly, Bitcoin operates without a central bank.

How does Bitcoin work?

Although Bitcoin’s invention coincided with the publication of the whitepaper in 2008, the work leading to its invention evolved over decades. Important foundational work included the invention of a certain type of cryptography in the seventies, digital cash inventions in the eighties, and inventions involving digital gold, smart contracts, and proof-of-work systems in the nineties.

Concepts from these inventions and others were brought together to make Bitcoin possible, so deeply understanding how Bitcoin functions can be challenging. To make matters worse, “Bitcoin” can be a tricky term because it refers to four different things: a network of computers, a software, a set of rules (protocol), and an asset.

Superficially, a Bitcoin transaction involves the transfer of a digital asset between metaphorical wallets. Authorizing transactions with Bitcoin wallets requires a private key, a secret piece of data used to sign transactions, providing mathematical proof they have come from the owner of the wallet. Once signed, a transaction is broadcasted to the Bitcoin network, with the transaction details recorded on the public ledger of the blockchain.

Why Should Accountants Care?

The rise of individuals purchasing Bitcoin as an investment and businesses accepting Bitcoin as payment or holding it on their balance sheets necessitates accountants understanding basic concepts relating to Bitcoin and cryptocurrencies. Publicly-traded companies that hold Bitcoin on their balance sheet include MicroStrategy, Tesla, Block, and Coinbase.

Bitcoin introduces uncommon processes and ideas into accounting activities. Additionally, given that market price quotations for Bitcoin can fluctuate significantly within short periods, recording and valuing transactions can require a thoughtful approach.

Accounting Issues

Accounting for Bitcoin on financial statements presents challenges. Barring industry-specific guidance, companies are required to account for Bitcoin as an indefinite-lived intangible asset, recorded at historic cost, subject to impairment analysis.

In October 2022, FASB decided that Bitcoin should be presented on the balance sheet at fair value. The exposure draft was published in March 2023, and comments are due in June 2023. Comprehensive accounting and auditing issues are addressed in the AICPA’s practice aid for accounting for and auditing digital assets.

Bitcoin transactions also carry tax implications. As property, the sale or exchange of Bitcoin is a taxable event, subject to recognition of capital gains and losses. Helpful IRS publications include virtual currency guidance published in 2014 and the subsequent frequently asked questions on virtual currency transactions.

Conclusion

In an increasingly digital world, understanding Bitcoin is becoming more important for modern accountants.

As adoption grows, accountants can stay informed about the implications of digital currencies like Bitcoin. Embracing this knowledge can help accountants continue to serve as trusted advisors to clients in an evolving financial landscape.

I write weekly about advisers innovating with technology.

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