Cryptocurrency Accounting: Why Net Income and the P / E Multiple Have Become Even More Useless

Many of the topics covered on this site are predictable.

If you had asked me in 2010 or 2015, “Do you think you’ll still be writing about private equity recruiting or investment banking interviews in 5, 10, or 15 years?” my answer would have been an easy “Yes.”

But sometimes, there are unexpected developments, such as cryptocurrency accounting.

Back when Bitcoin experienced its first bull market back in 2013, I thought it might remain a speculative asset that would interest only hardcore hodlers and autists.

That might still happen in the long term, but a few high-profile companies have now bought Bitcoin and put it on their Balance Sheets.

And that development opens up a can of worms:

• What type of “asset” is Bitcoin? A financial instrument? An intangible asset? Inventory? Should it even qualify as an asset?
• How do companies record Gains and Losses on it? What about Unrealized vs. Realized ones?
• What’s the tax treatment? How do these Gains and Losses affect a company’s Cash Taxes and Book Taxes?

I’ll cover all these points, but I need to give a short disclaimer before going down the rabbit hole:

The Warning/Disclaimer

Before diving in, I want to note that this is not a bullish or bearish article about the prices of various cryptocurrencies.

I will not recommend buying, selling, or hodling anything, and I don’t have a particularly strong view myself.

I have bought and sold Bitcoin and Ethereum before and made money doing so, but I am neither a crypto bull nor a crypto bear.

My goal here is to address some of the accounting and valuation issues that come up when companies adopt crypto.

Cryptocurrency Accounting: The Video Tutorial, Excel File, and PDFs

You can get the full video tutorial version of this article below, which focuses on the Excel walk-through:

And you can get the Excel file and PDFs for Tesla, MicroStrategy, and Galaxy Digital below:

• Cryptocurrency Accounting – Slides (PDF)
• Cryptocurrency Accounting – Excel File
• MicroStrategy – Financial Statements (PDF)
• Tesla – Financial Statements (PDF)
• Galaxy Digital – Financial Statements (PDF)

Note that the Excel file here is simplified and not robust.

It’s a simple illustration of a basic scenario: purchasing Bitcoin in Year 1, holding it in Year 2, and then selling it in Year 3.

Do not expect very complex changes or scenarios to work correctly.

MicroStrategy and Tesla: Cryptocurrency Accounting on the Financial Statements

As I write this in 2021, Tesla and MicroStrategy – the highest-profile corporate adopters of cryptocurrency so far – both consider Bitcoin an indefinite-lived intangible asset.

They list it on their Balance Sheets as a “Digital Asset,” and since it’s indefinite-lived, there is no amortization.

Under U.S. GAAP, companies record Impairment Losses on indefinite-lived intangible assets when their value falls, but they cannot revalue them up outside of M&A deals.

Under IFRS, upward revaluation is allowed, but I could not find solid examples of IFRS-based companies using crypto (???).

In practice, this means the following on the financial statements:

• Unrealized Gains: These do not appear anywhere on the financial statements. If Tesla buys BTC for $50K, and the price rises to $100K, nothing changes.
• Unrealized Losses: These appear as “Impairment Losses on Digital Assets.” If Tesla buys BTC for $50K, and the price falls to $25K, you’ll see a huge Impairment Loss on the Income Statement and a reversal for it on the Cash Flow Statement.
• Realized Gains and Losses: These always appear on the Income Statement, get reversed on the Cash Flow Statement, and get “re-classified” under Cash Flow from Investing in the “Proceeds from Sale of Digital Assets” line.

Additionally, there will be a Deferred Tax impact from many of these events because Unrealized Losses are not immediately deductible for Cash-Tax purposes.

For example, if MicroStrategy records a $100 million Impairment Loss on Bitcoin, yes, the Tax figure on its Income Statement will decrease by $100 million * ~25% = $25 million.

However, the company cannot deduct this Impairment Loss until it sells the Bitcoin and takes a Realized Loss on the sale.

So, you will see negative adjustments in the Deferred Tax line on the CFS whenever this happens:

Excel Examples with Crypto as an “Intangible Asset”

If you want some interactive examples, refer to the Excel file linked to above.

In this simple scenario, we assume that the company purchases 1,500 Bitcoin for $60K in Year 1, holds it in Year 2 as the price drops to $45K, and then sells it in Year 3 when the price increases to $100K.

The Income Statement looks like this:

On the Balance Sheet, the “Digital Assets” line:

• Increases to $90 million when the purchase takes place in Year 1.
• Falls to $68 million due to the Impairment Loss in Year 2.
• And finally decreases to $0 in Year 3 when the company sells all 1,500 BTC.

If we assume that BTC falls to $30K in Year 3, and the company sells all its holdings in that year:

Since the price falls by $15K per year, the Impairment Loss in Year 2 is identical to the Realized Loss in Year 3.

The Impairment Loss is not deductible in Year 2 because the company has not yet sold the corresponding asset.

But it becomes deductible in Year 3 once the company sells the 1,500 BTC, so the company gets the cash-tax benefit of both the Impairment Loss and the Realized Loss in that year.

And on the Balance Sheet, the Deferred Tax Asset initially increases in Year 2 because of the Impairment Loss and decreases in Year 3 when all the BTC are sold.

You could play around with this file and test many other combinations, such as what happens when the price falls and the company sells half its Bitcoin in Year 3:

Is This Accounting Treatment Appropriate?

If you’re wondering why Bitcoin is classified as an “intangible asset” rather than a financial instrument or security, BDO provides an answer:

“Intangible assets under U.S. GAAP are “assets (not including financial assets) that lack physical substance.” Further, financial assets are cash, evidence of an ownership interest in an entity, or a contract that conveys to one entity a right to receive cash or another financial instrument, or a right to exchange other financial instruments on potentially favorable terms.”

Since crypto is not cash, does not represent an ownership interest in an entity, and does not provide a right to receive cash or another financial instrument, it’s not a “financial asset.”

From an accounting perspective, this logic makes sense.

However, for valuation purposes, this classification may distort the numbers.

The problem is that intangible assets are normally “core business assets” when calculating Enterprise Value because they refer to items like patents, trademarks, and other intellectual property that the company uses to generate revenue.

So, labeling Bitcoin an “intangible asset” implies that it’s related to the core business operations of these companies.

But it’s a big stretch to call Tesla or MicroStrategy “crypto companies.”

Tesla is a car company that only makes money from selling regulatory credits accepts Bitcoin for some purchases, and MicroStrategy is an enterprise software company.

Therefore, it’s more appropriate to consider these Digital Assets non-core when calculating Enterprise Value, similar to the treatment for cash and financial investments.

This classification as an intangible asset also creates consistency issues because companies record Unrealized Losses but not Unrealized Gains.

That skews their results to the downside and makes Net Income an even more deceptive metric.

Either of these options would make more sense:

• Option #1: Record ALL Gains and Losses, including both Unrealized and Realized.
• Option #2: Record ONLY Realized Gains and Losses.

Cryptocurrency Accounting for a Financial Firm (Galaxy Digital)

Galaxy Digital is a financial services firm that offers “asset management for digital assets.”

It trades, invests, and mines for cryptocurrencies, and it offers traditional asset management and investment banking services as well.

Galaxy Digital considers crypto to be investments or financial assets, so it records Realized Gains and Losses and Unrealized Gains and Losses on its Income Statement:

The accounting rules differ for financial services firms such as banks and bank holding companies, but in context, this treatment is more consistent than what Tesla and MicroStrategy are doing.

The only quirk is that there’s no Deferred Tax impact because Galaxy Digital is a Limited Partnership.

Since there are no corporate-level taxes (all profits flow through to the individual Partners), there are no taxes to defer or pay in future periods.

So… What Does All This Mean? How Does Cryptocurrency Accounting Affect Valuation?

Net Income was never a great valuation metric because it’s easily distorted by a company’s capital structure, tax quirks, and non-recurring charges.

As a result, the P / E multiple, equal to Equity Value / Net Income, is also not that useful for comparing companies.

Yes, it’s quick and simple, but its advantages stop there (for more, see our comparison of EBIT vs. EBITDA vs. Net Income).

The adoption of cryptocurrencies by major companies means that Net Income and the corresponding P / E multiple will become even more useless.

Even if these companies start treating crypto as financial assets rather than intangible assets, Net Income will be skewed because of all the Unrealized Gains.

Warren Buffett even pointed out this issue when the accounting rules for Unrealized Gains and Losses on small investments in equity securities changed a few years ago:

Enterprise Value-based metrics such as EBITDA will become even more important because they exclude all Gains and Losses.

In the standard DCF model, little changes because Gains and Losses should never be a part of Unlevered Free Cash Flow.

But you need to be careful in the “bridge” to calculate Implied Equity Value at the end.

Unless the company’s primary business is crypto-related, Digital Assets should be considered non-core (i.e., added when moving from Enterprise Value to Equity Value).

The silver lining here is that crypto is still far from mainstream, and only a few high-profile companies seem to be using it.

So, these cryptocurrency accounting issues may not be relevant until a solid percentage of the S&P 500 is involved.

Of course, that probably won’t happen until DogeCoin and CumRocket both hit $100 trillion market caps, so we could be waiting a while…

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