Stablecoins are increasingly being used by businesses as a means of settlement, treasury management and participation in digital markets. However, their accounting treatment under UK GAAP is not straightforward. FRS 102 does not explicitly address digital assets, and stablecoins can exhibit characteristics of more than one accounting category depending on their design and use. This article explores the key accounting considerations for holders of stablecoins under FRS 102, highlighting areas where judgement is required and where practice may continue to evolve as both the market and regulatory landscape develop.
Introduction and Objective
Before we begin please note this article is intended to help preparers and practitioners navigate the challenges of accounting classification of stablecoins under FRS 102, and is not intended for IFRS preparers. While we explore the challenges, this is in no way authoritative guidance and does not replace the need for entities to exercise judgement based on their own facts and circumstances.
Stablecoins are a new and evolving asset class. While they often share common features, it would be a mistake to treat them as a single group for accounting purposes. Any analysis must consider the specific facts and circumstances, both of the stablecoin itself and of the holder. Accordingly, conclusions reached for one type of stablecoin may not be appropriate for others, and this help sheet does not seek to prescribe a single accounting outcome.
Common features of stablecoins include:
- A digital asset represented on a blockchain network designed to maintain a one-to-one value peg with a reference asset, such as fiat currency.
- Often backed by a reserve of highly liquid, low risk financial assets (for example, cash, short term deposits, government issued bonds and some high-quality corporate bonds) with a value that is intended to meet or exceed the redemption value of the stablecoins in circulation. Note that this is not always the case: depending on the regulatory regime, stablecoin issuers may have discretion over the composition of the backing assets and whether a one-to-one value peg is required and the way in which this is achieved.
- Contractual terms between the holder and issuer which, in the case of fiat-backed stablecoins, enable the holder to redeem some or all of the reference fiat currency on demand. In some cases, this is dependent on whether the holder has a direct contractual relationship with the Issuer and/or whether they can meet minimum redemption thresholds.
- The features and restrictions of stablecoins will varying according to local regulatory requirements. For example, these could include the nature and timeliness of redemption rights, whether issued coins are restricted to wholesale or retail transactions, restrictions to certain holders i.e. individuals or businesses’ use of private and or public blockchains, whether they are permissionless, whether independent third party custodians are mandatory for backing assets, and requirements around valid redemption requests (often subject to Know Your Customer and Anti Money Laundering Checks).
- Transferable on a secondary market via exchanges based on a mark-to-market valuation and on a peer to peer basis.
- Stored within digital wallets either directly by the holder or by third-party custodians.
- Generally, stablecoins do not offer holders rights to interest income.
Please note:
This article explores the accounting for holdings of stablecoins that represent a recognised asset for the reporting entity. Therefore, before considering the guidance set out below, holders are expected to first determine whether their stablecoin holdings represent an asset. This assessment may require significant judgement and is fundamental to subsequent classification and measurement conclusions, especially in the case of arrangements that involve third party custodians or wallet providers that might have access to the asset’s private keys.
This is still an emerging area and practice will no doubt evolve over time. The potential accounting consequences of stablecoins acquired as a part of a business combination are not covered in this help sheet.
Anyone holding, or working with clients that hold stablecoins, should ensure they have sufficient knowledge and experience to carefully articulate any choices in the accounting policies to the financial statements and any judgements made in the disclosure notes to the financial statements.
Considering the options for accounting for direct holders of stablecoins
A holder of stablecoins needs to determine whether the stablecoin meets the definition of a financial asset (which is a subset of financial instruments), or of a non-financial asset such as inventory or an intangible asset.
Financial instruments
A financial instrument is defined as:
“A contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.” (Appendix I: Glossary to FRS 102).
The definition of a financial asset is, in part:
"Any asset that is: (a) cash; (b) an equity instrument of another entity; (c) a contractual right: (i) to receive cash or another financial asset from another entity …" (Appendix I: Glossary to FRS 102).
To meet this definition, the arrangement:
- must be contractual, meaning that it must be based on a legally binding agreement between two or more clearly defined parties that gives rise to obligations enforceable by law, and
- must establish a right to receive either cash or another financial asset.
This would exclude non-contractual rights, such as those arising from statutory obligations or constructive arrangements.
In the context of a stablecoin, it is therefore important to assess whether the stablecoin’s terms and conditions give the holder the contractual right to redeem the asset for a specified amount of reference fiat currency from the issuer. It is also important to consider whether there are any conditions that limit this right, for example minimum redemption limits. In doing so, entities should consider not only the legal form of the arrangement but also how it operates in practice, including the enforceability and accessibility of redemption rights.
Whilst a financial asset may provide the holder with a contractual right, this does not eliminate the counterparty risk that the issuer may default on their obligation. That risk is addressed through subsequent measurement and impairment assessments.
Financial Asset Classification
Where an instrument meets the definition of a financial asset, the next step is to determine its presentation on the statement of financial position.
Cash
Cash is defined as:
“Cash on hand and demand deposits” (Appendix I: Glossary to FRS 102).
FRS 102 does not expand on this definition, which pre-dates the emergence of digital assets. Caution is therefore needed when concluding whether a stablecoin meets the definition of cash. In most cases, it is expected that stablecoins will not meet the definition of cash under FRS 102, although this will depend on the specific facts and circumstances and should be assessed with particular care given the implications for presentation and disclosure.
FRS 102 does not have a specific section dedicated to digital assets hence this analysis draws on the concepts within the standard itself, as well as requirements and guidance in IFRS Accounting Standards (as permitted by paragraph 10.6 of FRS 102), including relevant IFRS Interpretations Committee (IFRS IC) agenda decisions.
We note at its June 2019 meeting, the IFRS Interpretations Committee discussed the holding of cryptocurrencies. An important aspect of this agenda decision is the requirement that, in order to meet the definition of cash, a cryptocurrency would need to be “used as a medium of exchange and as the monetary unit in pricing goods or services to such an extent that it would be the basis on which all transactions are measured and recognised in financial statements”. Significantly, cryptocurrencies as defined in the agenda decision exclude those that give rise to a contract between the holder and another party. Therefore, stablecoins that establish contractual rights and obligations are not in scope of the agenda decision. Nevertheless, it would appear that the IFRS IC have set a high bar for the recognition of any asset as cash.
Cash equivalents
Cash equivalents is defined as:
“Short-term, highly liquid investments that are readily convertible to known amounts of cash and that are subject to an insignificant risk of changes in value.” (Appendix I: Glossary to FRS 102).
We will consider each of these requirements in turn.
“Short-term” is not defined, but FRS 102 says:
“an investment normally qualifies as a cash equivalent only when it has a short maturity of, say, three months or less from the date of acquisition.” (Paragraph 7.2 of FRS 102).
Stablecoins typically have no stated maturity. Their classification as short-term may therefore depend on whether the holder’s right to redeem a stablecoin with the issuer for the equivalent amount of reference fiat currency is contractually available on demand and is expected to be exercised in practice. On-demand redemptions are typically settled within a few business days, and in any case in under three months, consistent with standard banking settlement cycles.
“…,highly liquid investments that are readily convertible” is not explicitly defined in FRS 102, but it can be inferred from the definition of cash equivalents as a necessary condition for ensuring the asset is readily convertible into cash.
In this context, a stablecoin holder can assess two main sources of liquidity: redemption with the issuer and an active secondary market.
For a stablecoin that is redeemable into a reference fiat currency, “highly liquid” may be assessed with reference to the liquidity provided by the issuer, given the issuer’s obligation to redeem the stablecoin into a reference fiat currency.
An on-demand redemption right is a strong source of liquidity, but its effectiveness depends on, among others, the liquidity and credit quality of the issuer's reserve assets and any associated third party custodian of the backing assets. Any restrictions on the redemption right, like fees or temporary suspension clauses, must be carefully considered, as they could compromise the "highly liquid" nature of the stablecoin. Judgement will be required to determine whether such arrangements are sufficient to support classification as a cash equivalent.
A stablecoin could alternatively be regarded as highly liquid if it is traded in an active market accessible to the reporting entity. It is important to note that just because a stablecoin can be traded on a secondary market does not automatically mean the market is active.
Active market is defined as:
“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.” (Appendix I Glossary, FRS 102).
“…to known amounts of cash”
While FRS 102 does not define the meaning of “known amounts of cash”, it would be appropriate to consider the agenda decision of the IFRS IC in July 2009, given the definitions of cash equivalents under IFRS Accounting Standards and FRS 102 are aligned. The IFRS definition being “Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value”.
As explained in the agenda decision, the requirement that a cash equivalent is convertible to “known amounts of cash” means that the amount of cash that will be received must be known at the time of the initial investment and therefore at the point of initial recognition of the financial asset.
“…are subject to insignificant risk of changes in value”
Whether a stablecoin is subject to an insignificant risk of changes in value refers to the risk that the actual value at redemption, or, more generally, on disposal might differ from the value expected at the time of acquisition. This assessment should be performed at initial recognition and updated where relevant facts and circumstances change, with no single factor being determinative. Where a stablecoin does not offer rights to interest income for holders, the expected value on redemption should mirror the value of the initial investment.
As part of their assessment, a holder will need to consider, among others, the credit quality and liquidity of the underlying reserve assets. While not an exhaustive list, short-term liquid assets such as the fiat currency held at regulated financial institutions or trusts, short-term government securities and investments in money market funds are more likely to result in an insignificant risk of changes in the value of the stablecoin. Although this is not always the case, recent examples have shown that the value of government securities can experience significant short-term fluctuations.
The holder would also need to consider the credit risk associated with the regulated financial institutions or trusts themselves that hold the backing reserve of highly liquid, low risk financial assets.
To further support their assessment, a holder may also consider whether the stablecoin reserves are subject to regular attestations by a reputable independent third party verification on the value and existence of the underlying assets.
For holders that rely on the secondary market to sell or exchange a stablecoin, assessing the risk of changes in value requires consideration of whether the price of the stablecoin is stable relative to the reference fiat currency on a one-for-one basis in the secondary market. Establishing whether there is insignificant risk is likely to be difficult. While partly dependent on the nature of the underlying reserve assets, it should be acknowledged that other factors can influence prices on secondary markets. These include broader views on the asset class, the market share and competitive dynamics of other stablecoins, concerns about the issuer or any third-party custodian, and the extent to which the asset operates in an active market (frequency and volume). All of these can contribute to greater volatility and should be considered.
Other considerations
IFRS Accounting Standards require that cash equivalents “are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes” (IAS 7, paragraph 7). While not explicitly required by FRS 102, this principle may be relevant and, where applied, entities should explain how it has been considered in their accounting policies.
Where a stablecoin does not meet the definition of cash or cash equivalents, but does meet the definition of a financial instrument, refer to Section 11 of FRS 102 which deals with classification of Basic Financial Instruments.
Non-Financial Assets
Inventory
If a stablecoin does not meet the definition of a financial asset, it may meet the definition of inventory.
The definition of inventory includes:
"assets which are: held for sale in the ordinary course of business." (Appendix I: Glossary of FRS 102).
‘Ordinary course of business’ in the context of stablecoins might be determined by whether the holder regularly buys and sells stablecoins to generate profit from trading fees or price movements over the short term. This assessment will depend on the entity’s business model and intentions, and entities should take care not to infer trading intent solely from transaction frequency.
Intangible Asset
If a stablecoin meets the definition of neither a financial asset nor inventory, the holder should consider whether it meets the definition of an intangible asset. In such cases, many stablecoins may fall within the scope of Section 18 of FRS 102, and clear disclosure of the basis for classification will be important given the evolving nature of practice.
An intangible asset is defined as:
“An identifiable non-monetary asset without physical substance. Such an asset is identifiable when:
- it is separable, i.e. capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability; or
- it arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.”(Appendix I: Glossary, FRS 102).
In considering this definition the holder should consider whether the stablecoin being a digital representation on a blockchain is an “identifiable non-monetary asset without physical substance”.
In addition, in order to be identifiable, one of two requirements must be met. Firstly, the holder needs to consider if the asset can be separated from the entity. In the case of stablecoins this might be achieved by trading on a secondary market or on a peer to peer basis.
Or alternatively, the asset is identifiable because it has arisen out of contractual or legal rights. With regard to stablecoins, redemption rights with the issuer may feature as a contractual right.
