An exploration of crypto-assets
Ian Michael, senior technical specialist at the Bank of England, explores crypto-assets in the context of two recent publications from the IFRS Interpretations Committee and the Basel Committee on Banking Supervision.
The IFRIC announcement will bring much greater clarity to the accounting treatment of direct holdings of crypto-assets. In March, the IFRIC discussed how existing International Financial Reporting Standards (IFRS) applied to such holdings. It concluded, in a draft agenda decision that is available for comment until 15 May, that:
- crypto-assets are not cash or financial instruments. Rather, they are intangible assets: an identifiable non-monetary asset without physical substance;
- most holdings of crypto-assets will need to be accounted for in accordance with IAS 38 Intangible Assets – in general measured at cost, subject to periodic impairment tests;
- if crypto-assets are held for sale in the ordinary course of business, the holding will be required to be accounted for in accordance with IAS 2 Inventories.
This will usually mean measuring the assets at the lower of cost and market value. However, should the holder be a ‘broker-trader’ buying or selling the crypto-assets for others or on their own account, the assets will be measured at fair value less costs to sell.
This interpretation of IFRS is unlikely to prove controversial, but is nevertheless valuable because it helps to clarify the treatment of direct holdings of crypto-assets for regulatory capital purposes. Under Basel’s capital rules, intangible assets are disallowed for the purposes of determining a bank’s capital resources. Indirect holdings of crypto assets, for example as collateral or through derivatives, will be treated according to the applicable Basel rules – not usually complete disallowance.
Knowing how crypto-assets should be treated for accounting and prudential purposes is important, but the need for firms to approach such assets with the right mindset is even more so. The Prudential Regulation Authority addressed this in an open letter to CEOs in June 2018 and a recent paper from the Basel Committee, Statement on crypto-assets, has done the same on a global basis. The paper makes clear that the growth of crypto-assets and related products has the potential to create risks for financial stability and to increase the risks faced by banks. The paper says:
- it is unsafe to rely on crypto-assets as a medium of exchange or store of value;
- crypto-assets are an immature asset class given the lack of standardisation and constant evolution;
- crypto-assets have exhibited a high degree of volatility; and accordingly
- crypto-assets present a number of risks for banks, including liquidity risk, credit risk, market risk, fraud and cyber risk, money laundering and terrorist financing.
The paper goes on to explain that Basel expects that a bank should at a minimum:
- conduct comprehensive analyses of the risks arising from any direct or indirect crypto-asset holdings it is minded to take on;
- have a clear and robust risk management framework for its crypto-asset exposures and related services, and integrate that framework into its overall risk management processes;
- publicly disclose any material crypto-asset exposures or related services as part of its regular financial disclosures; and
- keep its supervisor informed of actual and planned crypto-asset exposures or activity in a timely manner.
Although directed at banks, many of Basel’s messages are also relevant to other firms that may be considering acquiring exposures to crypto-assets.
The Basel Committee’s paper adds to the messages that have been delivered by regulators – such as the Financial Stability Board in a report issued in October 2018 and the Bank of England’s Financial Policy Committee, following its meeting in March 2018 – on the implications of crypto-assets for financial stability as a whole.
About the author
Ian Michael is senior technical specialist at the Bank of England