Use of blockchain in business: cryptocurrencies

Publication date: November 20, 2023

Explanation and blockchain in cryptocurrencies

Being one of the most popular topics of the last years in technology, blockchain offers great perspectives but still remains often seen as vague, complicated matter. Not going into details, it can be surely stated that it is not as complicated as it may seem, both in understanding and especially in application. In a nutshell, blockchain is a technology which secures sharing of information, storing data in a digital database on a distributed ledger of blocks. It allows mostly to record transactions or track assets of various kinds. Importantly, it runs completely online but is properly secured: all information stored is cryptographically coded and to access specific data you need to use your own, private key which is authenticated by network.

That being said, the most important application for blockchain is now cryptocurrency, the most known being bitcoin. The very existence and operation of crypto depend on the blockchain technology. Nowadays, it is not just growing popularity of fashionable crypto assets but an actual growth in the use of this technology in business. In 2022, there were estimated 2,353 businesses in the US accepting bitcoin and the number is believed to grow. Cryptocurrencies are being used by different brands, for different purposes: from purchasing tickets or non-fungible tokens to even buying real estate. The scope of possibilities may be not unlimited but certainly is bound to be increasingly broader.

General profits of using cryptocurrencies

Among many advantages these are the most important ones for the companies:

• Access to new demographic groups: crypto users are often technologically aware clients with an income appropriate for luxury goods and services; according to a survey by “Cointelegraph”, the vast majority of merchants thinks crypto payments enable them to reach new customers
• Better positioning of a company for a future; e.g. the growing number of important figures, investors using crypto
• New investment or liquidity options, for instance using non-fungible tokens or investing in the very crypto as an asset
• Higher transparency and more easy way of conducting financial operations
• Stronger control over the capital of the company.

Despite having mentioned also investing, this article will concentrate on the other use of crypto which is its use for company’s operations. It is more complex issue than making investments and, as it is still not regulated in details, needs a proper consideration.a

Crypto facilitating payments (“hands-off”)

                The first option of making use of crypto in a company consists of adopting crypto-enabled payments by converting crypto to fiat currency, using service provider, thus not having e.g. bitcoin on a company’s balance sheet. Cryptocurrency formally is not present in a company, is not really “touched” but is used by a customer or even company itself. In that case, the role of service provider, the third-party vendor, appears to be crucial. Many aspects are done only by him, specifically technical issues of transactions, to some extent also compliance and risk matters. “To some extent” because the company still has some responsibilities and liabilities. It is required to comply with the restrictions set by the American agency, the Office of Foreign Assets Control and abide with anti-money laundering or know your customer (KYC) requirements. Moreover, performing proper due diligence of the vendor would be of great importance. He may provide third-party assurance but nevertheless the company should check the vendor’s financial condition, cybersecurity, anti-fraud schemes. Deciding to go this way, you will very much rely on the service provider. Consequently, making sure of his credibility, reliability will be necessary.

            However, despite potential (but possible to avoid) dangers in using the third party, facilitating payments by converting cryptocurrencies is not that demanding and enables making transactions in crypto without actually using blockchain technology on a larger scale. Therefore, it could be done quickly and give quick results while the company will be spared of a need of a real restructuring.

Crypto in a broader adoption (“hands-on”)

                Making use of cryptocurrencies on a larger scale, especially in e.g. the management of financial assets, can provide much more possible places, roles to adopt crypto in the company. Going this way, it would be vital to set the firm’s strategy, plan or to at least decide about aims, possible adjustments and other related matters. This time there are again two paths to follow:

• Using a third-party. Unlike in “hands-off” approach, the vendor or custodian has a bigger role here: not only does he provide wallet management services but also he takes care of the storage of crypto on the blockchain
• Fully implementing crypto into the company’s operations and dealing with private keys to the data stored on blocks on your own (depending on legal regulations it is possible that you will need some license for the transmission of crypto)

In most cases, the first path is chosen since it is less complex and easier especially for enterprises inexperienced in that area. Despite differences between them, the most of their operation is quite similar.

Digital wallets, tracking and stablecoins

            Like almost any item accepted as payment for some goods, crypto can be stored in a wallet, except it is a digital one. In fact, there are two main types of the digital wallets: these are named cold and hot wallets. Cold are used for long-term storage and have significantly different “form”: they are most often offline, on a physical plug-in device, such as flash drive. Because of that they are quite safe and less vulnerable to cyberattacks but they are not perfectly suited for operational accounts. For these accounts hot wallets are much better. They allow conducting rapid payments or transfer of funds and are perfect for short-term storage of savings and investments. As oppose to the cold wallets, they are constantly connected to the Internet, existing on a certain platform or application (such as “MetaMask” or “Exodus”). For a typical company’s operational needs on a daily basis using both of these types of wallets would be the best decision.

            Every crypto asset has to be properly recorded: its date, time of acquisition, its value etc.; this is called “tracking”. Due to frequent uncertainties in price of crypto assets, companies sometimes tend to convert crypto to stablecoins – cryptocurrencies that have their value tied to the value of another currency, for example USD Coin. By doing that, the company gains the crypto which has higher usability potential for traditional banks.

Keeping an eye on some risks

                Firstly, companies need to keep an eye on some legal requirements, such as AML (Anti-Money Laundering) and KYC (Know Your Customer) regulations. Despite having many advantages, blockchain technology can be also used for money laundering. When making large payments with foreign parties, there is a risk for companies of enabling money laundering through e.g. international supply chains, even with no intention of doing that. Again, proper due diligence is crucial to determine the source of crypto: for instance, if it does not come from restricted bitcoin address.

            Secondly, one should be careful with conducting transactions with so called second-layer protocols. These protocols are applications built on top of blockchain systems, making transactions faster and cheaper. The risk is the problem of recording the transaction on the blockchain: in this case it is not done immediately. Only after finalizing a series of smaller transactions can the record be stored on the blockchain. In the in between phase an error or scam can be made which endanger the whole transaction. However, there are more reasons to use these protocols than not to. To begin with, they make transactions much faster. Sometimes processing large numbers of transactions may be a problem for cryptocurrencies systems but this layer solves it and can even provide processing thousands transactions per second. Besides, protocols make transaction fees significantly smaller. These are one of the reasons why they are being already used quite often and are believed to compete with traditional payment systems soon.

Tax issues

            The company willing to use crypto needs to bear in mind some basic differences when dealing with non-traditional currency. First and foremost, crypto is an intangible asset which may cause the need of specific changes or adjustments in certain financial documents. According to existing regulations, a company might regard payments done with the use of crypto as barter transactions. Finally, crypto assets’ price is volatile. The price generally changes over time which makes the value determination of an asset sometimes challenging.

            That being said, it is commonly accepted that the establishment of the time and value of the crypto has to take place at the time of receipt. Having detailed documentation and accountant books is crucial for e.g. presenting the tax basis for the crypto before taxing authority or calculating additional taxes: indirect, value-added etc. The company can also use cryptocurrency for an expenditure or performing some transactions. Because of the volatility of the crypto price, proper documentation as well as segregated digital wallets are vital to determine how much gain or loss causes certain asset with the certain transaction.

            Another important factor is the need of remitting the crypto to fiat currency since most tax authorities do not accept crypto for now. Moreover, taking care of a detailed documentation has to be underlined again due to the fact that cryptocurrencies do not provide with conventional bank statements. Thus, any company will have to pay attention to disclosure all transactions details in a proper way.

Accounting issues

                Any consideration to a contract that is not cash has its value determined at the contract’s inception. The price is based on the value of the crypto at that moment – that will be the amount recognized as revenue, despite possible price changes later.

            Recently, The Financial Accounting Standards Board in the US published an exposure draft proposing amendments that could change the way of measuring digital assets’ value for companies holding these assets. However, none of these amendments provide changes to revenue accounting in crypto.

            According to the Deloitte report, any transaction using crypto as payment for expenses consists of: the sale of the crypto and the receipt of a service. The second is treated as the noncash consideration. It is important for financial statement to determine if the other party is considered as a “customer” (according to the accounting rules) or as a “noncustomer”. The value and price of the crypto are being set at the same time, when the contract is concluded. Nonetheless, the valuation can be complex. There are certain valuation concepts: for instance fair value is not the same as fair market value and there are various approaches to value crypto (e.g. market, income or cost approach). Each has its own accounting standards and rules. If applied to a transaction, it has to be followed in detail.

            Lastly, all this information needs to be taken into consideration when preparing financial statement. The main issue is to have a statement which presents the company’s strategy as regards to the use of crypto in a clear, transparent manner. That should refer to e.g. the impact that the crypto has on the cash flows, risks that the entity has taken or present and forecast financial performance of the company.

Sources:

Report by Deloitte. “The use of cryptocurrency in business. Why companies should consider using cryptocurrency” (June 2023)

https://www.mckinsey.com/featured-insights/mckinsey-explainers/what-is-blockchain

https://www.investopedia.com/terms/s/stablecoin.asp

https://www.coindesk.com/learn/hot-vs-cold-crypto-storage-what-are-the-differences/

https://www.fm-magazine.com/news/2023/mar/iasb-proposes-narrow-scope-amendments-ifrs-9.html

https://academy.binance.com/en/glossary/layer-2

https://eqvista.com/company-valuation/valuation-crypto-assets/