Coinbase Cryptocurrency Borrowings
Cryptocurrency borrowing guidance from AICPA confronts current industry practice established by Coinbase.
What are the current accounting requirements for borrowings of digital assets? First, we need to clarify that in this context we use the term "borrowings of digital assets" in its narrow form that does not include borrowings of those stablecoins and other tokens that meet the definition of financial assets. After adding this context, we can definitively say that no explicit guidance exists that directly applies to borrowings of digital assets.
This is because borrowers' obligations are to return the determinable number of units of specified digital assets at a certain point in time in the future instead of a specified or determinable amount of cash.
Digital assets are not treated as cash or the right to receive cash (with limited exceptions such as stablecoins redeemable by issuers for cash such as USDC redeemable at Centre Consortium, USDT redeemable at Tether, and BUSD redeemable at Paxos). This means that the debt guidance would generally not apply to digital asset borrowings because non-financial obligations are scoped out. The current industry practice was developed mainly using the approach established by Coinbase, which treats crypto borrowing as non-financial liabilities that are out of the scope of FASB debt guidance.
Excerpt from the most recent Coinbase Form 10-K:
Crypto asset borrowings
The Company borrows crypto assets from third parties on an unsecured basis. Such crypto assets borrowed by the Company are reported in crypto assets held on the Company’s consolidated balance sheets.
The borrowings are accounted for as hybrid instruments, with a liability host contract that contains an embedded derivative based on the changes in the fair value of the underlying crypto asset. The host contract is not accounted for as a debt instrument because it is not a financial liability, is carried at the fair value of the assets acquired and reported in crypto asset borrowings in the consolidated balance sheets. The embedded derivative is accounted for at fair value, with changes in fair value recognized in Other operating expense, net in the consolidated statements of operations. The embedded derivatives are included in crypto asset borrowings in the consolidated balance sheets.
The term of these borrowings can either be for a fixed term of less than one year or can be open-ended and repayable at the option of the Company or the lender. These borrowings bear a fee payable by the Company to the lender, which is based on a percentage of the amount borrowed and is denominated in the related crypto asset borrowed. The borrowing fee is recognized on an accrual basis and is included in Other operating expense, net in the consolidated statements of operations.
However, in the recently released update to the AICPA Digital Assets Guide, the authors concluded that cryptocurrency borrowings should be treated as a dollar-denominated debt obligation with an embedded feature indexed to the price of the cryptocurrency used to denominate the obligation.
Pursuant to FASB ASC 815, the obligation to return should be viewed as a hybrid instrument with a debt host contract and embedded derivatives linked to the fair value of Crypto Assets ABC loaned. Because the obligation is denominated in units of Crypto Asset ABC, the borrower will generally identify Crypto Asset ABC indexed embedded features in the hybrid instrument that may need to be bifurcated and marked to market pursuant to the provisions of FASB ASC 815.
This analysis of the obligation to deliver a fixed number of crypto assets in satisfaction of the obligation is similar to the example in FASB ASC 815-10-55-76, in which an obligation to deliver shares in the future is viewed as a hybrid instrument with a debt host and embedded forward derivative feature.
["Accounting for and auditing of digital assets" by AICPA (page 25)]
Comment: I wanted to note that the decision to use the FASB ASC 815-10-55-76 analogy here creates an implied assumption that there is no significant difference in the treatment of transactions with financial versus non-financial assets. This assumption has significant implications for practically any area of accounting for digital assets. However, this is a larger conversation to be addressed in future posts.
The borrower identifies the host contract as a dollar-denominated debt obligation with a fixed interest rate following the principles in FASB ASC 815-15-25-24. Consistent with that judgment, the Crypto Asset ABC indexed elements of the obligation are viewed as embedded features with an initial fair value of zero pursuant to FASB ASC 815-15-30-4.
Specifically, if the host contract is a fixed rate debt instrument, the embedded features represent pay crypto, receive dollar forward contract elements that should be evaluated for bifurcation.
["Accounting for and auditing of digital assets" by AICPA (page 25)]
If cryptocurrency-denominated borrowing is treated as debt, then all the numerous requirements for accounting for debt will also need to be applied to borrowings of cryptocurrency. Hence, interest on crypto borrowings should be presented within the interest expense (rather than other expenses) line item in the Coinbase's income statement, and crypto borrowing modifications need to be assessed for troubled debt restructuring.