Enforceability of Blockchain Transactions
Are blockchain transactions legally enforceable?
When analyzing customer arrangements between blockchain end users and miners, the AICPA Digital Assets guide concluded that there were specific arrangements due to end users' approval of the transaction before they initiated the blockchain transaction. We wanted to explore this statement and assess whether there are actual legally enforceable arrangements between the parties and the implications of this answer for the accounting treatment of block and inflation awards as per the AICPA guide.
Miners typically do not indicate acceptance of terms in any other way other than because they have included transactions in the mined block. There is no direct contract in place between miner and end-user, but rather two arrangements independent from each other (because termination by any of the parties does not have an effect on the existence of another agreement) - (1) contracts of blockchain protocol with end users who signed the transaction sent to the blockchain (2) contracts of blockchain protocol with miners who are executing the blockchain binaries in exchange for rewards distributed by the protocol to a selected miner
Here I will argue that the rights and obligations under such arrangements are enforceable by the protocol.
The core substance of the enforceability requirement is to ensure that there is a solid basis for entities to derive the value they expect to be entitled to in exchange for goods transferred and services provided to customers.
AICPA Digital Assets Guide p.26-27
"Question 27: If an entity operates as a crypto asset miner, how should the entity recognize, and measure, transaction fees and block rewards earned in connection with its mining efforts?
For purposes of this Q&A, assume the following:
• The miner does not apply any specialized industry accounting (for example, FASB ASC 946).
• A crypto asset is an intangible asset under FASB ASC 350.
Blockchain networks that use Proof-of-Work protocols rely on miners that compete to validate and add blocks of transactions to the distributed ledger. To incentivize these miners to compete in processing the transactions for the next block, the winning miner is entitled to transaction fees, a block reward or both. Transaction fees are specified in each transaction request and are paid by the participant who requested the transaction (the requester) in the native crypto asset for the blockchain (for example, bitcoin). Block rewards are newly created crypto asset units granted to the winning miner by the network under the blockchain’s consensus protocol...
…Transaction fees earned by a crypto asset miner should be recognized as revenue from customers in accordance with FASB ASC 606. The transaction fees are specified in each transaction request and paid by the requester to the successful miner in exchange for the successful processing of the transaction."
Requestors do not pay anything to the successful miner, and they do not pay miners. The payments are made to the protocol, which then distributes these payments based.
"The requester meets the definition of a customer in FASB ASC 606 because it has contracted with the miner to obtain a service (successful mining) that is an output of the miner’s ordinary activities in exchange for consideration. A contract with a customer exists at the point when the miner successfully validates a requesting customer’s transaction to the distributed ledger. At this point, the performance obligation has been satisfied in accordance with FASB ASC 606-10-25-30."
The requester usually couldn't obtain the refund for the submitted transaction, but the transaction may get stuck in the memory pool and never be processed.
No legal contract exists between the miner who mined the transaction and the requester. No single miner is responsible for including the requestor's transaction in the blockchain. Instead, regardless of whether they were awarded transaction fees, every miner will eventually have all past transactions. There are no mutual rights and obligations between miners and network participants. Instead, miners and requestors interact with a blockchain protocol - a separately identifiable entity (which can often be managed by DAO or another legal entity).
"Because of this, the additional criteria in FASB ASC 606-10-25-1 would be met as follows:
• Both the requester (a customer) and the miner have approved the contract and are committed to the transaction at the point of successfully validating and adding the transaction to the distributed ledger.
• Each party’s rights, the consideration to be transferred, and the payment terms are clear.
• The transaction has commercial substance (that is, the risk, timing, or amount of the miner’s future cash flows is expected to change as a result of the contract).
• Collection of the fees is probable because it is completed as part of closing a successful block.
By successfully mining a block, the miner satisfies its performance obligation to the requester and, thus, should recognize revenue at that point in time."
This is a loose analysis covering only the bitcoin protocol and nothing else. AICPA members, please do a more thorough research.
"The payment of transaction fees in crypto asset constitutes non-cash consideration under FASB ASC 606-10-32-21. This non-cash consideration is measured at its estimated fair value at contract inception — that is, the date that the criteria in FASB ASC 606-10-25-1 are met. If fair value cannot be reasonably estimated in accordance with FASB ASC 606-10-32-22, the consideration should be measured indirectly by reference to the stand-alone selling price of the miner’s services. Miners should disclose, if not presented separately in the statement of comprehensive income (statement of activities), transaction fees as revenue recognized from contracts with customers in accordance with FASB ASC 606-10-50-4. Block rewards Block rewards earned by a crypto asset miner are generally recognized as revenue, but the evaluation is required to determine if the block rewards earned should be recognized as revenue from contracts with customers under FASB ASC 606 or as other revenue. Entity A should first evaluate whether its mining activities represent a contract with a customer to provide services and, if so, whether it should recognize block rewards it receives from the network as revenue from a customer under FASB ASC 606.
All relevant facts and circumstances, including the network’s protocols, should be considered in determining
(1) whether Entity A has a contract with a customer under FASB ASC 606-10-25-2 and
(2) whether its mining activities on the network meet all the criteria in FASB ASC 606-10-25-1.
If the miner concludes that the block rewards aren’t revenue from contracts with customers under FASB ASC 606, it should consider other relevant guidance. The inflow of crypto assets as a result of the block reward would meet the definition of revenue in the concepts statements because it gives rise to economic benefits to the miner from rendering services or carrying out activities. Therefore, miners may account for the block reward as revenue.
Because there is no specific guidance that applies to revenues from block rewards, a miner could apply by analogy the revenue recognition guidance in FASB ASC 606 to recognize and measure the revenue from block rewards. If analogizing to FASB ASC 606, the revenue from block rewards would be presented separately from FASB ASC 606 revenues from contracts with customers on the statement of comprehensive income or separately disclosed in the notes to the financial statements. This is because FASB ASC 606-10-50-4(a) requires an entity to disclose, unless separately presented in the statement of comprehensive income, the amount of revenue recognized from contracts with customers under FASB ASC 606 separately from other sources of revenue."
Huh. AICPA suggests using ASC 606 by analogy... The issue with using ASC 606 by analogy is that under ASC 606, in the absence of enforceable rights, the following criteria are required to record revenue:
"a. The entity has no remaining obligations to transfer goods or services to the customer, and all, or substantially all, of the consideration promised by the customer has been received by the entity and is nonrefundable.
b. The contract has been terminated, and the consideration received from the customer is nonrefundable.
c. The entity has transferred control of the goods or services to which the consideration that has been received relates, the entity has stopped transferring goods or services to the customer (if applicable) and has no obligation under the contract to transfer additional goods or services, and the consideration received from the customer is nonrefundable."
It means that without an enforceable arrangement, under ASC 606 miners cannot recognize revenue until they cease the mining business. Obviously, this accounting would not provide any helpful information to users of financial statements. So, we typically see crypto miners record revenue on receipt of network rewards. However, this accounting treatment requires the company to assume that the blockchain protocol is by itself an enforcement mechanism.