Can Crypto Tokens Be Classified as Financial Instruments?

Classifying cryptocurrency tokens can be a tricky subject for accountants, finance professionals, and regulators. Should they be classified as cash equivalents, intangible assets, or even financial instruments? The answer depends on the token itself. But you’re not alone in facing this dilemma—many professionals grapple with the complexities of ERC tokens.

What Are Crypto Tokens?

Crypto tokens are digital assets that exist on a blockchain, but unlike native cryptocurrencies such as Bitcoin or Ethereum, they are typically built on top of existing blockchain networks. Ethereum is the most common platform used to create these tokens, making ERC tokens a popular choice.

ERC tokens share many characteristics with their native cryptocurrencies, including the ability to participate in decentralized finance (DeFi) applications (also known as DApps). The most commonly used ERC standard for creating tokens is ERC-20, which ensures interoperability across various platforms and wallets. However, it’s important to note that ERC-20 tokens cannot be mined, as they do not have their own blockchain.

Understanding ERC-20 Tokens

The ERC-20 standard outlines a set of functions that must be implemented for any token to interact with other smart contracts and platforms. These basic functions include transferring, approving, and checking balances, ensuring that all tokens follow the same essential rules.

Accounting for ERC Tokens: The Challenges

With the surge of cryptocurrencies and tokens, accounting and regulatory challenges have emerged. Standards-setting bodies like FASB (Financial Accounting Standards Board) and IASB (International Accounting Standards Board) have yet to issue definitive guidelines specific to cryptocurrencies and tokens. However, we can look to existing standards like IFRS (International Financial Reporting Standards) for guidance.

Here’s a brief overview of how tokens are categorized:

• IAS 38: Intangible Assets - According to IFRIC, cryptocurrencies meet the definition of intangible assets. Given that tokens share similar characteristics to cryptocurrencies, they too can be classified as intangible assets.
• IAS 32: Financial Instruments - Under this standard, a financial instrument is defined as a contract that creates a financial asset for one entity and a financial liability for another. However, since ERC tokens are not typically associated with the transfer of cash or equity interests, they do not meet this definition.
• IAS 7: Cash and Cash Equivalents - Cash equivalents are short-term investments that can be easily converted into cash with minimal risk of value change. While tokens might be liquid, they don’t fully meet the criteria for being classified as cash or cash equivalents.

Based on these definitions, ERC tokens are most often classified as intangible assets, though their classification may depend on the specific nature of the token.

Types of Tokens

There are several categories of tokens, each with distinct accounting considerations:

1. Security Tokens

Security tokens represent ownership or investment in an underlying asset, such as stocks or bonds. These tokens are issued by companies or governments and could promise dividends, profits, or other rights. As these tokens involve contractual obligations, they can be classified as financial instruments.

2. Asset-Backed Tokens

These tokens are backed by a tangible asset, like gold, fiat currency, or commodities. For instance, fiat-backed tokens (stablecoins) are often pegged to a specific currency, such as the US dollar. While stablecoins can be exchanged for cash, they don't fully meet the definition of cash and may be classified as cash equivalents under certain circumstances.

3. Utility Tokens

Utility tokens grant access to specific products or services within a platform. Their value is driven by demand and supply, and they function similarly to loyalty points or gift cards. Since utility tokens don't give ownership or profit rights, they are typically classified as intangible assets—unless they are held for trading purposes.

Conclusion: How to Classify ERC Tokens

While ERC tokens generally meet the definition of intangible assets, the specific classification may depend on their characteristics and the way they are issued. Tokens like security tokens and asset-backed tokens may require more complex accounting treatment, while utility tokens are easier to classify as intangible assets.

Understanding the complexities of token classification and the relevant accounting standards is crucial for accountants and finance professionals working in the cryptocurrency space.

By understanding the peculiarities of each token type, you can ensure proper accounting practices and classification based on their underlying characteristics and use cases.