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How do you calculate the net asset value of a cryptocurrency fund?

The pricing and valuation policy for traditional assets is straightforward. Independent pricing is available from the likes of Bloomberg and Reuters.

However, for cryptocurrencies, we must consider a whole new approach. Currently, pricing for crypto assets is only available from unregulated exchanges.

 

Cryptocurrency Volatility

The prices for crypto tokens or coins are extremely volatile. There are significant differences in the pricing spreads across the various exchanges.

For this reason, it is important that the fund manager comes up with a sound valuation policy to determine how the fund administrator arrives at fair market prices for the crypto fund portfolio positions.

The investment manager of a crypto fund should establish a valuation policy and confirm it with the fund administrator.

In addition, the auditor should check the valuation policy. This is to ensure that they are comfortable with it. Nobody wants a fund to adopt a valuation policy, only for the auditor to then consider it unacceptable.

The valuation of investments made directly in blockchain or crypto related companies can be challenging, especially if these companies are not generating revenue.

Even if they do generate a revenue, how do you value these highly specialised businesses?  Therefore, it is extremely important to find a consensus on a valuation policy with the fund administrator and auditor.

That said, there is a strong debate taking place within the accounting community on exactly how to value and audit a crypt fund.

Cryptocurrencies are a new asset class for audit firms and many are only starting to understand their mass application.

 

Cryptocurrency Definition

The key to agreeing on a valuation framework is to first agree on the definition of a cryptocurrency.

For example, how should a cryptocurrency such as Bitcoin be accounted for and what is its asset definition?

First, it cannot be defined as ‘cash’ as it is not issued or backed by any government. Second, it is not classed as a ‘financial instrument’ as it does not give the holder a contractual right or obligation to receive cash or another financial asset in exchange for it. Three, it is not a ‘physical asset’, as it has no physical form such as land or a building.

It cannot be classed as ‘inventory’. Inventory needs to be held for sale in the ordinary course of business. However, cryptocurrencies may not be traded frequently enough to establish that the trading activity would be an entity’s ‘ordinary’ course of business. Bitcoins would fail the definition of inventory unless this test is met.

It can, however, be classed as an ‘intangible asset’.  Cryptocurrencies appear to meet the definition of an intangible asset. They can be sold, exchanged or transferred individually, and are defined as non-monetary assets with no physical form.

At present, the consensus appears to be that the valuation of cryptocurrencies should be based on ‘fair value’ methodology.

The audit firms I have contacted advise that ‘fair value’ measurement feels like the most relevant measurement basis for a cryptocurrency. This is because it is being used as a currency-equivalent or alternative investment vehicle.

 

Looking To The Future

It will be interesting to see what accounting treatments will be adopted when the first crypto funds are audited.

Existing accounting frameworks, IFRS and US GAAP, do not specifically refer to cryptocurrencies and digital assets. Currently, the primary accounting questions are whether cryptocurrencies are assets – and, if so, what type of asset in terms of the accounting standards?

Added to this confusion is that there are over 1,500 cryptocurrencies and counting. Many have different characteristics. Plus, the reasons for acquiring them can vary, resulting in different accounting consequences. Therefore, an accounting policy established for one cryptocurrency may not be appropriate for others.

In conclusion, the manager, administrator and auditor of your cryptocurrency fund should agree the valuation methodology and audit treatment prior to its launch. The crypto-fund offering prospectus should also be transparent on this point.

Do you need help setting up your investment fund? Email sbratchie@ifina.com and we can arrange a call. If you have any questions, please leave them in the comments below.

 

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