April 1, 2022

Crypto: SAB No. 121 Addresses Accounting for Safeguarded Digital Assets

Yesterday, Corp Fin’s Accounting Staff issued SAB No. 121, which addresses the accounting treatment of safeguarded digital assets held by crypto platforms on behalf of customers who trade those securities digital assets. SAB 121 reflects the Staff’s view that “obligations associated with these arrangements involve unique risks and uncertainties not present in arrangements to safeguard assets that are not crypto-assets, including technological, legal, and regulatory risks and uncertainties.” Accordingly, it issued SAB 121 to provide guidance on the proper accounting treatment of those assets. This excerpt lays out the Staff’s position:

Facts: Entity A’s business includes operating a platform that allows its users to transact in crypto-assets. Entity A also provides a service where it will safeguard the platform users’ crypto-assets, including maintaining the cryptographic key information necessary to access the crypto-assets. Entity A also maintains internal recordkeeping of the amount of crypto-assets held for the benefit of each platform user. Entity A secures these crypto-assets and protects them from loss or theft, and any failure to do so exposes Entity A to significant risks, including a risk of financial loss. The platform users have the right to request that Entity A transact in the crypto-asset on the user’s behalf (e.g., to sell the crypto-asset and provide the user with the fiat currency (cash) proceeds associated with the sale) or to transfer the crypto-asset to a digital wallet for which Entity A does not maintain the cryptographic key information. However, execution and settlement of transactions involving the platform users’ crypto-assets may depend on actions taken by Entity A.

Question 1: How should Entity A account for its obligations to safeguard crypto-assets held for platform users?

Interpretive Response: The ability of Entity A’s platform users to obtain future benefits from crypto-assets in digital wallets where Entity A holds the cryptographic key information is dependent on the actions of Entity A to safeguard the assets. Those actions include securing the crypto-assets and the associated cryptographic key information and protecting them from loss, theft, or other misuse. The technological mechanisms supporting how crypto-assets are issued, held, or transferred, as well as legal uncertainties regarding holding crypto-assets for others, create significant increased risks to Entity A, including an increased risk of financial loss. Accordingly, as long as Entity A is responsible for safeguarding the crypto-assets held for its platform users, including maintaining the cryptographic key information necessary to access the crypto-assets, the staff believes that Entity A should present a liability on its balance sheet to reflect its obligation to safeguard the crypto-assets held for its platform users.

As Entity A’s loss exposure is based on the significant risks associated with safeguarding the crypto-assets held for its platform users, the staff believes it would be appropriate to measure this safeguarding liability at initial recognition and each reporting date at the fair value of the crypto-assets that Entity A is responsible for holding for its platform users. The staff also believes it would be appropriate for Entity A to recognize an asset at the same time that it recognizes the safeguarding liability, measured at initial recognition and each reporting date at the fair value of the crypto-assets held for its platform users.

SAB 121 also provides guidance on the disclosures with respect to these arrangements that would be required in the footnotes to the platform’s financial statements, and also points out that “disclosures regarding the significant risks and uncertainties associated with the entity holding crypto-assets for its platform users may also be required outside the financial statements under existing Commission rules, such as in the description of business, risk factors, or management’s discussion and analysis of financial condition and results of operation.”

In what’s become a tradition when it comes to SEC actions touching on crypto, the redoubtable crypto-evangelist Commissioner Hester Peirce (aka Crypto Mom) issued a statement expressing her displeasure with the decision to issue this guidance.

John Jenkins