Cryptocurrency Accounting: The Beginner’s Guide
New to cryptocurrency accounting? We're covering everything CPAs, tax managers, and accountants need to know about how to get started with crypto accounting.
What is cryptocurrency accounting?
Cryptocurrency accounting refers to the financial reporting requirements around cryptocurrencies both for investors and for businesses.
In this guide, we’ll be focusing on the former - helping accountants, CPAs, and tax managers navigate everything they need to know about cryptocurrency accounting.
What is blockchain technology?
In simple terms, a blockchain is a digital ledger - a chain of blocks of data, hence the name.
Blockchain technology uses cryptographic algorithms (secure processes) to secure each block of data and bind the blocks together to create a record of previous data.
Let's use the example of Bitcoin. Bitcoin transactions are recorded on the Bitcoin blockchain - a public ledger that records all Bitcoin transactions.
Who maintains the blockchain then?
Bitcoin is a proof-of-work blockchain, which means transactions are verified by solving a complicated mathematical puzzle. Other blockchain networks - like Ethereum and Solana - are proof-of-stake, where users stake their crypto assets as collateral in order to validate blocks.
What’s the purpose of blockchain technology?
Blockchain technology lets digital information be recorded and distributed in a secure manner. In doing so, it allows data to be more transparent, as well as decentralized.
When Bitcoin was first created - the mission was clear. The creator, Satoshi Sakamoto, created Bitcoin so anyone, anywhere could send money over the internet with no need for a centralized third party like a bank.
What’s the problem with centralized, traditional financial institutions? Well, those involved in the crypto market say traditional finance is limited by centralized institutions and outdated processes prone to human error. As well as this, to deal with traditional financial institutions - we often pay a premium, and many services, like credit, are unavailable based on the data they collect and hold about customers.
The decentralized finance (DeFi) movement has sprung up as a result of this and aims to resolve these problems by using blockchain technology to build financial applications - giving millions of people better access to finance and more control over their own finances. You can learn more in our DeFi guide.
What can blockchain technology be used for?
In theory - anything.
Blockchain technology is exciting because of its transparent and decentralized nature. Though it’s mainly focused on challenging the status quo of the finance industry - this kind of digital ledger has the potential to revolutionize many industries.
Some current ways other industries are using blockchain technology include:
Pharmaceutical companies are using blockchain technology to revolutionize track-and-trace serialization processes by utilizing a transparent, immutable digital ledger of data.
Accounting firms are utilizing blockchain technology to help eliminate the need to enter accounting information into multiple databases.
Fashion retailers are using blockchain technology to improve their supply chain logistics, as well as create transparency for consumers.
This said, currently blockchain technology is predominantly used for cryptocurrency coins, tokens, and NFTs. Let’s take a look at cryptocurrency accounting and the challenges faced.
Despite the fact that crypto has essentially gone mainstream - the financial reporting for digital assets doesn't fit cleanly into existing accounting guidance under generally accepted accounting principles (GAAP) or under International Financial Reporting Standards (IFRS).
In fact, many CPAs specializing in crypto accounting in the States have made requests to the Financial Accounting Standards Board (FASB) to issue updated guidance to quell concerns and create clarity. Similarly, members of the US Congress have encouraged the FASB to take action by sending letters.
At the moment, the best guidance on cryptocurrency accounting comes from the IRS and other tax offices globally who confirm that - for tax purposes at least - cryptocurrency should be seen as a capital asset and subject to Capital Gains Tax. But even they haven’t really cleared too much up because despite not being recognized as a fiat currency or equivalent - in some instances crypto will be subject to Income Tax depending on the transaction.
As well as this, the nature of crypto investments creates some unique challenges for crypto tax accounting.
What are the challenges of crypto tax accounting?
Cryptocurrency was once a niche area for accountants, CPAs, and tax managers to specialize in, but it’s not the case anymore. Cryptocurrencies have spiked in popularity - roughly 22% of the population now invest in cryptocurrency in some shape or form.
Crypto accounting has created some unique issues for accountants, CPAs, and tax managers alike, including:
A lack of crypto knowledge
Unclear tax guidance
Siloed transaction data
Unsuitable traditional methods
Koinly hopes to solve all of this for accountants and their clients - creating a simple crypto tax solution to aid accountants in adopting crypto accounting with ease. Let’s take a look at some of the challenges faced and how Koinly helps resolve them.
Lack of crypto knowledge
The crypto market is always evolving - with decentralized finance (DeFi) being the prime example of this. DeFi involves investors utilizing liquidity pools (literally pools of investor funds) to conduct a huge variety of transactions including trading, staking, lending, liquidity mining, yield farming, and more.
Each DeFi protocol works slightly differently and this means the tax implications can get complicated - fast. The IRS and other tax authorities have not given clear guidance on these transactions yet, so accountants are left to interpret the current crypto tax rules and apply them to DeFi transactions.
As well as this, there are many different kinds of cryptocurrency tokens/coins - like utility tokens, security tokens, asset-backed tokens, and more, not to mention non-fungible tokens (NFTs). Each of these may have a slightly different tax implication.
We’ve got great guides on everything crypto in our blog where you can find out about how each different transaction works and how it’s taxed. Koinly lets you customize the tax treatment of your crypto to suit your country’s crypto tax rules.
Unclear tax guidance
We’ve touched on this above - but it’s worth expanding on as it’s a real issue for cryptocurrency accounting.
The IRS doesn’t have clear guidance on most crypto transactions. They’re clear that selling, trading, and spending are subject to Capital Gains Tax and they’re clear that being paid in crypto for a service, airdrops, forks, and mining crypto is subject to Income Tax. But that’s where the clarity ends.
Not only is DeFi tax unclear - but other common transactions like staking, play-to-earn income, and even NFTs have no tax guidance.
Where tax offices like the UK’s HMRC have tried to tackle this with updated guidance - it’s left investors more confused than ever and accountants facing mounting pressure to interpret convoluted rules.
We’ve got helpful guides on the different crypto tax guidance from countries around the world. Koinly lets you customize the tax treatment of your crypto to suit your country’s crypto tax rules.
Siloed transaction data
A particularly unique challenge for crypto accounting is siloed transaction data. The vast majority of crypto investors are using multiple crypto exchanges and wallets, both centralized and decentralized, as well as potentially many specific DeFi protocols.
Combining transaction data to create a coherent financial report is a challenge in itself. Each crypto exchange only records the transactions made on that platform. In some instances, you’ll be able to get this data with relative ease, but on others platforms lacks even an option to export transaction data to CSV files.
This makes tracking crypto assets to calculate cost basis, fair market value, and any subsequent capital gains or losses a challenge logistically.
You can track transactions across every crypto exchange and wallet from one platform with Koinly, meaning all the data you need is available in the transactions page on your Koinly account.
Identifying market value
Cryptocurrencies are volatile in value - in just the last few months alone Bitcoin has lost more than $20,000 in value. This means identifying and tracking the fair market value of assets on specific days relating to client transactions can be time-consuming.
As well as this, there are often slight discrepancies between different crypto price index websites and individual crypto exchanges. With little guidance from the IRS and other tax offices as to how to identify fair market value for crypto assets - crypto accountants must use a consistent, fair approach when calculating fair market value.
Koinly identifies the fair market value of crypto for you - either using the data available from a transaction or by using market data from price aggregators like CoinMarketCap, CoinGecko, and CryptoCompare.
Crypto accounting resources
To help you tackle these various challenges - we’ve put together a list of crypto accounting resources to help crypto accounting professionals navigate crypto tax for their clients successfully.
Tax office crypto tax guidance
Canada: The Canada Revenue Agency
Australia: The Australian Tax Office
Ireland: Revenue Commissioners
Switzerland: Swiss Federal Tax Administration
France: Ministry of Economy and Finance
The Netherlands: The Belastingdienst
Austria: The Ministry of Finance
South Africa: Revenue Service
Japan: National Tax Association
Koinly crypto tax guides
How crypto tax software can help
Koinly can help make crypto tax simple for both you and your clients.
Our accountant platform lets you manage multiple clients from one account, track your clients' transactions, and calculate their taxes automatically.