July 24, 2022

Insights, news and analysis for the professional investor

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Prices as of 7/22/22 @ 5:13 p.m. UTC

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Welcome to Crypto Long & Short!

"The only thing that's certain is death and taxes." This idiom may be overused, but adding a third item to that list is usually pretty clever.

For example, my editor would probably say: "The only thing that's certain is death, taxes and a lot of misplaced commas that I have to edit out." My personal favorite use comes from The Roots' Tariq "Black Thought" Trotter's freestyle where he says: "The only thing for sure is taxes, death and trouble."

This week we'll dive into the less-commonly used version of this phrase: "The only thing that's certain is death, taxes and a whole bunch of off-base accounting rules governing the treatment of digital assets on corporate balance sheets leading to a misrepresentation of corporate earnings."

That's right, we're talking about U.S. accounting rules this week. And right on cue, Tesla announced last Wednesday that it sold 75% of its bitcoin in the second quarter. So let's dive in.

That (and maybe more …) below.

– George Kaloudis

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The Briefing

Regrettably, we will first have to dive into the story everyone was squawking about on Wednesday so that we can cleanly set up a transition to our main accounting topic. That story is Tesla selling $936 million worth of bitcoin (BTC), which made up roughly 75% of its holdings.

Even more regrettably, I am sorta kinda coming to the defense of Tesla. Corporations are people too!

So it goes.

"I might pump, but I don't dump"

Unlike what most of the internet wants you to believe, Tesla did not "paper hand" the bitcoin it bought last year for a loss. From Tesla's second quarter earnings call:

"Additionally, we converted a majority of our bitcoin holdings to fiat for a realized gain offset by impairment charges on the remainder of our holdings, netting a $106 million cost to the [income statement]."

Not sure if you realize this, but a realized gain means Tesla realized a gain. And to realize a gain, you have to sell something for more than you bought it for. Otherwise, it would be a realized loss.

And when you realize that it made those sales sometime between April and June 2022, that's when it gets a little interesting. For context, here is the price of bitcoin from April 1 to June 30, 2022.

Bitcoin Q2 Price Performance (TradingView)

Bitcoin opened the quarter trading around $45,000 and ended it below $20,000. Somewhere in there, amid a lot of selling, is Tesla unloading some ~30,000 BTC. Also featured in this timeframe is the Luna Foundation Guard selling ~80,000 BTC during the UST/LUNA death spiral. That's a lot of liquidity for the bitcoin market to soak up, and while it did cede 58% of its market capitalization, it didn't cede 100% of it (a low bar, I know, but still).

Before we can dive into accounting rules, we need to highlight why Tesla sold any of its bitcoin at all. From the same earnings call:

"We were uncertain when the COVID lockdowns in China would alleviate so we sold bitcoin to bolster our cash position."

Tesla's most recent bitcoin sale is certainly not a critique of bitcoin. When Tesla sold some bitcoin last April it did so to "test liquidity." Now, in the second quarter, when it needed cash, there was ample liquidity to supply that cash. So even though bitcoin was referred to as a "sideshow to a sideshow" on the call, Tesla's CEO added that "we are certainly open to increasing our bitcoin holdings in the future."

Tesla isn't in the bitcoin business, and neither are most companies. But hey, bitcoin can sit on balance sheets and act as a treasury asset for cash management if these companies so choose. Part of cash management means moving in and out of different assets as the needs of the business evolve.

Tesla, and other companies, will be back for more in due time.

Those off-base accounting rules governing digital assets

I promised to cover some off-base accounting rules, so I will because they're somewhat important. It also aligns with my general view that "going public is dumb" and that "infinite growth is not only impossible, but bad."

I'll keep it brief.

Right now, bitcoin is treated as an indefinite-lived intangible asset. That means the companies that hold bitcoin on their balance sheets need to mark down its balance sheet value if bitcoin's price decreases. This is sensible and gives an accurate representation of the financial reality that the asset it holds is now worth less.

Unfortunately, because bitcoin is treated as an indefinite-lived intangible asset, the company is not allowed to increase the value of the bitcoin to accurately represent the financial reality that the asset it holds is now worth more. Mark-to-market assets, in contrast, allow companies to adjust the value of an asset to reflect its value as determined by current market conditions. If bitcoin were allowed to be treated as a mark-to-market asset, companies could do this.

The rule that requires bitcoin to be treated as an indefinite-lived intangible asset is determined by the Financial Accounting Standards Board (FASB) in the U.S. And they should change the rule for two reasons.

First, it makes sense. Indefinite-lived intangible assets include things like goodwill, a made-up asset that allows acquiring companies to overpay for a target. Goodwill doesn't trade on any sort of liquid market, but bitcoin does. Marking goodwill to market is basically impossible; marking bitcoin to market is easy.

And second, it would give a more accurate representation of companies' financial positions. Public companies in the U.S. are already onerously tasked with providing quarterly financial reports to shareholders. If these companies hold bitcoin that is impaired one quarter and not allowed to be marked up the next, that will give an inaccurate representation of the company's financial position without additional information from the company.

To that point, we should bring it back to Tesla. Remember it converted a majority of its bitcoin holdings for a gain offset by "impairment charges on the remainder of our holdings netting a $106 million cost to the [income statement]." So Tesla's income statement doesn't show the sale of bitcoin that made money (which is normal; it shows up on the cash flow statement), but it does show an income statement loss associated with bitcoin it didn't sell. That makes no sense.

In the spirit of … ahem … making sense, perhaps we should start treating bitcoin like the mark-to-market asset it is.

Takeaways

Blockchain.com downsized its workforce by 25%, equating to roughly 150 people.

TAKEAWAY: In the past 16 months, Blockchain.com grew from 150 employees to more than 600, but with recent brutal bear market conditions, Blockchain.com will close its Argentina-based offices, cancel team expansion plans in several countries and reduce salaries of its executives. The exchange recently revealed it was dealing with a $270 million shortfall from lending to beleaguered hedge fund Three Arrows Capital. Read more here.

Vitalik Buterin gave "big thanks" to the Shiba Inu community for their role in supporting Ph.D. students researching artificial intelligence.

TAKEAWAY: The first cohort of recipients of an artificial intelligence grant program backed by Ethereum co-founder Vitalik Buterin was announced on July 20. In response to the tweet that announced the fellows, Buterin said, "Big thanks to the Shiba Inu community, whose cryptocurrency made these fellowships possible." Buterin likely acknowledged the meme coin's community because Shiba Inu developers had sent 50% of SHIB's total supply last year to Buterin, which amounted to billions of dollars at the time. Read more here.

A former Coinbase product manager was arrested on allegations of wire fraud and insider trading.

TAKEAWAY: The U.S. Department of Justice and the Securities and Exchange Commission both charged Ishan Wahi, former Coinbase product manager, on insider trading allegations. This is "the first-ever insider trading case involving cryptocurrency markets," said U.S. Attorney Damian Williams. "Our message with these charges is clear: Fraud is fraud, whether it occurs on the blockchain or on Wall Street. And the Southern District of New York will continue to be relentless in bringing fraudsters to justice, wherever we may find them." Read more here.

The SEC asserted cryptocurrencies were securities in an insider trading case without charging Coinbase, the issuer of the tokens.

TAKEAWAY: The U.S. Securities and Exchange Commission (SEC) used its first insider-trading case July 21 to formally declare nine digital tokens as "securities" in its ongoing practice of defining its crypto oversight through enforcement actions. The SEC has identified cryptocurrencies as securities in the past, but the insider trading complaint filed by the federal securities regulator on July 21 was the first time the SEC identified several cryptocurrencies as securities without charging the issuers or the exchange listing the so-called securities. Read more here.

Genesis Global Trading filed a $1.2 billion claim against now insolvent Three Arrows Capital.

TAKEAWAY: According to a 1,157-page court filing, crypto broker Genesis has filed a $1.2 billion claim against Three Arrows Capital (3AC). In May, sources told CoinDesk that Genesis faced losses in the "hundreds of millions" because of its 3AC exposure. Digital Currency Group, the parent company of Genesis and CoinDesk, has assumed the entire $1.2 billion claim. Genesis is left without any outstanding liabilities tied to 3AC. Read more here.

Introducing Market Wrap, our daily newsletter that explains what happened today in the crypto markets — and why. Sign up to get it in your inbox each weekday.

Podcasts Worth Listening To

CoinDesk Podcast Network

What's Next for Celsius Customers; Crypto VC Investments Drop 26% in First Half of 2022

"The Hash" team discusses today's top stories, including Celsius Network outlining its next steps as the insolvent crypto lender's bankruptcy hearing starts. Plus, a closer look at venture capital (VC) investments in crypto companies, as funding drops 26% in the first half of the year.

The Breakdown, With NLW

The Future of the Bitcoin Energy Debate, Feat. Troy Cross

Troy argues that Bitcoin can help usher in a more renewable energy mix.

On Purpose, With Tyrone Ross

What Now? What Should Advisers Be Thinking About After the Crypto Meltdown

How to become a guardian of the 'investor' galaxy.

Today's Market Wrap email was produced by Sage D. Young.