The SEC directs exchanges to treat customers’ crypto holdings as liabilities

WASHINGTON — Cryptocurrency exchanges will soon be required to report the digital tokens they hold for customers on their balance sheets, according to Securities and Exchange Commission accounting guidelines released Thursday.

The guidelines echo SEC Chairman Gary Gensler’s warning that cryptocurrency-owning investors use trading platforms like Coinbase Global inc

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effectively provide unsecured loans to these companies.

As part of their business, crypto trading platforms custodian or hold assets on behalf of their clients. Like publicly traded securities brokers, they currently disclose the total value of these assets apart from their own balance sheets, which detail their own assets and liabilities.

The new accounting rules direct publicly traded crypto firms to record the digital tokens they hold for clients as assets and their obligations to clients as liabilities.

SEC officials said the goal is to introduce consistency into the accounting methods used by such platforms. But the change could also cause the balance sheets of publicly traded crypto exchanges and other SEC-registered companies that hold cryptocurrencies to grow exponentially.

Coinbase, the largest publicly traded crypto exchange, says it holds $278 billion worth of cryptocurrencies and currencies for its customers as of December 31, 2021. However, on its balance sheet, it only shows assets and liabilities worth $21.3 billion.

“We’re going to see a very stretched balance sheet on both the debit and credit side for crypto exchange operators,” said Vivian Fang, associate accounting professor at the University of Minnesota.

WSJ’s Dion Rabouin explains why Wall Street is now heavily into crypto and what that means for the new asset class and its future. Photocomposite: Elizabeth Smelov

The SEC’s new guidance on crypto trading platforms contrasts with the approach used by brokers like Charles Schwab Co. Inc. These firms are allowed to take the value of customer assets off their own balance sheets as a precedent has established that in the event of bankruptcy the assets belong to the customers.

The law is less firm in the case of crypto, SEC officials say.

The crypto industry has grown rapidly in recent years thanks to a spate of Wall Street market participation and venture capital funding. But despite the rising popularity of digital tokens, the market remains largely unregulated.

While the technology behind cryptocurrencies allows people to trade directly with each other via digital wallets, most investors access the market via centralized trading platforms such as Coinbase, FTX or Kraken.

In such cases, these platforms hold customers’ bitcoins or other tokens in their own wallets.

“The obligations associated with these agreements involve unique risks and uncertainties not present in non-cryptoasset asset protection agreements, including technological, legal and regulatory risks and uncertainties,” SEC officials wrote in an am Bulletin published Thursday. “These risks can have a material impact on the Company’s operations and financial condition.”

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Appeared in the April 1, 2022 print edition as “Crypto Exchanges Told to Treat Customer Assets as Liabilities”. The SEC directs exchanges to treat customers’ crypto holdings as liabilities

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