SEC Tells Exchanges to Treat Client Crypto Holdings as Liabilities

WASHINGTON—Cryptocurrency exchanges will soon have 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 reflect SEC Chairman Gary Gensler’s warning that investors who own cryptocurrency through trading platforms like Coinbase Global Inc.

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actually provide unsecured loans to these companies.

As part of their business, crypto-trading platforms retain or hold assets on behalf of their clients. Like publicly traded securities firms, they currently disclose the total value of these assets outside of their own balance sheets, which correspond to their own assets and liabilities.

The new accounting guidelines require publicly traded crypto companies to record the digital tokens they hold for customers as assets and their obligations to customers as liabilities.

SEC officials said the goal was to introduce consistency in the accounting methods used by these platforms. But the change could also lead to exponential growth in the balance sheets of publicly traded crypto exchanges and other SEC-registered entities that hold cryptocurrencies.

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

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

WSJ’s Dion Rabouin explains why Wall Street is now betting big on crypto and what that means for the new asset class and its future. Photo composition: Elizabeth Smelov

The new SEC guidelines for crypto-trading platforms contrast with the approach used by brokerages such as Charles Schwab Co. Inc. These companies are allowed to leave the value of client assets out of their own hands. balance sheets due to a legal precedent which established that, in the event of bankruptcy, the assets belong to the customers.

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

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

While the technology behind cryptocurrencies allows people to transact directly with each other using digital wallets, most investors access the market through centralized trading platforms like Coinbase, FTX, or Kraken.

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

“The obligations associated with these agreements involve unique risks and uncertainties that are not present in non-cryptoasset asset protection agreements, including technological, legal and regulatory risks and uncertainties,” he said. wrote the SEC staff in a bulletin published Thursday. “These risks can have a significant impact on an entity’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”.

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