Accounting for a 51% Attack

In this article I will give a quick primer on what a 51% attack is, its implications, and describe a way to account for crypto assets that have undergone a 51% attack. As a general disclosure, please be sure to speak with your accountant / tax adviser to confirm how these assets should be reported for your company.

What is a 51% attack?

A 51% attack is an attack against a blockchain where a majority amount of mining power is coordinated to change the canonical chain. The game theory of Proof-of-Work systems requires that miners be in competition with one another to solve hash functions to validate the network. If miners pool together, or a single miner amasses enough computing power, they can control the network. This could lead to a variety of issues including double-spending and censorship of transactions of blocks that the attacker now has control of. For more information about how a 51% attack is actually executed at a high level, check out Coincenter’s overview. As of today, it appears there is a 51% attack taking place on the Ethereum Classic blockchain (ETC).

How exchanges protect against consensus discrepancies

For the Bitcoin blockchain, a 51% attack would be extremely expensive making it economically impractical. While 51% attacks themselves are rare, there are sometimes hiccups in consensus outcomes leading to discrepancies over recently minted blocks. It is for this reason that many exchanges require a certain amount of block confirmations to pass before they credit user accounts. Here is a sample of the standards that some exchanges have employed to ensure that they are transferring assets on canonical chains:

When it becomes apparent that a 51% attack is taking place, exchanges may either freeze the trading of that asset, or increase the number of block confirmations required to trade that asset. Exchanges that do not act quickly to protect against these attacks are likely to be the largest losers. When an attacker starts changing blocks that have been confirmed, the previously confirmed balances are still sitting in user accounts on the exchange, resulting in a conflict with the information on the chain. Here are some examples of reactions by exchanges today as a result of the 51% on ETC.

What does it mean for a trade to be settled?

In traditional asset classes it takes two days after a trade (T+2) is executed to be settled, although some asset types like mutual funds are on a different timeline. Given the settlement timeline, there are a few kinds of violations that are relatively common on brokerage sites. Below are examples of cash account violations.

Businesses can decide whether they prefer to account for trades as of their trade date or settled date. The settlement date sets the legal transfer of ownership of a security from seller to buyer.

With crypto assets, “settlement” times are generally much faster, but vary depending on the asset. There is no GAAP or IRS guidance yet for individuals or companies on how to treat assets that have been double-spent or otherwise corrupted via a 51% attack. In the absence of clear advice, these assets should at least be footnoted on financial statements to indicate the estimated write down in value. Companies that own other crypto assets may want to consider a line item in financial statements along the lines of “Allowance for Cryptocurrency Investment Losses” and maintain very clear documentation for the criteria against which these assets are compared against to estimate that line item.