Do stablecoins make crypto accounting easier?

There is no doubt that stablecoins are so hot right now. Many of the big players in the industry are coming out with their own stablecoins. That’s in addition to stablecoins that have already been out and about for a while. Here is a little summary of some popular and recent stablecoin releases:

Let’s go over quickly why stablecoins are a thing, why they are suddenly so popular, some of the dangers with stablecoins and misconceptions. The TLDR is, the way accounting regulations work right now, stablecoins add a layer of complication to cryptocurrency accounting rather than simplify it.

What is a stablecoin?

A stablecoin is simply a cryptocurrency that is pegged to a certain value. Right now, most altcoins are denominated back to the value of Bitcoin. This can be hassle when trying to assess the value of your portfolio or when trading, since sometimes you need to go through a few pairs. For the purposes of this article, I will focus on the implications of fiat-collateralized stablecoins (particularly USD pegs). For an explanation of other types of stablecoins, I would suggest reading this. Here’s an example of how stablecoins could improve trading:

Alice wants to buy Stellar Lumens (XLM) on Bittrex. She has some Bitcoin sitting in her account that she wants to use to buy it. There is no BTC-XLM market available on Bittrex. Alice needs to trade her BTC for ETH, then take that ETH and buy XLM. If she wants to liquidate her position, she needs to trade her XLM to ETH and since Bittrex has a USD-ETH market, she can sell her ETH for USD.

Super annoying, right? Depending on the liquidity of the market, it also takes extra time and incurs more exchange fees.

Stablecoins have the ability to make this kind of trading easier. Bittrex actually has stablecoin (Tether) trading pairs with 20 cryptocurrencies as of the writing of this article, but not for XLM. In the perfect stablecoin world, once Alice transfers USD into her Bittrex account, she should convert it at a 1-to-1 ratio to a stablecoin (Tether in this case), and then the whole world of Bittrex stablecoin trading pairs is open to her.

That’s the upside of stablecoins with regards to trading. You can imagine the ripple effect of ease when trying to value your portfolio, assess performance, and decrease trading fees.

Misconceptions

Various makers of stablecoins have glossed over accounting rules indicating that stablecoins will make reporting easier. Although it’s conceivable that stablecoins will one day improve cryptocurrency accounting (and other token management issues), given the current rules in the United States, it actually complicates it.

Those stablecoins are still considered assets, and we need to calculate gains and losses for them. While they are pegged to fiat, like all foreign exchange trades, the precise rate will fluctuate based on the market liquidity. If the stablecoin is backed by a cryptocurrency, the fluctuations will likely be more extreme. This means lots of adjusting entries that wouldn’t otherwise be made. It also mean miniscule calculations of taxable gains and losses. While well-intentioned, stablecoins may also introduce more risk. Maintaining a USD peg requires active management by a central party to ensure that the rate is staying constant. What if the stablecoin is not properly managed or isn’t holding the responsible amount of reserves or their algorithm goes haywire? Tether, for example, had $30 million worth of its tokens hacked around Thanksgiving in 2017. If you are familiar with this story already, you also probably know that they failed to follow through on their promise to conduct and audit as well.

Future of Stablecoins

Gemini and Paxos both made big announcements about their own stablecoin releases last week (September 12, 2018). The Gemini Dollar (GUSD) and Paxos Standard (PAX) each aimed to take the title of ‘the world’s first regulated stablecoin’ via press release. (Let’s call this one a tie). Each of the stablecoins is regulated by the New York Department of Financial Services. Generally, this regulation means that each of these companies will need to comply with certain anti-fraud, consumer protection, and anti-money laundering protocols. They will also each submit themselves to regular audits to ensure that they are holding adequate reserves.

The uptick in regulatory attention and openness to these new kinds of financial instruments fosters and environment where stablecoins can continue to proliferate. We must continue to wait, however, for the IRS to further specify how this enormous asset class should be reported.

Conclusion

While the future of stablecoins looks bright, like many things in the cryptocurrency ecosystem, that outcome is still speculative. We have seen an appetite by U.S. regulatory authorities to foster an environment for this mechanisms to grow. We have yet to see however, accounting guidance change to make this a feasible tool to manage a cryptocurrency portfolio.

If your business could use some help on cryptocurrency accounting, feel free to reach out to us here.