Accounting for Web3
Since my last article, I have received my bear name “BearMcNumbers”. I’ll caveat that this article ties more closely to my official bear name and is more accounting focused than my previous one about Mighty Bear’s culture, available here if you want to escape now.
Let's begin — the rise of cryptocurrencies and blockchain technology has the potential for a great many financial solutions. Be that as a hedge against traditional financial markets, or the promise of new systems and solutions that will forever change the financial landscape. It has also opened up a number of questions. How should on-chain transactions and cryptographic assets be tracked, valued, and represented? It is not what is an NFT, but where, when, and how much is an NFT?
In this article, I will discuss some of the finance solutions available in Web3, including crypto tracking and accounting software, the use of AI in finance, NFT valuation, and the accounting treatment of cryptographic assets.
Walking Before You Can Run
At the setup stage, it is beneficial from both a risk management and quality of life perspective to subdivide distinct revenue streams and functions into their own unique wallet addresses. This sets a limit on the percentage of the assets exposed if any one wallet is compromised and prevents distinct revenue and cost flows from becoming entangled.
A good starting point when trying to analyze any on-chain transaction is with a block explorer such as Etherscan. Here you can search by wallet and transaction IDs, referred to as “Transaction Hash”. Block explorers can be very effective when trying to confirm information regarding a small number of transactions, or assets. For example, Etherscan is a perfectly suitable tool to answer the following questions:
- What is the current ETH balance of a wallet?
- Did an on-chain transaction go through successfully?
- What NFTs are held in this wallet?
If you want to dig deeper, you can also click on any transaction ID to find the transaction details. This provides useful information for a given transaction such as sending wallet, receiving wallet, contracts interacted with, value, transaction fees, and gas price. A major benefit of blockchain technology is the availability of past transactions, with a few clicks you can trace an NFT back to its mint.
So When Do You Need To Use Software?
Block explorers are limited in their ability to efficiently analyze a large volume of transactions, assets, or wallets. As a result, the more on-chain activity there is, the more a software system is needed. A large amount of on-chain activity can be driven by a number of activities, such as testing, mints, issuances, and hype in general. As a result, a suitable crypto software system is essential for a Web3-based business to produce accurate information in a timely manner. Be it from an accounting perspective, or to accurately understand revenue metrics and analytics.
Dune is a great starting point on the analytics side. It is an open source with data and trends published across multiple crypto projects.
There are several crypto accounting software solutions available and coming to market, while some are better than others the choice will depend on the specific needs of each business. Having said this I would keep the following requirements front of mind when choosing a software system:
- Recognize internal transactions — if there is a transfer between two wallets that a company controls the software should recognize this as an internal transfer — this is very beneficial surrounding the moving of operational funds/assets and the testing of assets and contracts;
- Ability to automate transactions — for example, all transactions to a certain wallet address that interacted with a Seaport (OpenSea) address should be categorized as royalty revenues;
- Integration with existing bookkeeping systems and software — quality of life and time-saving reasons;
- Functionality around tracking of crypto prices and the cost basis method which can be applied —A number of tax jurisdictions and accounting bodies specify the accepted calculation methods of the gain or loss arising on the disposal of a payment token. For example first in first out (FIFO), or weighted average cost methods. In this case, it is essential that the software has this functionality enabled. You may also wish to set a stable coin at a set value;
- Refresh times and reliability — a general sign of quality, you should always test before you buy or implement that the software can meet a sufficient transaction volume;
- Ability to recognize realized and unrealized gains and losses; and
- Ability to roll up transactions — for example, many mints will have thousands of transactions, so it is preferable to group transactions together. Then roll transactions up into days, weeks, or months rather than the cumbersome alternative of having thousands of individual postings in your accounting records.
Well done to those of you still with me, the bear above is proud of you. Web3 is set to change the landscape of a number of industries and spaces, and new solutions are emerging every day to help us tackle the information collection challenges. Crypto accounting software, AI in finance, and accounting treatment of crypto assets are just a section of the landscape when it comes to the many challenges of Web3. The deeper complexities of NFT valuation and applying accounting standards to Web3 are worthy of separate articles, but I will note that if you were to write this article three years ago, it would be very different from if you were to write it today. As this technology continues to evolve, it is essential to stay up-to-date with the latest developments to make informed financial decisions.