Determining Principal Market Price for Crypto Assets: Bridging Traditional Accounting with Blockchain

Introduction: A New Era in Crypto Asset Accounting

The rapid evolution of the crypto assets industry has presented unique challenges for accounting professionals trying to apply traditional financial standards to an entirely new asset class. Historically, crypto assets have been treated as intangible assets, measured at cost less impairment, which often failed to represent the true economic value of these assets on financial statements.

With the Financial Accounting Standards Board (FASB) approving ASU 2023-08, a shift from cost less impairment to fair value measurement for certain crypto assets is ushering in a new era. Under the updated ASC 820, accounting practitioners must apply the concept of Principal Market Price (PMP), now more relevant than ever for accurate crypto asset valuations.

This post provides an in-depth exploration of PMP determination within the framework of ASC 820, Fair Value Measurement, focusing on crypto assets, the challenges practitioners face, and the best practices for adopting this new standard.

Understanding Principal Market Price (PMP) Under ASC 820

The Principal Market Price (PMP) is foundational for determining the fair value of crypto assets. ASC 820 provides a comprehensive framework for determining fair value, including the identification of a principal market or, if unavailable, the most advantageous market. This approach ensures that the valuation reflects the most accessible and relevant market for a reporting entity.

Principal vs. Most Advantageous Markets

Principal Market: The principal market is the market with the greatest volume and level of activity for the crypto asset that the reporting entity can access. Typically, this will be a centralized crypto exchange through which the entity transacts most frequently.
Most Advantageous Market: When a principal market is not identifiable, the entity should use the most advantageous market—the market that maximizes the net amount received from the sale. For crypto assets, this could mean considering factors like liquidity, fees, and order execution quality across several exchanges.

The principal market or most advantageous market will directly influence the valuation inputs, guiding whether a fair value measurement should rely on observable (Level 1 and 2) or unobservable (Level 3) inputs.

Fair Value Hierarchy

ASC 820 categorizes fair value measurement into three levels:

Level 1 Inputs: Observable, quoted prices in active markets for identical assets. For crypto assets, these typically include liquid exchanges such as Binance or Coinbase that provide direct price quotes for identical tokens.
Level 2 Inputs: Observable inputs other than Level 1. These might include quoted prices for similar assets traded on either active or inactive markets, or adjusted Level 1 inputs when direct pricing is unavailable.
Level 3 Inputs: Unobservable inputs for assets, often involving valuation models. In the context of crypto, VC investments, SAFTs (Simple Agreements for Future Tokens), and token warrants may fall under Level 3 due to a lack of active market trading.

Challenges in Determining Principal Market Price for Crypto Assets

1. Exchange Accessibility and Market Selection

Under ASC 820, reporting entities must consider only those markets that they can access when determining the principal market. This can be challenging for crypto assets, as many exchanges have geographic or regulatory restrictions limiting accessibility.

Price Aggregators are not considered a market in which transactions occur, and therefore cannot be used for PMP. For derivatives and other complex instruments related to crypto assets, PMP must be determined by assessing which markets provide reliable, accessible pricing data.

2. Exchange Reliability and Price Quality

The reliability of crypto exchanges varies significantly. Reporting entities must evaluate an exchange’s history, transparency, regulatory compliance, and security practices before relying on its data. If data from a particular exchange is deemed unreliable, it should be excluded from the PMP determination process.

3. Decentralized Exchange (DEX) Considerations

For crypto assets listed exclusively on decentralized exchanges (DEXs), PMP determination presents additional complexities. DEXs often have lower liquidity and higher volatility compared to centralized platforms. The decentralized nature also poses challenges in assessing transaction orderliness, requiring careful consideration regarding their influence on the overall fair value.

4. Cross-Pair Trading and Market Depth

Crypto assets frequently trade across different fiat and crypto trading pairs (e.g., BTC-ETH, BTC-USDC). Market depth and liquidity vary between these trading pairs, potentially affecting the reported PMP. For example, a highly liquid BTC-USD market will yield more reliable pricing than a less liquid BTC-DAI market, which must be reflected in PMP adjustments.

5. Orderliness and Price Relevance

Determining whether transactions are orderly is a critical step in assigning weight to pricing information. For crypto assets, particularly in volatile or illiquid markets, evaluating orderliness may involve making market participant adjustments. Transactions deemed disorderly should carry minimal or no weight, while those with unknown orderliness require complementary valuation inputs to enhance reliability.

Best Practices for Accounting Practitioners

1. Develop Robust Valuation Policies

To achieve consistency and audit readiness, reporting entities must establish robust valuation policies that define criteria for exchange selection, pricing reliability, and handling price anomalies. These policies should also address the process for determining PMP across both centralized and decentralized platforms.

2. Active Industry Engagement and Regulatory Monitoring

Given the dynamic regulatory landscape, practitioners should stay actively engaged in industry discussions and regulatory updates to ensure ongoing compliance. The accounting treatment for crypto assets will continue evolving, and being proactive in tracking changes is essential for maintaining alignment with the FASB and regulatory bodies.

3. Leveraging Advanced Tools for PMP Analysis

Valuation of crypto assets is resource-intensive. Practitioners should consider leveraging specialized valuation software capable of price aggregation, exchange ranking, and liquidity assessment to aid in determining the most reliable PMP. These tools can reduce errors and improve consistency in applying the ASC 820 framework.

4. Use Diverse Market Data

When determining PMP, practitioners should utilize data from a wide range of exchanges, including both centralized and decentralized platforms. This approach ensures a more comprehensive representation of market activity, ultimately leading to more accurate fair value estimates.

5. Emphasize Fair Value Measurement Levels

Maximizing the use of observable inputs is crucial for accurate valuation. Practitioners must prioritize Level 1 and Level 2 inputs where available, minimizing reliance on Level 3 models, which introduce greater subjectivity and complexity. Understanding where each crypto asset falls within the fair value hierarchy can significantly impact the reliability of reported values.

Conclusion: Navigating Crypto Asset Fair Value

As the adoption of ASU 2023-08 draws closer, accounting practitioners must focus on developing a nuanced understanding of principal market price determination under ASC 820. Crypto asset valuation presents unique challenges due to market fragmentation, differences in reliability, and emerging technologies such as DEXs. However, by adopting robust valuation methodologies, utilizing diverse data sources, and staying informed about regulatory changes, practitioners can ensure compliance and accuracy in reporting the fair value of crypto assets.

The dynamic nature of the crypto space demands flexible, proactive approaches to valuation. By embracing these best practices, accounting practitioners will be better equipped to navigate the complexities of PMP and help the industry transition smoothly to fair value measurement.

Call to Action: Sharpen Your Crypto Asset Valuation Skills

For those in the accounting field, now is the time to strengthen your understanding of PMP determination for crypto assets. Stay ahead by engaging in industry forums, utilizing the latest valuation tools, and refining your accounting practices to ensure compliance and precision in this evolving space.

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