Elon Musk’s decision to invest US$1.5-billion of Tesla’s cash in bitcoin is financial dynamite that unites two speculative bubbles. There’s plenty to suggest the move is inadvisable. Though small in the context of Tesla’s $830-billion market value, this is still a material portion of Tesla’s $19.4-billion cash reserves to park in such a volatile asset.
Tesla wouldn’t be the first car company to operate as a quasi hedge fund. For a time, Porsche made tons of money trading derivatives, almost bankrupting itself in the process. Owning cryptocurrency sits badly with Musk’s green ethos: Some bitcoins are mined with renewable power but the industry still leaves a sizeable carbon footprint.
Musk’s purchase has boosted bitcoin’s price by almost 20%, so in one sense he’s won already. Unfortunately, his bet won’t improve Tesla’s reported earnings or boost the value of its cash reserves. That’s because cryptocurrencies — despite the name — aren’t classified as cash or equivalents for accounting purposes.
Nor are they considered a financial investment under current accounting rules. Instead they’re deemed an intangible asset whose value is reported at cost in corporate accounts and must be written down if the price declines. The value cannot be written up again until they’re sold. This is a significant disadvantage and might discourage other corporate treasurers from following Musk’s lead.
It’s also not entirely fair, whatever you think about Musk gambling with Tesla’s money. Shouldn’t accounting standards be updated for the crypto era?
Here’s the relevant bit from Tesla’s filing:
Digital assets are considered indefinite-lived intangible assets under applicable accounting rules. Accordingly, any decrease in their fair values below our carrying values for such assets at any time subsequent to their acquisition will require us to recognise impairment charges, whereas we may make no upward revisions for any market price increases until a sale. As we currently intend to hold these assets long term, these charges may negatively impact our profitability in the periods in which such impairments occur even if the overall market values of these assets increase.
In plain English, if the price of bitcoin price suddenly fell by, say, a third compared to the Tesla’s cost of acquiring it — pretty plausible in the context of bitcoin’s historic volatility — then the car maker’s earnings would be short $500-million during that quarter. Tesla will book no corresponding gain if the price rises again. The volatility of Tesla’s earnings could increase even more if customers start paying for their cars in bitcoin, as Musk will soon allow, and the company elects not to convert it immediately into US dollars.
This isn’t just a Tesla problem. Business analytics company MicroStrategy had invested a whopping $1.1-billion in bitcoin as of 31 December. It even decided to make bitcoin its primary treasury reserve asset, and so far the decision has paid off: Its holdings have almost trebled in value. But because bitcoin’s price has fluctuated, MicroStrategy has already needed to book a total of $71-million of impairments, including $26.5-million in the fourth quarter.
The accounting treatment is weird because if you can buy a Tesla with bitcoin then it’s clearly serving as a medium of exchange, albeit a volatile one that’s not state-backed. Foreign currencies can be volatile too — just ask Argentina. There’s also a clearly observable market price for bitcoin as it’s traded on exchanges. In view of tentative efforts by airlines to accept cryptocurrencies as payment, industry body IATA has argued that these tokens should be “treated as cash if they function as cash”.
Analysts will doubtless adjust Tesla’s reported financials to reflect the current value of its bitcoin holdings but it’s an inelegant and less transparent approach.
Unfortunately, the standard setters don’t appear to be in a rush to embrace the crypto revolution. The Financial Accounting Standards Board, whose job is to oversee Generally Accepted Accounting Principles (GAAP), voted unanimously not to add cryptocurrencies to its technical agenda in October.
One can understand the reluctance. Accounting rules were created before cryptocurrencies were invented. The bean counters don’t want to be blamed if companies get their fingers burned.
Still, with interest rates at zero, I doubt Tesla will be the last tech company to try to earn a better return on its cash holdings. Anyone who does so is taking a massive financial risk but they should be allowed to record the value of their bitcoin at the current market price. Anything else gives investors an incomplete picture. — Reported by Chris Bryant, (c) 2021 Bloomberg LP