Managing cryptocurrency is not the same as managing traditional currencies, such as the U.S. dollar or the euro. While traditional currency is held in and processed via bank accounts, cryptocurrency is managed via cryptocurrency wallets (or digital wallets). Moreover, cryptocurrency is not considered a currency per se; rather, it is a digital asset. Each type of cryptocurrency — e.g., Bitcoin, Ethereum, USD Coin, central bank digital currency (CBDC) — has its own specific features, so each type behaves slightly differently.
All of these differences from traditional currency mean the risks associated with cryptocurrency are similarly different, and treasurers need to pay close attention to understanding the risks as they develop crypto strategies for their organizations. Here are three risks that warrant particular attention:
Counterparty risk is always an important consideration for treasurers and cryptocurrency management is no exception. However, evaluating counterparty risk for cryptocurrency is more complex than for many other treasury tasks for two important reasons. First, setting up a cryptocurrency wallet with a crypto exchange almost certainly involves establishing a relationship with a new counterparty. As a result, both parties will need to perform detailed due diligence on each other. Second, unlike most other counterparties, crypto exchanges are not subject to long-established regulatory requirements. This means there is less information available to assess counterparty risk when compared with the information available on banks for example. Moreover, the regulatory environment in the crypto space is less developed, meaning there is less protection available for corporate treasurers than is available in a traditional bank relationship.
Each cryptocurrency is designed differently, so it is important to understand the respective risk profile of a currency before deciding whether to accept payment in it or hold it as a digital asset. Bitcoin’s value comes from its relative scarcity, as it is generated via digital mining, with its value fluctuating in the market. Stablecoins, such as USD Coin, are designed to track a reference asset, which might be a fiat currency (the U.S. dollar in the case of USD Coin) or other reference assets. Understanding how a specific cryptocurrency’s price varies is a key component of managing that volatility.
Cryptocurrencies are managed via digital wallets which are accessed via the use of private keys. Managing access to these keys is central to the operational risk surrounding the use of cryptocurrencies. Holding internally requires having appropriate segregation of duties and other procedures to protect the integrity of the private keys. Outsourcing requires an additional layer of due diligence on the outsource provider. More generally, managing cryptocurrency is likely to be a novel activity for most treasurers; developing an understanding of the instrument is critical, so that the risks can be explained to internal partners, such as tax, legal and accounting, as well as to the board.
Want to learn more? Check out the 2022 AFP Payments Guide to Cryptocurrency and Non-fungible Tokens for Corporate Payments, underwritten by MUFG.