What are Non-fungible Tokens?

Illumeo Customer Success's Profile

Non-fungible tokens are a type of digital crypto asset that represents real-world objects such as art, music, videos, and in-game items.  Like other types of cryptocurrency, they are bought and sold online and encoded with an underlying software.

Characteristics of Non-fungible Tokens

Non-fungible tokens are a unique type of cryptocurrency.  While most cryptocurrencies are infinite in supply, non-fungible tokens have unique identifying codes and are often one-of-a-kind or a part of a very limited run.  Most cryptocurrencies are considered fungible, meaning they can be traded or exchanged for one another; similar to the trading of physical currency.  Because cryptocurrencies are fungible, they are a more trusted means of conducting transactions.  Non-fungible currencies cannot be traded between one another. A non-fungible token allows a buyer to purchase an original item with its own proof of ownership through the unique built-in authentication.  In many ways, a non-fungible token is like a collector’s item, but instead of owning a physical item, such as a work of art, the collector owns the item digitally through a digital file.  Currently, the most popular types of non-fungible tokens are art, GIFs, videos and sports highlights, collectibles, virtual avatars, video game skins, designer sneakers, and music.    

Accounting Challenges of Non-fungible Tokens

Non-fungible tokens are very challenging to value, as their values are often based on multiple factors, including the perceptions of the seller and buyer, the scarcity of the token, and how easy it is to access and receive.  The value is often dependent on the characteristics of its creator.  The current perceived value of the non-fungible token may have little bearing on the future value of the token for the next buyer.  The valuation through perceived or intrinsic value makes it even more complicated for accounting for these tokens.  Currently, there are few appraisal services valuing non-fungible tokens.

Lack of Authoritative Guidance

There is no guidance in the generally accepted accounting principles (GAAP) for accounting for non-fungible tokens.  The Financial Accounting Standards Board (FASB) has decided to not add a project related to accounting for cryptocurrency to its current agenda.  Due to the lack of guidance, there are many questions regarding which asset class to use in recording cryptocurrencies.  Cryptocurrencies most closely resemble GAAP’s intangible asset classification, which requires the currency to be recorded at cost and not adjusted on the financial statements for an increase in value.  They are also required to be tested for impairment at least annually.  

Asset Volatility

The market for digital assets is very volatile and the marketplace is speculative.  Historical costs are quite useless to financial statement users.  As referenced above, determining the fair market value is fluid, especially considering there may not be any similar transactions or assets for reference.  The accounting for investment companies and hedge funds, as a whole, is different from much of GAAP accounting.

Recording Transactions  

There is no GAAP guidance as to whether the costs of creating a non-fungible transaction should be capitalized or expensed.  Non-fungible tokens should be recorded at cost based on the purchase price.  Exchange gains or losses are recognized related to the cryptocurrency used to purchase the non-fungible token.  Income from the sale of non-fungible tokens is recorded when the cryptocurrency to pay for the tokens is received.  Revenue recognition is complicated as some non-fungible tokens are associated with a right to recurring revenue stream through limited memberships and future resales.