Place of Cryptocurrency in the System of Financial Instruments

In March 2020, the Federal Financial Supervisory Authority (BaFin), the responsible entity for ensuring the stability and integrity of Germany’s financial system, officially recognized Bitcoin and other cryptocurrencies as financial instruments, which motivated more people to buy Bitcoin.

The decision is a huge event in terms of regulatory transparency and acceptance of digital assets, especially considering that Germany still has Europe’s highest GDP and is one of the most powerful economies in the world.

Also, while many countries will follow the same path, other governments are still not sure about the nature of cryptocurrencies and how they need to be treated by the law.

In this article, you will discover all you need to know about the concept behind financial instruments and how cryptocurrencies fit in the category.

Financial Instruments – Explaining the Term

The debate around the concept of financial instruments and why certain assets are treated differently from others is still active in the international financial community.

In 2010, the IASB (International Accounting Standards Board), one of the most important accounting entities worldwide, updated its parameters for making the so-called IFRS (International Financial Reporting Standards).

Accordingly, the straightest definition of a financial instrument refers to any contract that generates a financial asset for one party involved while generating a financial liability or an equity instrument for the second part involved.

In layman’s terms, financial instruments are tradable assets. In most cases, the use of financial instruments allows investors to have efficient capital flow and seamless transfers of capital all through distinct financial transactions.

Understanding Financial Instruments – In Detail

Simply put, financial instruments are assets or packages of capital that can be traded in the financial market.

For instance, a financial instrument can represent ownership of something (e.g., stocks or company shares), a loan that an investor made to the owner of a specific asset, or even a foreign currency.

Contracts that are given a value to and then traded in the financial market, such as securities, are also financial instruments. Nowadays, there are two main types of financial instruments – cash instruments and derivative instruments.

Cash instruments are financial instruments that are valued directly by the financial market, such as:

  • Equity instruments
  • Bonds
  • Loans/borrowings
  • Receivables & payables
  • Cash deposits

Plus, readily transferable securities are also considered cash instruments.

On the other hand, derivative instruments are financial instruments whose value varies depending on at least one underlying asset. This category includes operations such as:

  • Forwards and futures
  • Financial options
  • Swaps
  • Caps & Collars
  • Financial guarantees
  • Letter of credit

Are Cryptocurrencies Financial Instruments? – Opening the Debate

According to the IFRS (International Financial Reporting Standards), the main problem with cryptocurrencies is that they do not fit easily within IFRS’s financial reporting structure.

Unlike cash cryptocurrencies are not backed by any government or central bank, meaning they cannot fit into the “Cash and Cash Equivalents” category.

Plus, given the fact the cryptocurrencies are neither equity instruments nor contracts to be settled in equity instruments, and they are not cash, the IFRS provides that “possession of cryptocurrency does not give the holder any contractual right to receive cash or another financial asset.” – especially since the cryptocurrency prices can vary wildly.

Under US GAAP (Generally Accepted Accounting Principles), cryptocurrencies cannot be considered financial instruments, as they neither represent cash nor contracts to establish a right or obligation to deliver or receive either cash or another financial instrument.

Then, what is the financial concept supporting the decision issued by the BaFin?

According to the German Monetary Authority, cryptocurrencies are neither issued nor guaranteed by any central bank or public entity. Also, they do not have the legal status of cash.

However, they can be used by individuals and companies as a means of exchange or payment, for investment purposes, and can be transmitted, stored, and traded electronically. This way, it is feasible to consider them as financial instruments.

Even though the debate is still going strong and many authorities around the world have distinct viewpoints about the same issue, the fact is that the acceptance of cryptocurrencies as financial instruments in Germany has contributed a lot to the crypto industry.

The Place of Cryptocurrencies Among Financial Instruments – Final Thoughts

Indeed, the validation of cryptocurrencies as solid financial instruments depends more on the principle applied in the analysis than on the concept of what a cryptocurrency actually is.

For instance, while the IFRS and the US GAAP do not recognize cryptocurrencies as financial instruments, the decision issued by the German Monetary Authority (BaFin) demonstrates that there is valid proof that cryptocurrencies fit in the category.

Regardless, the fact is that the popularity of digital assets is skyrocketing, especially after traditional players are changing their viewpoint toward crypto, including companies like PayPal, Visa, Mastercard, and JPMorgan.

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