Episode 34

Mackenzie Patel from Figment on Proof of Stake Accounting

Mackenzie Patel from Figment on Proof of Stake Accounting

What We Discuss With Mackenzie Patel

Proof of stake (PoS) blockchains will form the foundation of a more inclusive and user-owned Internet.

If institutional token holders are primed to enjoy the staking rewards embedded within these blockchains, either by acting as validators or delegators on the network, accounting for those rewards remains a headache.

Reason being that there is currently limited guidance from the accounting standards, be it US GAAP or the IFRS, on revenue recognition for staking rewards.

To help us better understand the accounting treatment on proof of stake networks, I spoke to Mackenzie Patel, a founding partner at Hash Basis, and at the time of filming this podcast episode, a CPA and Senior Revenue Accountant at Figment who was also a validator on over 50 POS networks.

In this episode, you will learn;

  • What does staking mean on proof of stake blockchains
  • The considerations and risks when choosing a validator
  • Revenue recognition for staking rewards
  • Accounting challenges within proof of stake networks
  • Audit approach and how to satisfy audit assertions
  • And hear Mackenzie’s thoughts on new career opportunities for accountants to transition into web3
Connect with
Mackenzie
Mackenzie Patel
Founding Partner @ Hash Basis

[00:00:00] Umar: Welcome to The Accountant Quits brought to you by Request Finance, an all in one platform for crypto organizations and freelancers to easily manage and track their invoices, salaries, and expenses in a compliant way. On this podcast, we discuss how blockchain will impact the accounting profession and how accountants should prepare themselves for the future of work.

[00:00:23] Umar: My name’s Umar, your host and even if some might prefer to me as the accountant gone rogue, my job is to provide you with the blockchain knowledge you need that will be relevant for the accounting industry as a whole.

[00:00:37] Umar: Welcome to Episode 34. Proof of stake blockchains will form the foundation of a more inclusive and user owned internet.

[00:00:45] Umar: If institutional token holders are primed to enjoy the staking rewards embedded within these blockchains, either by acting as validators or delegators on the network, accounting for those rewards remains a headache. Reason being that there’s currently limited guidance from the accounting standards, be the US GAAP or the IFRS on revenue recognition for staking rewards.

[00:01:09] Umar: To help us better understand the accounting treatment and challenges for institutional actors on proof of stake networks, I have the pleasure to have Mackenzie Patel, a CPA and Senior Revenue Accountant at Figment. Figment offers an enterprise grade staking infrastructure and is a validator on over 50 proof of stake networks. And yes, I was astonished just as you are to learn that there’s over 50 proof of stake networks.

[00:01:36] Umar: Mackenzie is not your ordinary accountant and embodies this new generation of emerging Web3 accountants. Besides working at Figment, she spends her free time contributing as a DAO accountant, is a regular contributor at Decrypt on crypto tax and accounting topics, and also host the book club for She256, a group for women in crypto.

[00:01:59] Umar: Mackenzie is slowly building a reputation as an expert on proof of stake accounting as she was recently invited as a speaker at the Enterprise Digital Asset Summit in Austin.

[00:02:10] Umar: In this episode today, we will learn what does staking mean on proof of stake blockchains, the considerations and risks when choosing a validator, revenue recognition for staking rewards, accounting challenges within proof of state networks, audit approach and how to satisfy audit assertions.

[00:02:30] Umar: And lastly, we’ll have Mackenzie’s thoughts on new career opportunities for accountants to transition into web3.

[00:02:37] Umar: Mackenzie, welcome, and thanks so much for making the time to be here.

[00:02:41] Mackenzie: Of course. Thanks for having me on.

[00:02:43] Umar: To start could you tell us a little bit more about your personal background, how you first became interested with blockchain and the story that led up to becoming a senior revenue accountant at Figment.

[00:02:56] Mackenzie: Sure. So it started, I think it was October of 2020. And so one of my really good friends from college, he was working at Maker DAO at the time. And he since left to start his own DeFi protocol called Send. So he was just really into the DeFi and the crypto space. And so we just started chatting about it one day and I saw the parallels between blockchains and sort of my more traditional world of accounting.

[00:03:19] Mackenzie: Cause the blockchain is just a ledger, right. And so what is traditional accounting? Ledgers. So I just saw a really interesting parallel there, and I definitely wanted to explore it more because, you know, accounting tends to be a little bit boring. So I was looking for something that would be a little more interesting for my career.

[00:03:34] Mackenzie: And so from there, I just started researching in a lot myself and just really getting into some of the bigger topics like DeFi, NFTs. And I also got really heavily involved in different communities. I think everyone finds their way into crypto through different avenues. And so for me personally, I started with like the, the women in crypto groups.

[00:03:53] Mackenzie: So it was part of, one of the first cohorts of SheFi, which is a DeFi educational platform for women. And then she256, like you mentioned, which is another group for women in crypto. And so I, I just found very welcoming communities there. And from those sessions and those communities, I was able to learn a lot.

[00:04:09] Mackenzie: And so after that, then I started my own crypto community. Cause I’m a big community person. I love posting events. And especially like, this is all during COVID. Right. So it was just a lot of online events that were happening. So then I started a chapter on code academy, so they have different communities or chapters.

[00:04:24] Mackenzie: I started one related to crypto and I called it Phoenix Crypto. Cause I was living in Phoenix at the time. And so that was so fun. This was me just hosting random online events about different crypto topics, like hardware wallets, how to like simulate a blockchain and Python and just some really fun interviews as well.

[00:04:42] Mackenzie: So with that, that really helped me just understand crypto because I was trying to teach other people about it. And so that kind of forced me to learn it myself. And so that was really great. I did that for a couple of months. And then yeah, I started, I was in the she256 Discord and that’s where I met someone from Figment.

[00:04:59] Mackenzie: Shout out to Elizabeth and we just started chatting and I thought the infrastructure layer of crypto was really interesting. And so that’s sort of how my journey with Figment started.

[00:05:08] Umar: The subject for today is accounting for staking rewards on proof of stake blockchains. As a refresher, could we start simple and could you tell us a little bit more on what is proof of stake and maybe the benefits that the different actors get to enjoy in terms of rewards and governance?

[00:05:26] Mackenzie: Sure. So think of proof of stake as just a different type of blockchain to maybe the more familiar proof of work. So if you think of proof of work on Bitcoin, that’s where the network is being secured by, by energy, essentially. So computational power. And so how that shifts in proof of stake is that in this model, the network’s actually secured by collateral, so people’s tokens. So users will lock up their tokens, contributing to network security and in exchange for not having, you know, immediate access to their assets, they earn rewards for that.

[00:05:54] Mackenzie: And so it’s just a really interesting model. Definitely, you know, more environmentally friendly like we have mentioned, and it’s just, I think. Yeah, a different sort of model for securing blockchains and how they work. So you mentioned the governance part of it too, which is fascinating. So users that lock up or stake their tokens, they then have governance rights.

[00:06:12] Mackenzie: And so if someone has a proposal on chain, like I wanna upgrade the network to this new, to this new version or something, then I can vote and my tokens have weight. And so it just introduces a whole new element of community that I think some of the proof of work chains don’t really have.

[00:06:28] Mackenzie: And so a great example, I like to talk about, is the Cosmos family of blockchains. And so they have really interesting governance modules that you can implement. And it’s definitely, it feels more like people are in it together. It’s a community and it’s all enabled by proof stake.

[00:06:41] Umar: Now, before we dive into how Figment offers secure infrastructure for institutions to delegate their tokens and participate in securing the network.

[00:06:50] Umar: Could you tell us a little bit more about the questions to consider when choosing a validator?

[00:06:56] Mackenzie: Yeah, but I think that’s a great question. And especially if you’re looking to delegate your tokens, it’s something you need to think kind of deeply about. So I think reputation is definitely a big one. And so there’s a lot of different components that go into the reputation of a validator.

[00:07:10] Mackenzie: One of them is just sort of it’s main function, which is what is uptime. Is it actually, you know, validating blocks? Is it online? Because if a validator isn’t or there’s downtime, then it can be subject to penalties. And so delegators can be affected by that too, meaning there’s not gonna earn rewards. And so along with downtime is also slashing penalties. If a validator acts, maliciously, such as double signing a block, then, then your state can also be slashed as well. And this again, impacts delegators. The principle that you locked up could be subject to slashing too. And so it’s kind of the first part, like is the validator actually up and running and is it, you know, doing its essential function of securing the network?

[00:07:45] Mackenzie: And just to break that down a little bit more. So when users submit transactions on a proof of stake blockchain, it’s actually the validators that are verifying those transactions to make sure they’re accurate. And that there’s nothing, you know, fishy going on in those. And then if the transactions are good, then those are packaged into blocks and then added to the chain.

[00:08:02] Mackenzie: So that’s sort of what I mean by securing the network, validators are actually the ones manufacturing the block. So that’s the first part of the validators up and running. And then I think it also comes down to how involved are the validators in the community that they’re, that they’re validating for. So, and again, this manifests itself in governance, a lot of the time.

[00:08:20] Mackenzie: So, are validators actively voting on proposals that the community is submitting? Yes, no. Are they abstaining? Is there some kind of life from these validators that they care about the actual community? And so that kind of goes beyond just voting on chain as well. It’s actually, you know, members for the, for in this case, like a staking company, are they actually in the forums?

[00:08:40] Mackenzie: Are they in the discords? Are they actually participating in the conversation that’s going on? Because one of the main, I think, functions of, of proof a stake or, you know, one of the main tenets of it is that the users of it have skin in the game. And so for example, with Figment, people are delegating their tokens to us, but we’re also self staking a bunch of our own tokens too.

[00:08:59] Mackenzie: And so we want to see the protocols that we validated on also be successful because, you know, everyone has some sort of skin in the game. So, yeah, I think the community aspect is definitely one of the biggest ones and sort of related to that is also just having expertise on the networks that we validate for.

[00:09:15] Mackenzie: So at Figment, we have our own protocol team with a bunch of different team members and they’re these members are just so smart and just complete experts on the networks that we, that we validate for. And so overall just creates a really rich ecosystem. The validators actually care about the transactions they’re validating in the community around these transactions.

[00:09:34] Mackenzie: And I think that just makes for a better experience. Overall for everyone using the blockchain or just, you know, connected to it in some way.

[00:09:41] Umar: I also briefly want to touch on the difference with the liquid staking. So when one chooses to stake their tokens, they are unable to access those funds for a certain period.

[00:09:53] Umar: So after locking those funds in the staking protocol, you won’t be able to trade, sell or transfer any of the assets. But then with liquid staking, one can still earn rewards while still having access to the funds. So could you elaborate some of the DeFi opportunities that comes with liquid staking?

[00:10:12] Mackenzie: Sure. I think before that though, might be useful to give an overview of like how DeFi staking is different to proof of stake staking, because I get this question a lot and people might say, oh, like you worked for staking company, but they think about like DeFi staking or liquidity providing versus sort of network security staking that we’re involved with.

[00:10:29] Mackenzie: So I think there’s, it comes down with three main differences. I think. So the first one is just the point of proof of stake staking is to secure the network and make sure there’s not a bunch of volatility, but tokens everywhere. Like your tokens aren’t locked, like they’re staked. And so with DeFi, that’s not like it is a concept like staking obviously exists, but there’s not really a higher purpose in terms of like, ensuring the network doesn’t go down or something like.

[00:10:51] Mackenzie: So I think just the purposes are completely different. And then also, like, I think the yields tend to be different. So DeFi is known for like crazy thousands of percent APYs. So staking like with proof of stake staking like that could be possible if it’s like an early stage network, the APYs tend to be a lot higher, but there’s a curve basically.

[00:11:10] Mackenzie: So as more participants stake their tokens, then the APY tends to go down. And so the rewards of course are impacted by that. And then there’s a few other differences. Oh, so the second one is the responsibilities as well. So if you’re a proof of stake validator, again, you have responsibility to maintain uptime and to make sure that you’re voting on governance proposals and in DeFi again, that’s not really a concept and especially slashing as well.

[00:11:33] Mackenzie: If you don’t maintain your role as a validator, you will get slashed or in DeFi slashing isn’t as much of a concern. And then finally liquidity, which this will kind of get into liquid staking as well. So when you lock up your tokens in a traditional proof stake network, you don’t really have access to them anymore.

[00:11:49] Mackenzie: And then if you wanna get the principal back, you’re often subject to unbonding periods, which might be a few days, or it could be up to like 28 days of the case of Polkadot. And so with DeFi, the point is to have liquidity. So you can yield farm and drop your tokens in a bunch of different protocols. So that’s just a little bit different, but on the point of liquid staking, that is sort of changing the game and making proof of stake staking more like DeFi staking.

[00:12:12] Mackenzie: So a great example, and probably the most popular one is the Lido protocol. So users, if they have, you know, any fraction of Eth they can deposit their Eth and then get StEth or staked Eth. And so basically it’s just a representation of your locked stake. And then you can then use this liquid token, deposit it in other DeFi protocols, like Curve or something and then further generate yield on that.

[00:12:35] Mackenzie: And so I think this is unlocking a lot of potential, cause I think people tend to be a little bit hesitant about proof of stake, cause they don’t just wanna have their assets locked up and without, you know, having access to them. But this is enabling so much more. And I think especially like more institutional players might wanna see this.

[00:12:50] Mackenzie: Because if you tell someone, no, just lock up your asset and you can’t get it for like however many months. People don’t really like that. So with liquid staking, like now you have that, that power to use your assets and make them like work harder for you as people say.

[00:13:03] Umar: Now, could we speak a little bit more about what do you guys do at Figment and maybe for companies who hold their proof of stake tokens, and wish to start delegating these tokens through Figment as the validator, could you provide us with a walkthrough of that process?

[00:13:20] Mackenzie: Yeah, for sure. So at a high level, Figment is a blockchain infrastructure provider. And so staking is our main service offering we’re on over, I think we’re over 55 around like 60 networks today. We just like, by far the most of any other provider, we just believe in a multi chain future. So we support a lot of, a lot of blockchains.

[00:13:38] Mackenzie: So in addition to staking, we have a few other business lines. So one of the supporting ones is called Data Hub. And so essentially it’s APIs that blockchain developers can query to get data about various blockchains. So it just makes it easier for devs to get data. And then we’re also core developers for the Graph Protocol.

[00:13:54] Mackenzie: So The Graph is a decentralized data indexing layer. And so part of our, there’s a subset of Figment engineers that just work fulltime on The Graph to build it out. And so I think that’s really awesome. The Graph is personally like one of my favorite protocols. So the fact that we actively have a stake in it and are working on it, is pretty cool.

[00:14:10] Mackenzie: So that’s what Figment learn, we are also committed to helping educate and onboard people from web2, specifically web2 developers onto web3. So if you search Figment Learn, there’s a bunch of really great tutorials. And like, I think one of them is Substrate Kitties. Like how to build some sort of like cat application using Polkadot Substrate.

[00:14:27] Mackenzie: So just like fun things like that, where. Yeah, we really, we support these blockchains. We validate on them, but we also wanna see ecosystems pop up around them and that manifests itself in, in application. So definitely trying to nurture that as well.

[00:14:39] Mackenzie: And then your other question. So if let’s say, if someone wants to stake with us, what would that process look like?

[00:14:44] Mackenzie: So we support both types of customers. So if it’s just, you know, you are me and we wanna delegate a few ATOM tokens that we have, we can just do that without having to like contact someone at Figment. We have public validators across again, like 60 proof of stake networks. And so if we just have like our, if we have Figment’s validator operator address, we can just do it ourselves.

[00:15:03] Mackenzie: Like with ATOM, we can stake through the Kepler wallet. And so we have a bunch of staking guides and tutorials on basically how to do that across our networks. So you really, you can just do it yourself. You don’t really need to, to talk with any of us. But if you are a larger player, like an institutional customer, like a custodian or a VC fund, something like that.

[00:15:22] Mackenzie: And it’s just a larger volume, then definitely reach out to one of Figment sales people. And we can walk you through that process. It kind looks very similar to what we call like a retail delegator. So you still have to, you know, go through some sort of UI stake your tokens. The only difference is that. As an institutional player, you might be staking through a custodian, like a Fireblocks or a Copper or something like that.

[00:15:41] Mackenzie: And so that just might a little, might look a little bit different than you and me having a ledger, plugging it in and like going through some sort of wallet

[00:15:47] Umar: and maybe some additional KYC. If it’s an institution. Maybe.

[00:15:52] Mackenzie: Yeah. Yeah, definitely. There’s other contracts as well that we have with identified parties.

[00:15:56] Mackenzie: But that raises a really interesting point. Like most of our delegators are anonymous coz it’s just, you know, public addresses that are delegated to us. And so we might not know. And in most cases we don’t know unless you are a bigger customer and we have like a contract with you, in a more formal relationship, but by far like we have thousands of delegators.

[00:16:15] Mackenzie: We only know like a fraction of who they actually are. So that’s just the nature of proof of stake though. That’s sort of how the model is built. So I’m curious to see how that changes in the future. Especially as staking is more regulated. I think there is going to have to be more KYC, AML procedures. I just have no idea what that’s gonna look like.

[00:16:32] Mackenzie: Cause that’s not, that’s not really how, how it’s built. So we’ll see.

[00:16:36] Umar: Moving on to the main topic of the episode today regarding revenue recognition for staking rewards. So both under US GAAP ASC606 and IFRS 15, there’s a five step model for revenue recognition.

[00:16:50] Umar: For the audience briefly, these five steps are so firstly, you have to identify the contract with the customer. Secondly, you have to identify the performance obligations within that contract. You have to determine the transaction price. Fourth, you have to allocate the transaction price across that contract. And finally, you have to recognize the revenue.

[00:17:10] Umar: I wanna ask you if you could compare and contrast, how revenue recognition would be applicable to both the validator and the delegator under this 5 step model.

[00:17:22] Umar: And what are maybe, yeah, maybe it’s not very clear as how it’s supposed to be. And what are those challenges that you’ve seen?

[00:17:30] Mackenzie: Well, there, there’s definitely a lot of challenges. So I think revenue recognition is definitely the biggest gray area, especially on the validator side, on the delegator side.

[00:17:37] Mackenzie: It’s not, it’s not this bad. So you’re just sort of earning a stream of staking rewards. And so that’s considered income to you, but the validator side, which is the one that I, you know, mostly deal with day to day gets very nuanced. And so I love that you mentioned the five steps of revenue recognition, cuz you know, you’re getting back to basics, but it’s like still important.

[00:17:55] Mackenzie: If you can’t answer those questions, then you can’t recognize revenue, which affects your whole business. So there’s definitely a lot that goes along with that. And so I figured I could sort of break it down, start with the first question, which is, even identifying the contract. And so I guess when you think, think of a traditional world, you have a contract with the customer to provide a service.

[00:18:14] Mackenzie: And usually it’s like a written one or like a DocuSign or something like that. But that concept just doesn’t really exist in proof of stake, because it’s a transaction that’s happening somewhere on the blockchain, in the ether, like on the internet. And so if you feel like a bigger institutional customer, as I said, there will be contracts.

[00:18:29] Mackenzie: So like that part’s a little bit easier, but again, for most of our networks or most of our delegators, we don’t have that. So even the first part, like identifying the contract gets tricky and then you kind of have to dig a little bit deeper and say, okay, like since they decided to delegate to our validator, that could be an implicit contract.

[00:18:46] Mackenzie: And so it kind of turns out that like a smart contract becomes the actual contract. And so I feel like that’s sort of a, a whole other legal can of worms, but. For revenue recognition purposes, that’s sort of what we’re going with. And then it also gets down to, well, what exactly is this contract? And more importantly, who exactly is our customer?

[00:19:04] Mackenzie: So in the proof of stake model, there’s lots of different roles that users can play. So you can be like a delegator or a validator. Just some user that has a wallet address. And so the question really becomes well out of those parties, like which one is our customers? Is it the delegator, which might seem obvious, or is it the users who are submitting transactions and they’re expecting someone to validate them and execute them.

[00:19:27] Mackenzie: So in that sense, you could definitely say anyone submitting a transaction could be your customer as a validator. Or is it the protocol code? So we run open source code for the most part. And so is it really the code who’s expecting the validator to essentially like carry out the functions and carry out as well?

[00:19:43] Mackenzie: So yeah, this very interesting, I guess I call it like an orchestra that starts to appear. And so even questions as fundamentals, who is our customer and what is the contract is not entirely clear. And so kind of a, a side tangent on that. And one that I’m thinking about a lot is principle versus agent, because of course there’s no guidance for this, really.

[00:20:01] Mackenzie: So, you know, the FASB is not saying non custodial, validators or agents, whereas maybe custodial validators are principles. And just to clarify that non custodial just means we don’t hold keys to our customer’s assets. So you can still delegate without having to give your private keys to validator. And so it’s, again, very unclear.

[00:20:18] Mackenzie: There’s arguments, both ways for whether the validator like Figment could be a principal or an agent essentially comes down to the concept of who has control over this transaction. And even then, so like for most blockchains, the reward split happens simultaneously.

[00:20:32] Mackenzie: So like the validators get their commissions and the delegators get their percent of the rewards. And so in that sense, we don’t really have control, it’s the protocol. But on the other hand, we are the ones validating the transactions. And if we don’t validate maybe the transaction won’t go through. So there’s a whole analysis that we did at Figment just around this topic.

[00:20:51] Mackenzie: Like there’s a concept called inventory risk. That’s not really a thing in crypto, so we don’t really have that, but again, it also gets down to primary responsibility. So assuming we identify a customer, like who do they think has a primary responsibility for executing some sort of transaction. So, yeah, that’s just stuff one there’s a lot.

[00:21:09] Mackenzie: That’s a little bit unclear there. and then step two, which is to identify the performance obligation. So essentially like what’s, what’s the promise, what are we promising a customer to provide to them? And so, again, that gets a little bit nuanced. If our customer is a delegator, are we obligated to provide them staking rewards?

[00:21:25] Mackenzie: So maintaining uptime so that they can earn the, the most amount that they can, or if it’s the transacting user is our obligation to confirm their transaction and add it to the chain, or if it’s protocol, is it again to like carry out, carry out their functions, essentially.

[00:21:40] Mackenzie: So one example that I always like to cite is Coinbase’s 10 K. And so if you read through it, it’s really great and definitely a good model for other, for other businesses in the crypto industry. And so their 10K says that the performance obligation is to validate blocks at the block level. And so that gets to be from an actual, like recording perspective, a little bit tricky because each block could be like 6.5, 7 milliseconds or something like super, super fast.

[00:22:06] Mackenzie: So. Yeah. In that case, you have a stream of like near instantaneous performance obligations you have to account for which gets tricky, especially since the systems aren’t that robust right now.

[00:22:16] Mackenzie: And so the third one is to determine the transaction price. So what pricing source should we even be using? And so if you’re strictly following US GAAP, it says that in order to use fair value, so the fair value an asset or rewards you have to use principle market pricing. So basically what pricing source has the most volume. So even that gets, yeah, it gets hard because there’s multiple exchanges out there. So you have to find which one has the most volume for each of the assets that you’re on.

[00:22:42] Mackenzie: So Figment we’re on 55 assets. So that’s 55 separate analyses that pretty much have to be done. And so that’s assuming there even is a price. If we’re on a really early stage network and it’s only on a DEX, do we trust the DEX price? Even though the volume might be like 200K per day, if we just dump our tokens, that ruins like the price.

[00:22:59] Mackenzie: So. In that sense, it’s really hard to support or verify a price like that because it’s not really substantiated. And like, where is that price even coming from? So that’s another big issue. You can use a price aggregator. Like crypto compare is one that we use a figment. We like that one a lot. It’s just not principle market.

[00:23:14] Mackenzie: So you just have to do an analysis, which I’m currently doing right now to compare, like how much are we off? If we use a price aggregator versus a principal market. And the fourth step, just allocate the transaction price and then finally begin into recognizing revenue. But there’s yeah, a lot of different topics within just recognizing revenue itself that we can get into.

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[00:25:25] Umar: So under the accrual concept, revenue from staking rewards should be recorded at the time the transaction occurs rather than when payment is received. So with no proof of stake networks being completely alike, meaning I read so some have to be claimed manually, some are automatic. What are some of the challenges when it comes to recognizing these staking rewards under an accrual concept?

[00:25:50] Mackenzie: Mm. Yeah. So I think one important concept is that blockchains are cash basis most of the time, right? So it’s like everything that’s happening on chain is in my mind, like more of cash basis versus what we’re trying to do on a US GAAP, which is a accrual basis.

[00:26:04] Mackenzie: And so. You mentioned it in the intro, but like, there’s definitely a difference between accrued versus claimed staking rewards. So again, I’ll use an example of the cosmos networks. So they’re kind of like a family of chains already in the cosmos SDK, but they all have the same function where you have to claim rewards.

[00:26:21] Mackenzie: And so what this means is that you might be earning rewards or under accrual accounting, you are earning rewards, every block, because as a validator, you’re performing the service. You’re maintaining uptime, you’re proposing, verifying new blocks. So under US GAAP, accrual accounting, you can recognize that revenue because you’re earning it.

[00:26:38] Mackenzie: But that revenue might not actually be in your wallet yet. So what it works on cosmos is you actually have to submit an on chain transaction to claim your rewards. At which point they become liquid in your wallet. So I recommend anyone’s listening. I’d go over to Mintscan. It’s a really amazing block explorer.

[00:26:55] Mackenzie: I love it. And it breaks down the wall. It bounces really well. So, if you look at like our validator beneficiary address of the address, where our rewards land, you can see there’s different fields. There’s an available field, which is essentially just the liquid balance that we have, or the balance that’s freely transferable.

[00:27:12] Mackenzie: You have the delegated balance, which is what we’re currently staking. You have the unbonding. So in an unbonding period, it’ll show up. and then the two at the bottom are the most critical. So it says staking reward and commission. And so when I first started at Figment, I was so confused by this cause I’m like, wait a second.

[00:27:26] Mackenzie: What’s the difference between a staking reward and a commission? I thought they were all staking rewards and they technically are, but Mintscan breaks it down. This one, I think it’s a really useful way to think about it. So the staking reward is the rewards that you’re earning on the amount that you’re self staking, which, you know, makes sense.

[00:27:42] Mackenzie: So as a validator, again, as I said, you’re receiving outside delegations, but you’re also, you could be delegating your own tokens. And so those tokens that you’re self staking are earning your rewards. And so in this, in that example, that’s what can be called a staking reward. But then there’s also a commission.

[00:27:57] Mackenzie: And so the way it works on chain is that I think about in terms of like a validator pool. And so in my mind, a validator pool is a validator like Figment, and then all of our delegators that are staking to us. And so the protocol it’s giving our validator pool rewards, let’s say it gives us a hundred tokens and Figment’s charging a 10% commission.

[00:28:16] Mackenzie: So, what that means is that the split’s gonna happen on chain. Our delegators are gonna get 90 tokens, and then Figment gonna keep 10 tokens. Again, this is assuming, let’s say ourselves stake is zero at this point. So the commission that we receive is just part of the total pie of stake rewards. It’s just labeled as a commission because we’re taking a piece of our delegators total rewards that they’ve earned.

[00:28:35] Mackenzie: And so I like this breakdown a lot though, cuz commission is that we’re earning for our core operation of being a validator. It’s what customers are you think of as like what they’re paying us, even though it’s coming from the protocol where a staking reward is, what we’re earning on our balance sheet, essentially.

[00:28:51] Mackenzie: And so the point of that this whole rant here is that the staking rewards and commissions are basically accruing in our wallet. And so they’re not, we don’t have them. They’re not liquid. They’re kind of like, it’s like almost like a holding period, like they’re accruing in our wallet, but really the tokens are living within the protocol.

[00:29:09] Mackenzie: And so we have to submit an on chain transaction to claim them at which point they come out as staking rewards and commission and into the available balance, at least on the Mintscan example. So. That gets really tricky from an accounting perspective, because you have to keep track of your accrued rewards.

[00:29:24] Mackenzie: And then once there’s an on chain transaction, that’s submitted, you don’t wanna double count cuz if you already recognize revenue in the accrued amount, but then you see some amount of like a hundred tokens hitting your wallet, you might have already accrued like 98% of that revenue. And so you make sure you don’t wanna double count those.

[00:29:39] Mackenzie: So the way we’ve been doing it at Figment is just calling it like a token receivable. And so if we’re earning revenue, but we haven’t claimed yet we’ll debit token receivable, credit the revenue. And then when we actually claim and we have the assets in our wallet, we’ll go ahead and debit digital assets and then credit the token receivable.

[00:29:56] Mackenzie: And so that’s something that’s taken us some time to develop a process around because it just comes down to really meticulous tracking. And almost like we created schedules between what do we book as accrued revenue versus like what’s coming into claim. And then, especially as we’re doing monthly, like month end close right now, we have to back out the monthly number that we should, that we should accrue for.

[00:30:14] Mackenzie: So it definitely, it’s fun. It’s a, it’s a good exercise to go through, but it’s just something you have to keep in mind because if you wait to recognize revenue until the tokens are physically or not physically, but like digitally in your wallet, then theoretically you could defer revenue recognition.

[00:30:29] Mackenzie: And just never claim. And so there’s some earnings manipulations that could be involved with that, which is why under US GAAP, if you’re performing the work, satisfied performance obligation, you should record revenue, which is what we’re trying to do. It’s just from like a data perspective, really tricky.

[00:30:43] Mackenzie: And so I guess that’s another challenge I can go into now, which is like getting data from block change it, or blockchains is so difficult cause you think it’s easy, right? Like it’s all on chain, but that’s just not, that’s just like, not true at all. I mean, the data is there most of the time, but to actually parse it, extract it, make sense of it is such a nightmare and accountants are not software engineers. And so part of like a lot of my job is going through GitHub files and like Genesis JSON files to try to figure out like our beginning balances, because it’s not at like an on chain transaction, it’s a state change.

[00:31:17] Mackenzie: And so I feel like I’ve learned so many like random terminal commands and things like that just to get my job done. So anyway, that being said, the two problems kind of feed into each other, like the data problem and also just the accrual accounting problem.

[00:31:30] Umar: Yeah. And so you mentioned cosmos makes your life maybe a little bit easier with given that they show you like the rewards that has to be accrued, but, and given that you are working on like 50 different proof of stake blockchains and given that not all of them are alike, it’s such a challenge to like to know the different ways to go about how to recognize these accrued rewards. And I’m sure most of them you’re recognizing them probably on a cash basis.

[00:31:58] Mackenzie: Yep. So the accountant definitely becomes a like protocol research analyst, with crypto accounting. And so what that means that yuo, at least from like our viewpoint, you really have to understand the rewards flow for each network.

[00:32:11] Mackenzie: And so I usually group them in terms of like network family. So like the cosmos networks are kind of one where the reward flow pretty much works the same with the whole like accrued rewards and then you claim them and they come to your wallet. So, that’s one family. And then there’s those that operate on Ethereum or like settle on Ethereum.

[00:32:28] Mackenzie: So you got like Polygon and then The Graph, Livepeer. And so those are a little bit easier because I can go to Etherscan and those transactions typically sink into your crypto subledger. So those aren’t as bad. But then you’ve got other random L1s we’re on like Flow or Near or Oasis. And those, you just have to learn and like read the documentation on how each of them operate.

[00:32:49] Mackenzie: And they tend to be the more troublesome chains. Like Oasis, for example, trying to get staking rewards is an absolute nightmare because the rewards, pretty much, they land in your wallet automatically, and then they auto compound or like auto restake, but they don’t actually show you the rewards that you earned per block.

[00:33:05] Mackenzie: So it’s not in the Explorer. It’s really hard to even index that data. So, yeah, it’s definitely, it’s a fun time. I feel like I’ve learned more about different proof of stake protocols than I ever thought I would, but it’s almost like it’s a necessity. You have to learn how the technology actually works. How the block explorers work and like the different fields that you’re showing you or else like, who knows what you’re booking is actually correct.

[00:33:28] Umar: Next, moving on to audit. Now as per the auditor’s responsibilities, when they issue the audit opinion at the year end, they’re also required to assess whether the organization has an effective system of internal control.

[00:33:42] Umar: So for their financial reporting, and there’s a report called the Service Organization Controls report or the SOC report. And now I’ve been an external auditor before, and it made me laugh when reading your article, when you mentioned that having this report is something auditors drool over.

[00:33:59] Umar: Because it allows them to trust third party data providers and limit the amount of substantive testing needed during the audit. Now, given that you yourself are accounting for the revenue for over 50 blockchain networks, like we previously mentioned, how do you go about trusting the data available from these block explorers in the absence of an SOC report, let’s say.

[00:34:22] Mackenzie: Yeah, but it’s definitely tricky. So I think in my article, I mentioned like, you know, explorers like Ape Board or something like that. They’re not really gonna have a SOC report, but it’s not really a reflection on them. Like most people in the industry don’t really have one yet. So you definitely just have to do reconciliations on top of that.

[00:34:36] Mackenzie: So right now, at Figment we’re going through a whole exercise of pulling all of our historical data and we’re getting it from block explorers, for the most part, some we’re getting it from our own internal indexers or like third party indexers. But most of this just like, go on a Mintscan or some other explorer to pull all of our transactions.

[00:34:51] Mackenzie: And so the way sort of the internal control is how I think about it is actually just reconciling balances. And so that might sound simple, but it’s really not. So it’s basically like a token roll. So starting with beginning balance and then any receives or any withdrawals, and then trying to get to an ending balance at the end of the period.

[00:35:08] Mackenzie: We’re sort of doing this whole exercise to come up with a token roll, but it’s definitely, it’s been challenging because even trying to reconcile to, you know, the balance that’s currently showing and adding up all our transactions to try to get there is, yeah, there’s a lot that goes into that.

[00:35:22] Mackenzie: And so I think one of the main challenges for us is coming up with beginning balances just like when the blockchain even first started. And so, you know, there’s a variety of reasons for that. So like if we participated in incentivized testnet, so we did tasks during the test net phase. And so we got rewards for those. That’s not an on chain transaction when we actually get those most of the time, it’s just within the Genesis block.

[00:35:45] Mackenzie: And so you really have to, you know, find that beginning balance. And then you have some chains, like Secret Network where there’s no on chain transactions at all for community pool grants. So if you get grants, there’s not like the foundation sending us Secret tokens. It’s just a, again, like a state change.

[00:36:00] Mackenzie: And so the longer, or the far back, you’re trying to reconcile, the more challenging it becomes, cuz there might just be some things that aren’t on chain or that the data’s just very inaccessible. And so that being said, it’s still possible to do reconciliations on the data. You just have to really a lot of dig in like within Slack, Google, just a whole bunch of things.

[00:36:20] Mackenzie: Again, I say you’re like pretty much a forensic accountant. And so that’s what we’ve been doing to get comfort in the data and also just like historical screenshots. Like if our CTO claimed rewards and like there was a screenshot somewhere, like we snapshot that. So getting evidence for our balances.

[00:36:36] Umar: And maybe I thought would be helpful is if you’ve been involved in the auditing exercise at Figment is to understand maybe the kind of information auditors are a seeking to test for completeness and accuracy of data from these block explorers.

[00:36:52] Umar: Or maybe even if they haven’t asked it, what do you, are you foreseeing that they would ask?

[00:36:58] Mackenzie: Yeah, so it’s interesting because a lot of the Big4 auditors are spinning up their own nodes or their own indexers in house. And so they’re pulling the rewards data themselves, and then they’re gonna compare it to like what we pulled for instance.

[00:37:11] Mackenzie: So that’s what I’ve seen them do so far, just have their own data source and then compare it to ours, which I guess the less reliance on internal controls. And I guess that would be more substantive testing at that point. But yeah, they’re looking more for processes as well. So like month end close is a great example.

[00:37:26] Mackenzie: So who’s actually preparing the data. Who’s reviewing it. Who’s entering it into the system. Who’s doing a month-end analytics check. And so, in addition to like actually them pulling their own data, they’re just layering a bunch of controls on this process to make sure that there is an error that somebody catches it.

[00:37:42] Mackenzie: And so in terms of completeness of data, I think that’s where the token role comes in just looking at our ending balance and saying, okay, like, does it actually reconcile what the transactions that happen during the month? But then, you know, it’s really tricky because who knows that the balance we’re seeing on the block explorer is even correct or that’s accurate.

[00:37:59] Mackenzie: So then at that point you might wanna explore the options of getting third party indexers to also independently run your data. And so I’ve also approached it just by getting data from multiple sources. So whether it’s from Explorer or like someone like a Sidelight or running our own indexers, usually just getting data from multiple places and trying to reconcile it to make sure it all adds up.

[00:38:18] Mackenzie: But at the end of the day, like auditing is still auditing. They’re gonna wanna see controls and different processes in place. It’s, it’s no different really for crypto.

[00:38:26] Umar: Now for the remaining part of episode today, I’d like to change topic a little bit, not so much about proof of stake and speak about your experience working as a DAO accountant.

[00:38:36] Umar: I wanna ask you what made you want to start contributing in the DAO space and what do you find exciting about this new way of working.

[00:38:43] Mackenzie: I think there’s so many exciting things. So as it’s funny, I got my Figment job through Discord and I got my Dorg job through Twitter, which is, I think just like such a web3 way of getting employed these days.

[00:38:53] Mackenzie: But yeah, I think someone Kevin Ngo, who was previous guest on this podcast, he posted something on Twitter or like someone did a post about, oh, tag your crypto accounting people. And it was like me, Kevin Ngo and like two other people, which I thought was so funny. And so then from there we just started chatting.

[00:39:10] Mackenzie: And he was pretty familiar with dOrg. I think, where he works now or contributes to now was a client of dOrg. And so at the time dOrg was looking for an internal bookkeeper accountant. And so I just got connected to them through there. And so I wasn’t really looking specifically to work for a DAO.

[00:39:26] Mackenzie: I just thought the concept is really interesting. I was like, oh, like, I’ll give this a shot. Cause I don’t really know what it’s like to be part of the DAO. And so I’ve loved it so far. I think it’s a very novel way of working and one that I really like. So people at dOrg, they’re mostly not even in the US, there’s a lot of south Americans, Europeans, and everyone just kind of works everywhere, but everyone also is just very into the DAO way of working in sort of like the ethos of web3.

[00:39:50] Mackenzie: And so it’s been a really cool experience so far, mostly first started off just doing like more bookkeeping tasks, like payments. And things like that, but now we’re implementing a more full-fledged accounting system. And so using tools like Cryptio to actually sink in all of our transactions and QuickBooks to automatically push out entries to the ERP system.

[00:40:09] Mackenzie: And so, yeah, basically just trying to get financial statements and books for us, because trying to I did our taxes manually for 2021, and that was not a fun exercise. So I’m just trying to make the process a lot more automated now. Yeah, there’s just a lot of interesting things happening on the DAO accounting forefront.

[00:40:25] Mackenzie: I think tooling is definitely a big one. Like we use Utopia for payments. We’re looking at Multis for treasury management, there’s den, which is a gnosis safe approval bot. So there’s just a lot of cool tools that are popping up. So I personally just enjoy doing demos and like seeing what people are working on. And yeah, it’s just, I really enjoy this sort of new way working.

[00:40:45] Mackenzie: I don’t think every entity is gonna be a DAO one day and I don’t think they necessarily need to be, but especially for, for entities, that natively start off as DAO. So I think the model works really.

[00:40:55] Umar: And to give a glimpse to people, to who maybe want to transition to web3. And I’ve told you before that, I think over a short period of time, you went on this accelerated path into web3 accounting.

[00:41:09] Umar: For people working in web2, who are maybe curious to get into web3, what would you say are some of the prerequisites to be a DAO accountant? What should they be comfortable with and have good knowledge in the web3 space, maybe have a good grasp of, how block explorers work would be one of them.

[00:41:25] Mackenzie: Yeah, definitely block explorers. Cause that’s sort of the gateway to accounting information right now, but also just having extreme curiosity about how blockchains work and about how the, the crypto space is developing, where we’ve been like, how we started. So I think just having passion for this is I think one of the biggest things, because there’s no guide on like how to recognize revenue for so, so crypto transaction, you’re basically figuring it out on your own.

[00:41:50] Mackenzie: And you have to almost be a forensic accountant. That’s sort of how I like to think about it. You have to be willing to comb through block explorers for hours and understand every single transaction, even though there might be thousands of transactions. And so for me, I think it’s important that you also like to solve puzzles because there’s gonna be some missing.

[00:42:08] Mackenzie: There’s a lot of missing pieces. And if you don’t wanna do that, then it’s gonna be, it’s gonna be really challenging. This is not like traditional accounting where there’s a full fledged ERP system where every single vendor is labeled or every single person you’ve paid, like anything like that. It’s, that’s not really how it works.

[00:42:24] Mackenzie: And, and you have to be comfortable with the fact that there’s not a lot of guidance, basically, no guidance. And so, you have to just, you know, be comfortable researching things on your own and trying to figure it out yourself. Cause that’s why I think this space is so exciting though, especially for accountants, because I feel like I really am forging the way for new guidance to come out and hopefully shape it in a way that really reflects the activity and not just arbitrary guidance that, you know, the FASB might come out with.

[00:42:50] Umar: And maybe a question that I have for you is. We don’t learn all of these stuff in our accounting degrees. Right. And how much would you say, and from what, how you’ve spoken in this episode today, you’re pretty conversant on the tech side and that’s something accountants don’t learn.

[00:43:06] Umar: Do you think that accountants today, like have a responsibility to, if they want to learn more about web3 and crypto, to be more comfortable with learning, how to code, for example, is this something that you see necessary to accelerate one’s knowledge of web3.

[00:43:23] Mackenzie: I definitely think so, especially if you’re doing accounting in tech or in crypto, that’s a very necessary skill. And just the way, at least in the US, the accounting programs are structured. There is almost like no tech component. You just learn the accounting basics, but there’s not even any programming courses.

[00:43:38] Mackenzie: There might be some basic, how do you use Excel, but that’s really not gonna cut it these days. Cause especially in the crypto space, like it’s on the onus is on the accounts to come up with the data. As I’ve said, the data might be nested in Github pages. And so you’re gonna have to know, like how to use your terminal, how to open or like parse a JSON file, things like that.

[00:43:56] Mackenzie: And schools just do not teach you that at all. I, I had one course in college where we talked about blockchain for one lesson. That was my grand exposure to blockchain, but I really wish you had gone a lot further and not just for crypto, but I think in general accountants just need be way more tech savvy, like Excel.

[00:44:13] Mackenzie: Everyone pretty much has Excel skills if you’re an accountant these days. So I think the next step is like learning Python or the very minimum learning SQL. It’s very difficult though, because once you start working, it’s hard to have time to take Code Academy courses or something like that, but to stay competitive in this field, I really think you need to.

[00:44:29] Umar: Mackenzie. We are coming soon to the end of the podcast. Maybe if you could tell us, and we could wrap up the episode on your closing thoughts on proof of stake, accounting. Maybe, what are you looking forward to in the coming months?

[00:44:45] Umar: A lot of the regulations right now, or in terms of accounting, a lot of the accounting standards are unwritten and there aren’t many people thinking about these issues as much as you are. Could you tell us what you’re looking forward to in the upcoming months? And maybe you would have like a message to the accounting standards board?

[00:45:05] Mackenzie: Yeah. So I guess that’s the part I’m excited about digital assets are on FASB’s technical agenda. So they are diving more deeper into the field and talking to experts in the industry to come up with better guidance. So I am really excited to see what they come out with.

[00:45:19] Mackenzie: Also a little bit apprehensive, so I’m not sure if noncustodial validators will be included in that, cuz that’s still a pretty niche subset of crypto accounting, but yeah, just really excited to see what that says because you know, it keeps on your toes. I feel like once guidance comes out, you can totally shift your way of thinking and your processes.

[00:45:36] Mackenzie: And I personally, like, I like chaos and I like change. So I’m very much looking forward to that. And yeah, I guess message for the FASB is definitely, maybe don’t try to relate everything in web3 back to its comparable in web2, because sometimes there’s just not. If you try to learn web3 by relating everything to a traditional web2 concept, I feel like you’re missing out on what web3 really means.

[00:45:59] Mackenzie: So at least that’s what’s helped me, like I’m started in my profession mostly like in the crypto accounting space. And so I didn’t really learn a lot of the traditional accounting stuff, which I think for me has been an advantage, cuz I can just fully, you know, try to grasp and understand the technology. So that’ll be my message for them.

[00:46:15] Umar: And this last question, which I like to ask my guess is, do you have a favorite quote or a maxim that you live with

[00:46:22] Mackenzie: I do. And I love this question. So I have two of them. The first one is try things that scare you the most. And it sounds kind of cheesy, but it’s something that I heard in high school and I’ve tried to live by this.

[00:46:32] Mackenzie: Cause I think when you put yourself in uncomfortable situations, I think that’s when you grow the most. And so if there’s opportunity to public speak or it just do something where my introvert self is like, Ooh, I don’t wanna do that. Then I’m like, okay, that’s a sign I should actually do it then. So that’s the first one.

[00:46:47] Mackenzie: And then second one, we get it up here. It’s a quote by Cicero who was an ancient Roman scholar, and I’m obsessed with Cicero. He’s got really amazing lectures. I recommend the , but anyway, he said, if you have a garden and a library, you have everything you need. And I think that’s a really beautiful quote because I love books and I love nature.

[00:47:07] Mackenzie: So put those two together and you’ve got a great quote.

[00:47:10] Mackenzie. I really enjoyed this episode today. Thank you so much. I told you this before, but I have so much respect for the work that you’re currently doing. And I think you’re setting the example for so many other accountants.

[00:47:22] Umar: I truly think like accountants have an important role to play for crypto adoption and you’re setting the bar high. So I hope more accountants will join you on that adventure. Let’s say. I’m sure you’d be, someone will be hearing and regularly seeing in the web3 accounting space in the years to come.

[00:47:40] Mackenzie: Yeah, for sure. And I definitely think more accountants should get into crypto accounting. There’s a lot of space for development and opportunity and just like lots of learning. So I would definitely recommend it

[00:47:50] Umar: Before we go, if people want to reach out to you, what’s the best way for them to do so.

[00:47:55] Mackenzie: Probably Twitter. My handle is figgy_feline. I love figment, I love cats. So there you go. So yeah, probably Twitter.

[00:48:04] Umar: All right. Perfect. I’ll include that. And I’ll include the link to your articles on the Decrypt as well.

[00:48:10] Mackenzie: Perfect. Sounds great.

[00:48:12] Umar: Thanks a lot, Mackenzie.

[00:48:13] Mackenzie: Thank you.

[00:48:14] Umar: I would like to thank everyone for listening to this episode, you will find all the links of the episode, shownotes and transcript on the website of The Accountant Quits at theaccountantquits.com

[00:48:26] Umar: Please note that this content is for general information purposes only, and is not a substitute for consultation with professional advisors. If you do know anyone who could benefit from the episode and you care about them, please do share the episode with them. All the episodes are available on Spotify, Apple Podcasts, and Google podcasts.

[00:48:46] Umar: And by leaving us a review and rating, you will support the channel and all your fellow accountants. In order to be notified each time we release a new episode, do follow us on Instagram and LinkedIn.

[00:48:58] Umar: We hope to have you with us next time. Bye. For now.

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