Key Lessons from MicroStrategy Bitcoin Initiative – Project Roadmap

1. Strategic Purpose of Bitcoin Investment

• Lesson: Before embarking on a Bitcoin investment strategy, it is crucial to clearly define the purpose of the investment. This could include using Bitcoin as a treasury asset, for balance sheet management, as a P&L strategy, or as a hedge against inflation.
• Example: MicroStrategy’s Bitcoin initiative emphasized using Bitcoin as a treasury reserve asset to protect against currency devaluation, aligning with the company’s long-term strategy.

2. Corporate Governance and Team Formation

• Lesson: Effective governance is critical for a successful Bitcoin investment strategy. It requires assembling a cross-functional team, including finance, legal, IT, and external advisors, to manage the complexities involved.
• Example: MicroStrategy formed a dedicated internal team, including finance, legal, and IT departments, to ensure the Bitcoin strategy was well-governed and compliant with regulatory requirements.

3. Risk Management and Regulatory Considerations

• Lesson: Managing risks, including regulatory, security, and financial risks, is vital for any corporate Bitcoin strategy. Companies must account for factors such as potential conflicts of interest, tax implications, and security risks.
• Example: MicroStrategy’s roadmap included detailed steps for evaluating regulatory considerations, tax implications, and potential conflicts of interest, ensuring that all legal risks were addressed before making any Bitcoin purchase.

4. Execution and Security

• Lesson: Once the governance structure is in place, execution involves negotiating with brokers and custodians, setting up secure trading accounts, and preparing for ongoing reporting and disclosure requirements.
• Example: MicroStrategy secured brokerage and custodial agreements and implemented cybersecurity measures to protect its Bitcoin assets and ensure compliance with financial reporting standards.

5. Ongoing Management and Communication

• Lesson: After the initial Bitcoin purchase, companies must manage subsequent purchases, monitor the market, and maintain clear communication with stakeholders, including investors, employees, and the media.
• Example: MicroStrategy’s ongoing strategy involved regular Bitcoin purchases, frequent updates to investors, and carefully crafted communication strategies through press releases and SEC filings.

  Key Lessons from MicroStrategy Bitcoin Trading Policy

1. Compliance with Insider Trading Laws

• Lesson: The policy ensures that all MicroStrategy personnel who have access to nonpublic information regarding the company's Bitcoin investments adhere to federal and state laws against insider trading. This is crucial for maintaining integrity and compliance with legal standards.
• Example: Covered MicroStrategy personnel are prohibited from trading Bitcoin based on material nonpublic information, which includes undisclosed details about the company’s Bitcoin holdings or planned transactions.

2. Application of Trading Restrictions

• Lesson: MicroStrategy's Bitcoin Trading Policy applies to a wide range of Bitcoin-related transactions, including acquisitions, sales, short sales, and derivatives. These restrictions ensure that employees and their households are not unfairly advantaged by internal knowledge.
• Example: During designated non-trading periods, personnel are restricted from engaging in any Bitcoin transactions. These periods may be triggered when the company is conducting significant transactions or holds material nonpublic information.

3. Material Nonpublic Information

• Lesson: Employees must carefully assess whether any information they hold constitutes material nonpublic information (MNPI). Even indirect actions, such as disclosing MNPI to others (tipping), can result in liability for both the discloser and the recipient.
• Example: If an employee shares nonpublic information with a friend (a Tippee), and that friend trades Bitcoin based on the tip, both the employee and the friend could face legal consequences.

4. Market Manipulation and Ethics

• Lesson: The policy explicitly prohibits market manipulation and trading activities that could be seen as acting against the company's interests. This includes practices like front-running or artificially influencing Bitcoin's price or volume.
• Example: Employees are forbidden from engaging in activities such as manipulating Bitcoin's price or creating misleading market signals, which could harm market integrity and the company’s reputation.

5. Individual Responsibility and Reporting

• Lesson: All employees have a personal responsibility to follow the trading policy and insider trading laws, even if no formal restrictions are in place at the time. Additionally, employees must report any known or suspected violations.
• Example: If an employee becomes aware of a potential violation of the trading policy, they are required to report it to the company’s Compliance Officers. Failure to adhere to the policy can result in severe penalties, including termination.

  Key Lessons from MicroStrategy Treasury Reserve Policy

1. Treasury Reserve Assets and Allocation to Bitcoin

• Lesson: MicroStrategy’s Treasury Reserve Policy outlines how it manages its treasury reserve assets, prioritizing Bitcoin as its primary treasury reserve asset while maintaining a portion in cash for liquidity and working capital needs.
• Example: The policy specifies that any cash exceeding the company's working capital requirements is eligible for investment in Bitcoin, ensuring liquidity while benefiting from Bitcoin's long-term appreciation potential.

2. Governance and Oversight

• Lesson: The policy establishes clear roles for governance, with designated officers responsible for decisions regarding the acquisition, management, and disposition of Bitcoin. It emphasizes the need for oversight and accountability at every stage of the process.
• Example: The policy requires that the designated officers jointly approve any Bitcoin transaction, ensuring that all decisions are aligned with the company's broader financial and strategic goals.

3. Risk Management and Thresholds

• Lesson: To balance the company’s need for liquidity and risk management, the policy sets specific thresholds for working capital and cash reserves. Bitcoin is only purchased when these thresholds are met, and sales of Bitcoin can occur if liquidity needs arise.
• Example: The policy outlines a “Cash Reserve Threshold,” which requires the company to maintain a minimum amount of cash before additional Bitcoin purchases can be made. This ensures that liquidity is preserved to meet operational needs.

4. Transaction Approval and Execution

• Lesson: All Bitcoin-related transactions, whether acquisitions or disposals, must follow a formal approval process, which includes reviewing the legal, tax, and accounting implications before execution. The transactions must be executed with approved service providers and custodians.
• Example: The designated officers must use a transaction approval form to document the amount, timing, pricing, and the selection of service providers or OTC counterparties, ensuring transparency and adherence to the company’s policy.

5. Security and Custody of Bitcoin

• Lesson: The policy emphasizes the importance of using trusted custodians for the safekeeping of the company’s Bitcoin. MicroStrategy ensures that all Bitcoin holdings are stored with permitted custodians who adhere to strict security protocols.
• Example: The company’s Bitcoin must be held by a permitted custodian, and additional security protocols are implemented to safeguard the assets from theft or loss.

  Key Lessons from MicroStrategy Contractual Considerations for Digital Asset Custodians

1. Jurisdiction and Regulatory Compliance

• Lesson: When selecting a digital asset custodian, it’s crucial to ensure that the custodian operates within a jurisdiction with proper regulatory oversight and licensing. Understanding the regulatory environment of custodians in various states or countries can help mitigate risks.
• Example: States like New York and South Dakota have specific licenses for digital asset custodians, which should be considered when choosing a custodian.

2. Scope of Services and Segregation of Assets

• Lesson: Custodians may offer different services, such as asset segregation or additional offerings like lending or brokerage. It's important to evaluate the custodian’s ability to securely store assets, particularly whether assets are held on a segregated basis (separate from other clients).
• Example: Some custodians use "cold storage" to segregate digital assets, reducing the risk that a security breach impacting one customer will affect others.

3. Legal Characterization and Bankruptcy Protections

• Lesson: The legal treatment of digital assets under the custodian agreement is critical, especially in the event of bankruptcy. Assets should remain customer property and not be considered part of the custodian’s assets.
• Example: Agreements that treat digital assets as "financial assets" under UCC Article 8 provide more robust protection than general intangibles.

4. Fees and Notice of Changes

• Lesson: Custodial agreements should clearly outline fee structures and provide advance notice of any fee changes. This transparency allows companies to better manage costs associated with digital asset custody.
• Example: Some custodians may offer fee discounts based on contract length or volume of assets under custody.

5. Security and Onboarding Process

• Lesson: The onboarding process for establishing and accessing accounts, as well as security protocols for accessing digital assets, should be scrutinized. Look for custodians that provide robust API access for account integration and secure onboarding processes.
• Example: Custodians with strong API access allow for better integration with company systems, streamlining asset management.

6. Data Privacy, Cybersecurity, and Incident Reporting

• Lesson: Custodians should have a clearly defined cybersecurity policy that includes provisions for incident reporting and assumes liability for data breaches. Assess the custodian’s ability to protect sensitive account information and disclose breaches in a timely manner.
• Example: A comprehensive incident disclosure policy helps ensure that any data or cybersecurity breaches are managed promptly and transparently.

7. Dispute Resolution and Governing Law

• Lesson: Custodial agreements should include clear dispute resolution procedures, specifying governing law and arbitration processes. This helps prevent prolonged legal disputes in case of a disagreement between the custodian and the client.
• Example: Agreements may outline arbitration as the preferred method for resolving disputes, which can be more efficient than traditional legal proceedings.

Key Lessons from MicroStrategy Bitcoin Accounting Treatment and Tax Considerations

1. Bitcoin as an Indefinite-Lived Intangible Asset

• Lesson: MicroStrategy accounts for its Bitcoin holdings as indefinite-lived intangible assets under FASB ASC 350. This means that Bitcoin is not amortized but is tested for impairment annually or more frequently if circumstances indicate potential impairment.
• Example: Bitcoin purchased by MicroStrategy is recorded at cost and impaired if its fair value drops below the carrying value. Once impaired, the loss is permanent and cannot be reversed, even if the value increases in the future.

2. Impairment Testing and Fair Value

• Lesson: If an impairment trigger occurs (e.g., market price falling below the carrying value), the company must test for impairment by comparing the fair value of Bitcoin to its carrying value. Any impairment loss is recorded in the income statement.
• Example: MicroStrategy monitors the market price of Bitcoin and records impairment losses if the price drops below the purchase price, as required by ASC 350-30-35.

3. Transaction Costs

• Lesson: Transaction costs related to purchasing Bitcoin, such as fees and commissions, are capitalized and added to the basis of the digital asset, aligning with general accounting principles for asset acquisition.
• Example: If MicroStrategy purchases Bitcoin for $50,000 and pays $500 in transaction fees, the total cost basis for that Bitcoin is $50,500.

4. Tax Treatment of Bitcoin

• Lesson: For tax purposes, Bitcoin is treated as property under IRS Notice 2014-21. This means that any gains or losses from the sale or exchange of Bitcoin are treated as capital gains or losses. Additionally, impairment losses for tax purposes are treated as potential capital losses.
• Example: If MicroStrategy sells Bitcoin at a loss, the capital loss can be carried forward or carried back to offset capital gains, consistent with the IRS guidance.

5. Deferred Tax Accounting

• Lesson: When Bitcoin is impaired, it creates a book-tax difference, as the impairment loss affects financial reporting but does not impact the tax basis. This results in a deferred tax asset that needs to be evaluated for realizability based on future capital gains.
• Example: If MicroStrategy records an impairment loss on Bitcoin, it will recognize a deferred tax asset. However, the company must assess whether it has future capital gains to utilize the deferred tax asset; otherwise, a valuation allowance may be required.

6. Tax Accounting Methods

• Lesson: MicroStrategy uses a specific identification method for tax purposes to calculate the cost basis of Bitcoin sold. This allows the company to manage which tranches of Bitcoin are sold and optimize tax outcomes.
• Example: By segregating its Bitcoin purchases, MicroStrategy can choose which units of Bitcoin to sell, thereby managing its realized gains or losses for tax purposes.

  Key Lessons from MicroStrategy Key Considerations for Corporate Investment in Bitcoin

1. Business Strategy and Rationale

• Lesson: Investing in Bitcoin requires aligning the rationale for the investment with the company's overall business strategy. It's important to evaluate the risk-reward shift between holding Bitcoin versus traditional cash equivalents, as this affects investor, customer, and employee perception.
• Example: MicroStrategy adopted Bitcoin as a primary treasury reserve asset to mitigate inflation risk and take advantage of Bitcoin's appreciation potential, while considering the volatility impacts on stock price and earnings.

2. Risk Management and Controls

• Lesson: Risk management is crucial in Bitcoin investment, with key elements including setting clear policies for transaction authorization, vendor management, and approval thresholds for large transactions.
• Example: The policy emphasizes the importance of selecting trusted custodians for Bitcoin storage and ensuring that authorized personnel are the only ones executing Bitcoin transactions, reducing the risk of fraud.

3. Disclosure and Transparency

• Lesson: Publicly traded companies need to clearly disclose the financial and accounting impacts of Bitcoin investments, including how Bitcoin valuation affects quarterly results and liquidity. Transparent discussion of the risks, such as Bitcoin’s volatility and regulatory concerns, is crucial for investor trust.
• Example: MicroStrategy's disclosure includes financial statement impacts of Bitcoin investments, ensuring investors are aware of how fluctuations in Bitcoin value could influence corporate earnings.

4. Execution and Custody Solutions

• Lesson: Establishing secure custody and storage solutions is a priority. Companies should work with qualified custodians and consider a combination of hot wallets for liquidity and cold storage for security. Custodians should offer robust security protocols and insurance coverage to mitigate risks.
• Example: MicroStrategy advises using a U.S.-based qualified custodian and implementing cold storage for the bulk of Bitcoin holdings, ensuring the highest level of security while minimizing liquidity risks.

5. Regulatory and Legal Compliance

• Lesson: Companies investing in Bitcoin must navigate complex regulatory environments, ensuring that Bitcoin transactions do not unintentionally fall under money transmission or securities laws. Compliance with regulatory requirements protects the company from legal and financial penalties.
• Example: The document highlights the importance of establishing guardrails to ensure that Bitcoin investments do not violate money transmitter or commodity laws, thus avoiding additional regulatory scrutiny.

  Key Lessons from MicroStrategy and Deloitte: Corporates Investing in Crypto

1. Strategic Purpose for Investing in Crypto

• Lesson: Corporations considering digital asset investments must align their crypto strategy with their broader financial goals, ensuring that investments in assets like Bitcoin serve specific business objectives, whether as a hedge against inflation or to enhance financial returns.
• Example: MicroStrategy’s decision to invest over $1 billion in Bitcoin during 2020 was framed as a strategic move to preserve value and enhance capital returns compared to traditional fiat holdings.

2. Governance and Risk Tolerance

• Lesson: Effective governance is essential when investing in digital assets. Companies need to ensure that their leadership understands the risks associated with the chosen assets and adjusts their risk tolerance as needed. Regular risk assessments and governance structures help in managing these dynamic investments.
• Example: MicroStrategy’s leadership, including its CEO, CFO, and board of directors, regularly evaluated Bitcoin’s risk profile to ensure that it aligned with the company’s risk appetite and broader investment strategy.

3. Accounting and Tax Challenges

• Lesson: The lack of clear accounting standards for digital assets under US GAAP presents challenges for corporates. Bitcoin and other digital assets are generally treated as intangible assets, meaning impairments must be recognized when their value drops, but gains cannot be recorded until the asset is sold.
• Example: MicroStrategy held 70,469 Bitcoins as of December 2020, which were acquired at a cost of $1.125 billion and reflected at a lower book value of $1.054 billion due to impairments, despite the market value being significantly higher.

4. Controls and Security for Digital Assets

• Lesson: Companies must implement strong internal controls and security measures to protect digital assets. This includes securing private keys, selecting reputable custodians, and ensuring that assets are adequately insured and safeguarded against theft or loss.
• Example: The document emphasizes the importance of using third-party custodians for digital assets and conducting rigorous due diligence on the custodian’s policies regarding private key security, insurance, and risk management.

5. Cross-Department Collaboration

• Lesson: Successful crypto investment strategies require cross-departmental collaboration. Departments such as finance, treasury, legal, compliance, and IT must work together to navigate the complexities of digital asset investments and align operational strategies.
• Example: The report stresses the need for various departments within a company, including the board of directors and external advisors, to rethink the application of traditional rules and collaborate effectively to manage digital assets.