To ensure you’re carrying your business in the best way possible, you have to utilize the right tools and processes, especially when the trade or purchase of a digital asset is involved. This is where Liquidity Pool Accounting comes in.
Unlike a regular transaction where funds move from one account to another, Liquidity pools are more of a financial instrument, even an investment, that generates yield. Moreover, the “liquidity” gets mixed with other’s assets, the volatility of the underlying assets plays a crucial factor and the term “impermanent loss” becomes a thing you have to be aware of.
Complex? Oh yes.
Solvable? Well, you will probably need a Web3 native accounting professional, to be honest.
First things first - what is a Liquidity Pool?
A liquidity pool is a pool of funds provided by market-makers which is used to facilitate trading on exchanges. It is a form of automated market-making which allows traders to buy and sell assets without having to wait for an order to be filled by a third party.
The liquidity pool allows market-makers to provide buyers and sellers with access to larger amounts of liquidity than would be available without the pool. Liquidity pools are typically used on digital asset exchanges to provide liquidity for cryptocurrencies but can also be used for other financial instruments such as stocks, bonds, and derivatives.
However, like with anything, there comes an element of risk regarding liquidity pools, such as impermanent loss.
Impermanent loss is the difference in value between a trade and the current market value of a cryptocurrency, which can occur due to price volatility and is most common with decentralized exchanges. It occurs when a user trades one asset for another and the price of the asset they are trading away falls before they can rebalance their portfolio. The impact is that the user will experience a financial loss, but it is not permanent, as the user can rebalance their portfolio once the price of the asset stabilizes.
Accounting Treatment for Liquidity Pools
The accounting treatment for liquidity pools on a decentralized exchange will vary depending on the specific exchange and the type of asset being traded.
Generally, the accounting treatment for liquidity pools is similar to that of a traditional exchange. Funds deposited by users into a liquidity pool are typically treated as a current asset, with the value of the pool increasing or decreasing depending on the changes in the price of the asset.
Any fees collected from users for providing liquidity are generally recorded as revenue. Any income generated from liquidity pools, such as interest or trading profits, are typically recorded as income. Any capital gains or losses resulting from trading activities are typically recorded as capital gains or losses. Finally, any costs associated with running a liquidity pool, such as transaction fees or other administrative expenses, are typically recorded as expenses.
On the data side of things, tracking the liquidity pool, specifically, the fiat values isn’t easy. From our experience, a monthly snapshot of the end-of-month balance is important, in addition to making sure the cost basis is recorded and any withdrawal of rewards. In cases where the fees/rewards are streamed directly into the pool, it is much more difficult to differentiate between the underlying assets and the rewards
In addition, tracking the deposits, withdrawals and fees is essential for accounting hygiene but also for the operational trading organization. There is a need to understand if there is an impermanent loss caused by these activities.
How can Myna & Tres Finance Support?
A great question to ask.
Myna and Tres Finance have formed a powerful partnership that is set to revolutionize the world of crypto accounting.
Myna, a world-leading crypto accounting firm, provides services such as liquidity pool accounting, DeFi reconciliations and other services related to the accounting of digital assets. In addition to this, Tres Finance is a Web3 financial data platform, enabling you as a user to track all your crypto activity with expertise in DeFi and specifically in LP movements. Tres can track all your DeFi deposits and withdrawals across multiple chains, applications and protocols. They have even written a blog recently on the challenges of accounting for DeFi bridges.
Using Tres you can monitor LP fiat value at any given moment, export historical values and make sure that you are in 100% control of your crypto financials.
Together, Myna and Tres Finance provide a comprehensive package of services and tools that can help businesses and individuals manage their crypto assets and transactions.
For instance, the combination of accounting expertise and DeFi financial data can save finance teams at crypto companies up to 80% of their monthly work and increase data integrity and completeness by up to 65%.
This type of accounting involves tracking and recording the flow of funds from various sources and into various pools of assets, allowing for greater transparency and insight into the overall liquidity of the pool.
If you need assistance with your crypto accounting, please get in contact with Myna and Tres today.
