In recent litigation before the English High Court, DAC Beachcroft LLP and Nicholas Parton of Opus Forensic Accounting had to consider the complexities of valuing a crypto business, in the context of an unfair prejudice petition pursuant to Section 994 of the Companies Act 2006.
In this article, we offer our perspectives, drawn from our experience as solicitors and forensic accountants who regularly act for crypto companies, on overcoming the challenges associated with valuing these types of businesses.
Why is it so difficult to value crypto companies?
The reasons why crypto companies are difficult to value can essentially be traced back to their very reason for existing: they are enterprises which reject traditional assets, eschew traditional ways of doing business, and (mostly) operate outside traditional regulatory oversight.
The consequences of deviating from the norm are unsurprising: volatility, unpredictability, and greater risk, against a background of a fast-changing regulatory backdrop. Any valuation that fails to appreciate the non-traditional context in which crypto businesses operate is always going to end up wide of the mark.
It goes without saying that, at the heart of any crypto business is crypto assets. So much about crypto assets makes them more complex to value than more traditional assets. First and foremost, cryptocurrencies and tokens are notorious for their extreme price volatility. Unlike traditional assets, where values tends to fluctuate within more predictable ranges, cryptocurrencies can experience dramatic swings in value over short periods. This volatility is a product of the novelty of crypto coupled with an unpredictable economic and regulatory landscape, meaning that even the best-known and established cryptocurrencies can behave erratically. As a result, we must assume that it will remain volatile for the foreseeable future.
If cryptocurrencies like Bitcoin and Ethereum are considered volatile, smaller and less well-known coins, known as "altcoins", are even more so. Altcoins typically have low trading volumes, making it difficult to convert them into cash without significantly impacting their market price and this lack of liquidity can affect the valuation of a business that holds substantial amounts of altcoins. That being said, while altcoins may not have a wide base of potential buyers, they are not without value. To those individuals or business that accumulate altcoins, they can be incredibly valuable.
In litigation, this volatility poses a real challenge. A general rule in the English law of damages is that damages are assessed as at the date of the defendant's breach. But the extreme volatility of cryptocurrencies means that using the date of breach can lead to absurd outcomes. In a recent case, the High Court questioned whether a defendant should be ordered to pay massive damages based on a valuation of crypto assets that had plummeted in value since the date of breach.[1] In its judgment, the Court affirmed that assessing loss at the date of breach is by no means an absolute rule in English law, and proposed that Courts should take a more flexible approach if circumstances demand.
Beyond the volatility of their assets, crypto companies can be difficult to value because they often eschew ways of managing themselves which are considered fundamental in traditional businesses. Thus, although crypto transactions will be recorded "on chain", much is also done "off chain". Record keeping can be rudimentary and many crypto businesses do not keep typical records of business transactions or maintain accounts and financial data that would meet an internationally recognisable standard. In our experience, even well-established crypto enterprises can have record-keeping more akin to a start up business.
Indeed, a certain lack of sophistication should be expected. This is not because people in these businesses are incapable (far from it) but because it is antithetical to their own philosophy of business.
As a result, we have seen many businesses that are not incorporated through traditional structures (e.g. limited companies or partnerships) intentionally to legally side-step the need for compliance with requirements such as the regular filing of accounts.
Even if they do not adopt a rigorous autonomy-based philosophy, some crypto businesses have simply grown so extraordinarily fast that they have not had a chance to develop the sort of record-keeping discipline that might be expected in more entrenched parts of the financial sector.
Whether as the result of unintentional oversight, or as a highly intentional consequence of a wish to be free from strangling regulation, many crypto companies simply do not keep many of the types of records upon which forensic accountants traditionally base their valuations.
As a result, many crypto businesses face common challenges. For example, it is extremely typical for crypto start ups to struggle to open a bank account, or, once opened, to keep it open.
What to consider in a crypto valuation?
Given these challenges, how can parties involved in litigation effectively approach the valuation of a cryptocurrency business? There are several key features and characteristics that a forensic accountant might consider to arrive at a more accurate and defensible valuation.
Sources of revenue
In any corporate valuation, it is necessary to understand revenue but in the context of a cryptocurrency business, it’s important to examine the different, and often novel, ways crypto companies generate income. This may include trading and referral fees, staking rewards, transaction processing fees, and subscription services for premium features.
It is crucial to properly assess the sustainability of these revenue streams over time. For instance, a business that relies heavily on volatile trading fees may be considered riskier than one with a more stable income source, such as a subscription model. Additionally, analysing historical profitability, even if only limited data is available, can provide insights into the business’s financial health and future potential.
Intangible assets
The composition and liquidity of any company’s assets are critical factors in its valuation and crypto businesses are no different in this regard. Most crypto businesses will have little or no tangible assets familiar to traditional enterprise: such as real estate, (fiat) cash, or stock.
Assets are likely to include well-established coins like Bitcoin or Ethereum, altcoins, or tokens. Some tokens may confer voting rights or control over decentralised, autonomous organisations ("DAOs"), more akin to shares in a company than a currency. A forensic accountant will inevitably have to consider the volatility, liquidity and historical trends for each crypto-asset held.
It is also common for major crypto companies to hold valuable intellectual property. This can be among the most valuable assets a crypto company possesses, particularly proprietary tech like algorithms, patents, and other innovations which are unlikely to feature on the business’s balance sheet (that is, if one is even prepared).
Valuing IP assets can be challenging, not least because of the speed with which technological advancements occur. New innovations become obsolete remarkably fast and loss of a first mover advantage can be catastrophic for the value of this asset.
User data
Beyond intellectual property, most crypto companies inevitably have key user data that will be fundamental to the valuation process.
In particular, operational metrics such as user engagement, transaction volumes, and customer retention rates provide valuable insights into a cryptocurrency business’s performance and growth potential. A large, active user base can be a strong indicator of the business’s market penetration and future revenue prospects.
In our experience, judges are often particularly receptive to evidence about user data, whether it is being used to project future earnings or to assess the impact of certain events on the company’s operations.
Corporate structure and regulatory environment
Crypto enterprises come in all shapes and sizes, and this will often depend on the company's goals and philosophical approach to regulation. In turn, the regulatory environment in which a cryptocurrency business operates plays a significant role in its valuation.
As a result, it is necessary to consider where any given crypto business sits on the spectrum. Some may operate as DAOs, aspiring to exist nowhere (legally-speaking), with no legal structure. The "purer" a DAO is, the harder they will be to value.
Along the spectrum are crypto businesses that adopt one of a limited number of familiar legal entities, even if only for limited jurisdictional, operational, or regulatory purposes.
A company that adopts a traditional legal structure, tied to a particular jurisdiction, is always easier to value. Likewise, a company which is subject to regulatory requirements, and which complies with those requirements, is likely to be valued more highly than one operating in an offshore jurisdiction that does not require company filings and imposes little to no regulatory oversight. Unsurprisingly, there is a stark contrast between a business that is a private company limited by shares, and an unincorporated association, with founding members located in a variety of jurisdictions.
Conclusion
If we were to summarise our views on the challenges of valuing crypto business, we would say simply that crypto is different. The Courts are struggling to get to grips with the difficulties associated with valuing crypto businesses. As a result, helping the Court understand how and why these businesses operate in a different environment is crucial to ensuring clients' positions are protected, and to avoid prejudicial and unfair outcomes from legal proceedings. It is important to highlight these differences, and prepare a valuation that appreciates them, while explaining to the reader novel and technical concepts in plain English. Crucially, in our experience, over-reliance by parties on "analogue" comparators (that is, by assuming that crypto business operates like any other business and should be valued accordingly) will undermine the credibility of the whole exercise.
For parties in litigation involving cryptocurrency companies, understanding these challenges and features is essential. We strive to work together, as solicitors and forensic accountants, to ensure that valuations are based on a thorough and nuanced analysis, which is appreciative of this dynamic, and often unpredictable industry.
[1] Southgate v Graham [2024] EWHC 1692
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