Cryptocurrency is a digital asset that could serve as a medium of exchange, for other currencies or for goods and services, whereby the ownership records of the asset by individuals are stored in a digital “ledger” or a computer database. Bitcoin was the first cryptocurrency, invented in 2008 by the pseudonymous Satoshi Nakamoto and began trading that year. Bitcoin was a decentralized currency: users on its peer-to-peer network can send Bitcoins to each other without the need for intermediaries such as a bank or an administrator. Bitcoin was facilitated by “block chain” technology that allowed the computer database to securely track transaction records and to verify the transfer of coin ownership. Unlike traditional currencies, Bitcoin was not backed by any government and its creation or supply did not depend on a central bank. Instead, they were created as a reward for a computing-intensive process called “mining,” in which highly complex computational math problems are solved by (typically very sophisticated) computers. By design, the supply of Bitcoin was fixed: only 21 million Bitcoins can be ever mined, and by the end of February 2021, 18.648 million Bitcoins were already in circulation. 2

Since Bitcoin’s creation, cryptocurrencies and Bitcoin in particular had garnered significant attention and interest from investors. Some hailed cryptocurrencies as the beginning of a new monetary age. Indeed, the excitement over them had resulted in the creation of more than 2,000 different cryptocurrencies by the end of 2018 and more than 4,000 by the end of 2020. 3 ^, 4 Despite the new entrants, Bitcoin remained the most significant (in terms of total capitalization) cryptocurrency, which saw a 100 fold increase in the dollar value of a single coin from 2009 to 2021 (see Exhibit 2 ). 5 However, some economists had characterized digital currencies’ meteoric rise in value as a speculative bubble, and questioned whether they can be considered “money” due to their price volatility. For example, in the last two months of 2017, the capitalization of cryptocurrencies multiplied by a factor of four; however, from December 2017 to February 2018, the cryptocurrencies’ values plummeted, with Bitcoin losing 60% of its value and resulting in an all-time low market share of just under 35%. 6 ^, 7 Scott Wolla, Ph.D. of the St. Louis Fed explained in 2018:

Money serves three functions in an economy: medium of exchange, store of value, and unit of account. […] Bitcoin has characteristics that allow it to function as money and make it a useful payment method. That is, it is relatively easy to transfer Bitcoin to other people or businesses, even for international transactions. However, other aspects of Bitcoin make it less desirable for everyday transactions, including security problems and volatile price fluctuations […] as demand for Bitcoin has fluctuated, so has its price. This price volatility has undermined Bitcoin's ability to serve as a store of value. In contrast, governments often delegate the value of their official currencies to their central banks. For example, the Federal Reserve was founded to provide an "elastic currency" to ensure that it could adjust the money supply to provide price stability in the face of changing demand […] Bitcoin's characteristics as a financial asset have drawn the interest of many and created the potential for financial loss. While the line between money and financial asset is not clear, people's actions often reveal the role the asset is playing in the economy. Lately, the excitement surrounding Bitcoin has been around buying it as a financial investment, not using it as money to buy goods and services. Weighing in on the issue, former Federal Reserve Chair Janet Yellen said that Bitcoin is ‘not a stable source of store of value, and it doesn't constitute legal tender’; in her judgement, Bitcoin ‘is a highly speculative asset.’ 8

Some regulatory agencies, such as the SEC, have issued alerts to investors about the heightened volatility and risks of fraud associated with Bitcoin related investments. 9

On February 8 ^th 2021, Tesla filed its 10-K for the fiscal year ended December 31, 2020. For the sixth straight quarter, the company reported positive net income, and for the first time it was profitable over the full fiscal year. Additionally, Tesla disclosed in the filing its Bitcoin purchases and the intention to accept Bitcoin payments for the first time.

In January 2021, we updated our investment policy to provide us with more flexibility to further diversify and maximize returns on our cash that is not required to maintain adequate operating liquidity. As part of the policy, we may invest a portion of such cash in certain specified alternative reserve assets. Thereafter, we invested an aggregate $1.50 billion in Bitcoin under this policy. Moreover, we expect to begin accepting Bitcoin as a form of payment for our products in the near future, subject to applicable laws and initially on a limited basis, which we may or may not liquidate upon receipt. We believe our Bitcoin holdings are highly liquid. However, digital assets may be subject to volatile market prices, which may be unfavorable at the time when we want or need to liquidate them. 10

Musk justified the move into Bitcoin as “simply a less dumb form of liquidity than cash” and is “adventurous enough for an S&P 500 company.” 11 He added, “when fiat currency has negative real interest, only a fool wouldn’t look elsewhere.”

Tesla’s decision was met with mixed reactions. Some hailed the move as pioneering and a brilliant financial move. Gene Munster, Managing Partner of venture capital firm Loup Ventures, said, “ Tesla has money to lose with $19 billion in assets […] Bitcoin can move the needle for Tesla. If it goes up 10x, that's $15 billion to Tesla. That's real money.” 12 Mike Novogratz, founder of the digital asset financial services firm Galaxy Digital, believed that the move could lead to broader adoption of cryptocurrency by corporations. He said, “Every company should be looking at how to accept digital currencies, digital payments as part of their business scheme.” 13

A few other public firms had also begun to make bets on the rise of cryptocurrency. In July 2020, MicroStrategy, a business intelligence and analytics solutions firm, announced a new capital allocation strategy in which it sought to invest excess cash in “alternative investments or assets” including digital assets such as Bitcoin. 14 By February 2021, the company held more than 90,000 Bitcoins, making it the largest public company holder of digital currencies, and it had done so in part by issuing more than $1.5 billion of debt explicitly for the purpose of acquiring Bitcoins. 15 ^, 16 In October 2020, Square Inc., the digital payments company, announced that it had purchased $50 million of Bitcoin. Since 2018, Square’s customers had the ability to buy and sell Bitcoin through the company’s “Cash App.” Square explained the decision in a whitepaper accompanying the announcement: “Given the rapid evolution of cryptocurrency and unprecedented uncertainty from a macroeconomic and currency regime perspective, we believe now is the right time for us to expand our largely USD-denominated balance sheet and make a meaningful investment in bitcoin.” 17 In October 2020, Paypal announced that its customers could buy, sell, and hold cryptocurrency through their accounts. 18 Novogratz added, “It’s not that difficult. It’s what customers want, it’s where the world is moving. And so that I think [Musk is] getting ahead of the curve, and I think you’re going to see every company look to figure out how they could, from McDonald’s to Bojangles, you name it.” 19

Others expressed skepticism about the move and its implication for Tesla’s stock price and performance. Mohamed El-Erian, chief economic advisor at Allianz, commented that the move was a positive sign for cryptocurrency but not necessarily for Tesla’s investors: “What did Tesla tell you? Two things. One is that this will be a form of payment. And two is that this is an investment vehicle. So those are two powerful endorsements for the notion, I want to stress the notion, that Bitcoins are a currency, a money, because after all money is a store of value.” He further added that “[some] will see it as visionary, others will say ‘wait a minute, if I want to invest in Bitcoin, I’ll do it directly, I don’t need Tesla to do it for me.’” 20  ( Exhibit 3 displays the section from Tesla’s S-1 filing describing the company’s intended use of the initial public offering proceeds.) King Lip, chief strategist at Baker Avenue Wealth Management, whose firm had owned Tesla shares since 2015, agreed. “This is better for Bitcoin than it is for Tesla,” he said. “It will add volatility to the stock due to exposure to Bitcoin.” In addition, because Tesla was part of major stock indexes, including the S&P 500 since December 2020, investors of many index-tracking ETFs were also exposed to Bitcoin as well. 21

Musk’s public statements, including those over Twitter, prior to Tesla’s February 8 ^th 2021 10-K filing were also scrutinized by market participants. Nouriel Roubini, Professor of Economics and International Business at New York University, said that to “take an individual position in Bitcoin, pump up the stock price, and say that Tesla has invested, […] it’s irresponsible and it’s market manipulation. The SEC could be looking into people that have market impact that manipulate the price of assets. That’s also criminal behavior.” 22

This was not the first time Musk was criticized for manipulating market prices through his tweets. On August 7, 2018, Musk tweeted to his 22 million followers: “Am considering taking Tesla private at $420. Funding secured.” After the tweet, the company’s stock price jumped by more than 6% on the same day, although no deal ultimately consummated. In September 2018, the SEC charged Musk for securities fraud due for his “misleading tweets about a potential transaction to take Tesla private.” 23 The SEC’s complaint alleged that Musk had not in fact discussed any specific deal terms with potential financing partners. “Corporate officers hold positions of trust in our markets and have important responsibilities to shareholders,” said Steven Peikin, Co-Director of the SEC’s Enforcement Division. “An officer’s celebrity status or reputation as a technological innovator does not give license to take those responsibilities lightly.” 24 Stephanie Avakian, Co-Director of the SEC’s Enforcement Division, added, “Taking care to provide truthful and accurate information is among CEO’s most critical obligations […] That standard applies with equal force when the communications are made via social media or another non-traditional form.” In the end, Tesla and Musk settled with the SEC, agreeing to pay a $20 million fine each to the regulator. In addition, Musk agreed to step down as the company’s chairman for three years but would remain as its CEO. Moreover, the deal called for Tesla’s lawyers to pre-approve Musk’s written communications, including tweets with material information about the company. 25

Despite the criticisms, there was uncertainty as to which agency had the regulatory oversight over potential manipulation of cryptocurrency. This was in part due to an uncertainty around how cryptocurrencies are classified as assets. For example, whereas the Commodity Futures Trading Commission considered Bitcoin as a commodity, the IRS treated it as property, whereas the SEC treated certain cryptocurrencies, such as tokens issued by businesses as a medium of exchange for its current or future products, as securities. By the end of March, no charges were brought against Musk for his cryptocurrency related tweets.

Among the topics heavily discussed about Tesla’s move was the accounting treatment for Bitcoin. One reason was that there was no official guidance under the Generally Accepted Accounting Principles (GAAP) for how companies should account for digital assets. The Financial Accounting Standards Board (FASB) had rejected three requests to craft rules on the basis that “too few companies had material holdings in digital assets.” 26 Following Tesla’s announcement regarding its Bitcoin purchase, FASB re-iterated its decision not to add a project to its agenda to develop formal accounting rules for digital assets. 27

Absent formal guidance, companies like Tesla had to rely on industry guidance. Deloitte, one of the “Big Four” auditors that also audited MicroStrategy, published its opinion on the classification of cryptocurrency holdings in July of 2018. Under U.S. GAAP, there were four possible asset categories that cryptocurrency holdings can fall under: cash or cash equivalent, inventory, financial instruments, or intangible assets. 28

In principle, an asset is considered “cash” or “cash equivalent” if it is short-term, highly liquid, readily convertible to known amounts of cash, and subject to an insignificant risk of change in value. 29 Currency on hand, demand deposits, treasury bills, and money market funds would typically all fall under this category. Deloitte determined that cryptocurrencies such as Bitcoin could not be classified as cash, because “they are not backed by a sovereign government and do not represent legal tender that must be accepted as a form of payment.” However, it also determined that digital currencies could not be considered as cash equivalents, because they “are not readily convertible to known amounts of cash and have more than an insignificant risk of change in value.” In addition, Deloitte determined that cryptocurrencies are not financial assets because “they are not cash, an ownership interest in an entity, or a contract establishing a right or obligation or receive cash or another financial instrument.” 30 An asset is considered “inventory” when “[t]he aggregate of those items of tangible personal property that [are held for sale] in the ordinary course of business.” Deloitte determined that, while for some businesses accounting for Bitcoin (e.g., a broker) as inventory or as financial instrument (e.g., for an investment company) may be appropriate, for most businesses, cryptocurrencies should be accounted for as intangible assets, defined as non-financial assets that lack physical substance.

In its 10-K for the fiscal year ended December 31 ^st, 2020, filed on February 8 ^th of 2021, Tesla disclosed that it would account for Bitcoin assets as intangible assets, the same treatment applied by MicroStrategy and Square.

We will account for digital assets as indefinite-lived intangible assets in accordance with ASC 350,  Intangibles–Goodwill and Other. The digital assets are initially recorded at cost and are subsequently remeasured on the consolidated balance sheet at cost, net of any impairment losses incurred since acquisition. We will perform an analysis each quarter to identify impairment. If the carrying value of the digital asset exceeds the fair value based on the lowest price quoted in the active exchanges during the period, we will recognize an impairment loss equal to the difference in the consolidated statement of operations.

The cost basis of the digital assets will not be adjusted upward for any subsequent increases in their quoted prices on the active exchanges. Gains (if any) will not be recorded until realized upon sale. 31

Had Tesla chosen to account for the Bitcoin as cash or a financial asset, changes in Bitcoin’s value in each financial reporting period would impact the company’s financial statements in different ways. (See Exhibit 4 for Tesla’s accounting policies for inventory and financial instruments.)

Analysts wondered how much impact Bitcoin’s performance will have on both Tesla’s bottom line and stock price (see Exhibit 5, 6, and 7 for Tesla’s financial performance and Exhibit 8 for its stock returns in January and February of 2021), Elon Musk’s motives for buying Bitcoin, as well as the impact on his financial incentives (see Exhibit 9 for an example of the revenue and adjusted EBIDTA targets from Tesla’s 2018 CEO Performance Award plan). Francine McKenna, a financial journalist, estimated: “If I assume that Tesla’s average cost basis for its $1.5 billion in Bitcoin is $32,886.60, Tesla is currently sitting on an unrealized gain on its investment of $20,224.67 for each Bitcoin based on a closing price on Feb. 22 of $53,111.27. That means Tesla is currently looking at, as of Feb. 22, a total unrealized gain of nearly $1 billion.” 32 These gains would only be reflected in the financials, however, when Tesla decided to sell Bitcoin at a profit. There were also questions about how the firm and its investors may react in the event of a crash in Bitcoin prices similar to the end of 2017. In such an event, Tesla would be forced to write down the value of its Bitcoin assets and recognize a loss in its income statement. “Elon Musk has exposed Tesla to immense mark-to-market risk,” Peter Garnry, head of equity strategy at Saxo Bank, wrote in a research note. 33 In such events, McKenna expected Tesla to adjust its non-GAAP earnings numbers, the financial performance metrics that managers define and use to communicate their views of firm performance: “I suspect Tesla will adjust the non-cash hits to net income from any impairments as non-GAAP adjustments the way everyone does when other intangibles like goodwill or IP are impaired.” A first glimpse into Bitcoin’s impact on Tesla’s financial performance will be revealed in May 2021, when Tesla is expected to file its 2021 first quarter financial report (10-Q) with the SEC.