How to Best Navigate the Complexities of Crypto Accounting, with Rich Zhou @ Aquifer CFO (Audio)

[00:00:04] Hello, everybody, and welcome to the Crypto Hipster Podcast. This is your host, Jamil Hasan, the Crypto Hipster, where I interview founders, entrepreneurs, executives, thought leaders, amazing people all over the world of crypto and blockchain. And today I have another amazing guest. With me today, I have Rich Zhou, who's the CEO and founder of Aquifer CFO. Rich, welcome to the show today.

[00:00:32] Thanks for having me, Jamal. Happy New Year, too. Happy New Year. Wonderful start of a new year. I think crypto markets are going to be quite hot this year. And, you know, we have probably seen it all the way since November, right, since the Trump election. Yes, we have. Up until yesterday when something happened in the market, which I don't understand, but hey, we have little blips here and there. Yeah. Yeah.

[00:00:58] You know, so I'm interested to know, you know, what about your background? Now, what is your background? And is it logical? Is it a logical background for what you're doing now? Yeah. Yeah. Yeah. And so I come from TradFi. So, you know, went to business school, you know, MBA, traditional stuff, worked in investment banking on the trading side. Eventually left for corporate finance jobs across different industries, you know, CPGs, commercial banking, so forth.

[00:01:26] Eventually, you know, became a CFO at a fintech startup that eventually grew to, you know, 280 people. I was the 26th employee, first finance hire. And so I was at one man department, you know, walked in, you know, this was like, you know, 2017, very hot market. Founder raised, I remember millions of dollars on napkin math.

[00:01:53] Walked in without, you know, anything there, no financial model, no sub ledger, general ledger. I think they had a few bank accounts and that's it. And in the whole time there, they were running a fintech company telling, you know, their customers that they have all this, you know, AI system that accounts for where their money is at. So there was obviously that that's the initial stress of coming in and just building that infrastructure right away.

[00:02:21] And what that led to is, you know, in 2020, you know, the year of COVID, I started this, you know, accounting advisory firm cater to startups. And so we provide something that's quite unique. We provide something that's called a fractional finance department. You probably heard of fractional CFOs. You know, we provide the whole nine yards, including the CFO. But with us, you get everything from bookkeeping all the way up and we've been in business for five years now.

[00:02:51] And the reason why I like to say I'm a crypto expert in some areas is that we have, you know, almost like, you know, 40% of our revenue coming from the crypto industry. It used to be much, much more when we were smaller. But we've seen all sorts of, you know, accounting implications for crypto clients. Got it. So I was about to hear what Aquifer CFO is all about.

[00:03:20] You answered briefly how, what it's your, what you're about, accounting solutions and fractional CFO. How do you, how do you help startups succeed? Yeah. So I think most startups that's out there, and I don't know why this is a phenomenon, but, you know, every department is capitalized heavily except the finance accounting department. Right. And, you know, the reason could be that over 95% of founders don't come from accounting background.

[00:03:50] Right. So they don't care for it. They don't want to deal with it. They don't want to look at it. They rather sit on the issue. And so we seen large crypto companies that are doing, you know, as much as 20, 30 million dollars a year in revenue, spend as little as 500 bucks per month on an overseas bookkeeper.

[00:04:14] It's almost ludicrous. But this happens time and time again, not just in the crypto industry, but, you know, the reason this happens exactly is because no one wants to spend money on accounting. It's a cost center. And people view accounting as, hey, it's something I need to do to file taxes. So the IRS is not, you know, on my file. But there's been a lot of repercussions of that kind of thinking.

[00:04:39] For example, post 2016. And let's talk about the crypto industry, not just the startup industry. After the whole FTX debacle, you know, now startups need to present numbers that are properly managed, filed, updated to the very last month to investors. Investors will no longer cut checks based on some napkin math. That is the reality of it.

[00:05:05] And I've seen many prospect clients. I've seen current clients that we were engaged a bit too late. They lost investors because they couldn't get those numbers ready in time. They were three, four years backdated. I mean, it's crazy how much, you know, time has elapsed. It's crazy how much founders are willing to sit on the issue for.

[00:05:30] And so there's been a lot of that going on. Another thing is, you know, numbers help you manage the business, not just by filing taxes, right? Like you run highly volatile assets called crypto and they, you know, increase in value. You know, one day they go down another day. You have people that are, you know, on your payroll. You have rent to pay. You have marketing expenses. These are fixed expenses that happen every day.

[00:05:59] So how do you manage that capital is another thing that we help founders achieve with just ultimately better accounting and reporting. Interesting. Yeah. So people need an account. I just find the whole concept fascinating that, you know, people don't like accounting, but that's exactly what the blockchain is. It's an accounting ledger. You know, how can you have an accounting industry?

[00:06:29] Yeah. Yeah. Yeah. You know, it's ironic, right? It was invented because it has a record for every transaction that happens in the ecosystem. Right. And then so you're blessed with being in the crypto industry. You're definitely blessed with having the blockchain technology. So everything you've ever done ever, there's record for it, but no one's doing the accounting for it, which is quite funny versus, you know, other industries.

[00:06:56] If let's say you're running a restaurant business, a lot of the accounting is naturally a mess because it deals with a lot of cash. Right. And I'm talking about cash bills and coins. And that's that's, you know, very difficult to reconcile. Sometimes there's a lot of, you know, slippage and just where it goes. But, you know, crypto, you're you're really halfway there. Yeah. Yeah, that's true. So. I think it's important, right?

[00:07:24] People bridge the gap between financial strategy and technology. Right. So there's a big gap there. Right. So how do you bridge that gap from both a technical perspective and a human resource perspective? Yeah, definitely. You know, I think that the first step is to really educate, you know, founders on what is important to look at on a financial metric standpoint. A lot of them just say, hey, look, what's my profit?

[00:07:54] You know, everyone knows to look at profit. Right. But there's so many other metrics you should look at, especially, you know, depending on what kind of crypto business you're in. Are you in, you know, brokerage business? Right. Right. There are a lot of like risk metrics you need to look at, you know, how many bitcoins or, you know, stable coins are you holding at any given time? Like how much risk are you taking?

[00:08:18] So things like that, you know, we're trying to bridge that gap of knowledge that that's the biggest problem right there. Second is a lot of founders know about the technicals, you know, the white paper, how these coins work, you know, the value of it and the community. The issue is how do we then transform that into traditional finance?

[00:08:45] And it's quite simple. You know, crypto is very, very similar to FX. It's it's it acts the same way. It's it's got the same kind of like, you know, market, you know, valuation or understanding of it. But, you know, the accounting standards apply to FX need to also apply to crypto. And a few years ago, I remember some clients said, you know, we're in crypto. It's unique.

[00:09:12] The regulations, the tax standards are never going to come to crypto. They were so wrong. Of course, they were going to come over. And of course, they're going to copy and paste whatever, you know, they got from derivative FX, you know, equity or fixed income world and apply it over because it's the same people now that we've seen in Wall Street. Now they're also working in the crypto industry. Yeah, true.

[00:09:41] So you said a couple of times about TradFi, right? Yeah. So there's there's a certain needs. It's a gap account. It's all kinds of different regulations, certifications, regulations, stuff like that. So what do you like that doesn't exist yet for crypto or maybe it does, you know, from an accounting needs perspective, what's the overlap there between TradFi and crypto? Yeah.

[00:10:10] So you're working with you're working with capital market assets that, you know, have a change of valuation every second. Actually, every every millisecond. But, you know, from from reporting basis, if you can just get, you know, the value in which you move the asset, the daily close value and the month end close, you're pretty good. So there's a lot of overlap in that.

[00:10:36] And in what plagues the crypto industry is that because you have assets that change in value at all time, they're highly liquid. You're you're basically on the hook for one of the most complicated forms of accounting. Because, you know, if you sold something that didn't change in value, like like a pencil or sweater, things are much easier.

[00:11:00] But because you have you have, you know, assets that do change every every transaction has a lot of components. For example, you have, you know, you have the the fee that you probably charge clients to to transfer that maybe that's a revenue and then you have your own fee. That's the cost. But it doesn't end there. You have capital gains. Right.

[00:11:20] So for capital gains to be reported accurately and IRS will come and challenge you because it's it could be a lot of money that they're after. You know, you need to have all those records calculated correctly in terms of like when you got the asset initially, what was the cost? Right. And then to when you offloaded asset, it could be one hour, one minute, one day, one year.

[00:11:47] But you have to have records of that for as long as you've had that asset. And a lot of founders, you know, don't have it. But like I said earlier, we're blessed with the blockchain technology. If I go on the blockchain ledger, I can find the value when that asset was first transferred into the client's wallet. So there is hope there.

[00:12:10] So, you know, a lot of things that, you know, you know, founders tend to do is they say, well, here's the wallet. You go sync the blockchain ledger and then you'll be able to calculate that for sure. But then there's also other implications that they never look at, which is like inventory, which is, you know, how much did you buy it for? Right. I know you're transferred in like that. But what about inventory? Right.

[00:12:35] Because, you know, you're stockpiled on Bitcoin, you know, in a pile when the price was low and now you're selling it. You kind of need to use some of that gap standard that you just mentioned, Jamil, like, like, you know, first in, first out or weighted average cost inventory accounting. You have to do that. You know, I've had founders that say, hey, look, I, you know, I sold it for 10 and I got this Bitcoin the two minutes ago. It doesn't work like that. You don't get to pick and choose what your cost is.

[00:13:08] So that opens up a couple other questions. So I'll give you an example. Say you bought something five years ago and it had a certain price. Yeah. You transferred it to another wallet. When you make a transfer, it's not a taxable event. We can make a transfer of like property to like property for your own wallet. It's different, you know, and say a sale happened in that other wallet or trade or exchange.

[00:13:35] And then you brought it back to your wallet and you do this on a rotational basis with a lot of your assets. How do you revalue or constantly revalue your cost basis? Or do you have to keep a record of your original cost basis, even though, you know, your transfers are not taxable events? Yeah, you have to.

[00:13:55] So first of all, if it's all personal or all corporate within the same corporation, the transfer between wallets, it's a non-taxable event. You are correct there. You still need to get the original cost that you got it for. Right. And so like, what's the best way? You know, I tell people that, you know, if you're starting out in crypto and then you're not going to get an accountant for a while, you know, using crypto brokerage accounts.

[00:14:23] To do all your trades is a wonderful idea because they keep all that record in your logged in account. One day you can extract it as PDF or CSV and give it to your accountant. And it is all there. And if you get audited, you can pull that up. Now, what we've seen is founders would actually transfer assets from their company owned wallets to their personal wallets.

[00:14:51] And they thought it was a non-taxable event. It absolutely is a taxable event. They just didn't know about it. You're taking a withdrawal from the company. It's almost like, you know, if I go to my company and I take, you know, 5,000 bucks. Well, what was that? Was that management fee? Was it, you know, paying myself dividends because I'm the owner? There's a lot of that implication. And then when it hits personal, it depends on your residency, right?

[00:15:21] You know, a lot of people, you know, they say, you know, I'm no longer resident of, you know, this country and that country. You know, well, are you self-declaring it? You're not allowed to self-declare. You have to work with an immigration lawyer to get all that solidified before you do something like a corporation to personal transfer. Or else you will be taxed on how the IRS interprets your case.

[00:15:52] So I have an example. Say I got a distribution in 2024 from Celsius. I call it Celsius customer. People say Celsius victim. I say, you know what, I mean, no one put a funnel in my mouth and made me force the Kool-Aid, right? I got, let's say, 40% back on the 100%, right? So I have a 60% book loss for the year, right? Yeah.

[00:16:21] I said, okay, cool. I can say I lost $60,000 and claim that against my taxes. I'm like, no, wait a second. You can only claim three. You can only claim $3,000 per year for the next 20 years. Like, how, you know, how do people, you know, I don't know. Is that right? And, you know, is there another way to consider that as a loss or it's just got to go with the 3,000 limit? Well, you know, I don't know about that limit.

[00:16:50] But if I lost, you know, value in my investment assets, you know, in this year, I could claim it all in this calendar year, right? You know, it goes with stocks or crypto. And obviously, you know, the whole Celsius thing is very public. It's not a made-up story. You can get proof of that. You can get it from your logged in account, whatever. That's something you can claim against. So that's another benefit of getting all this accounting, you know, added together.

[00:17:20] Because, you know, everyone in crypto has made money, but they also have lost money. So you can claim against your losses. But, you know, if you only have records of your gains, and that's when, you know, the tax bureau really goes after is your gains. They never really go for your losses. That's what people need to understand. That's the key thing here. It's up to you to bring up the losses. You see, this is how it works.

[00:17:48] And so it just really pays off if you have everything organized and put together. Yeah, that makes sense. That's good. That's good. So there's this other element of crypto that's called DeFi, right? There's a lot of unique, you know, passions in DeFi that are not even covered by Gap accounting, right? Yeah.

[00:18:13] So how do you begin to come up with accounting for DeFi? DeFi is just an innovative crypto term for something that is possibly three or four different financial instruments put together. So it is not 100% unique. What we have to do every time is we look at that DeFi contract that our client has.

[00:18:41] And we look at, you know, substance over form. Well, we often say that in accounting. What does that mean? We don't care what it's called. We don't care what it looks like. We care about how the revenue is split. We care about the engagements. We even care about the legal liabilities and so forth. Is this a partnership? Is this a loan plus a partnership? Is this a convertible debt, right? It's all sorts.

[00:19:09] Then we need to split it up on the, you know, the proportionalities, right? On a pro rata basis. That's how you deal with DeFi. You know, a lot of people say, oh, DeFi is new. You know, there's no regulations. I'm not going to do the accounting for it. It's not true. Like there's, I can speak right now. We're in like the 21st century. There's definitely not going to be something purely unique that we haven't seen in the past. You're either giving someone money.

[00:19:36] You're either earning money or you own something together. There's only a few possibilities of the world of business. Interesting. Interesting. So it has, yeah. So it has existed before. So you used that. Interesting. Yeah. A lot of it has existed before. It's just automated in terms of how they split the revenue, which is, you know, at the core,

[00:20:01] it's the proprietary value of the, you know, crypto technology, right? Because that automation is like, I don't have to go through lawyers and trust and then figure out, you know, how much I'm old and then we do the accounting and I wait for a bank wire, you know, six months later, you know, that that's it. But other than that, it's the same thing. You're earning money or borrowing, you're giving money or you own something together.

[00:20:27] And that just, that doesn't like, you know, exonerate you from having to do accounting. Got it. Yeah. So best practices and methods to navigate the complexity of the currency. I mean, I'm sure there's a whole host of them, but what, for a founder who does like, you know, to have financial records, right? What do you, what are the best practices and approaches you tell them, you know,

[00:20:54] to get them to feel confident with the, you know, they're built for it to do this. Yeah. So a lot of people we meet, sometimes they're, you know, a bit too early for us to take them on as a client. They could be running a small business, you know, that that's only making, you know, $500,000 a year, but they might hit, you know, two or $3 million. What we tell them is if you're making 500K a year, you probably don't want to spend much on accounting anyways. You're still trying to figure out this business.

[00:21:25] There's a few best practices that you can do today as a founder, and you don't need to know accounting to really get this thing more organized by the time you really hire someone to come in either full-time or some, you know, someone like Aquifer CFO that comes in and access a plug-in finance department. One of the things you can do today is to have segregated bank accounts where you should have at least two bank accounts, one bank account for trading purposes.

[00:21:54] You know, you're swapping Bitcoin in and out or whatever that goes into one account. The other account has funds that once a month, maybe you move the fund from the trading account to the other account, which we call operational account. You can use that account to pay your people. You can pay for marketing. You can pay for rent. You can pay for restaurants, meals, entertainment, whatever from that account.

[00:22:22] So by having segregated account, you don't commingle those funds. And it gives whoever you hire in the future a much easier time to sort out your mess. And it's more definitive than ever. That's something you can do today. The other thing you can do is to do the same on the wallet side. Crypto wallets. You have one that's doing all the trades. The other one is for operational.

[00:22:49] Why I say that is because some vendors, they take crypto as a payment, right? So you could be paying them straight out of the wallet rather than having to pay them through fiat. So the same knowledge transfers over there. Same thing over there. And I think we can do that at least because it's very simple to do. Now, the hard part is to be consistent.

[00:23:14] I've had clients that did it for three months and then they start commingling and then they couldn't help themselves. Maybe they did that out of convenience or the spur of the moment, but it is very crucial to maintain that rule base. Got it. So we focused a lot so far on accounting, taxation and stuff. You have another part of your business that's really important. It's called the fractional CFO and fractional leadership, right?

[00:23:43] What's important for startups especially, but for new companies who don't have that senior leadership to have a fractional CFO in the door? What benefits will they receive by having that? It really depends on what you're trying to do, right? So the CFO package that we offer is when we turn the accounting to more financial planning. And obviously with that, there's the analysis.

[00:24:08] So in today's era, like to raise money, you need a few things. You need financial statements obviously in a data bank, but what VCs are paying attention to is the operational financial model. And that's basically a P&L model that has all the volume movement metrics, your number of users, whatever.

[00:24:32] And it shows how you've extrapolated this company from current to 5, 10 years from now. That's what they're really after to decide whether they want to invest or not. And a lot of companies, they have the income statement, they have the balance sheet, they have the cash flow. They don't have the model. So it hinders their ability to raise money. So that's the first thing.

[00:24:55] On the other side is how do you interpret financial data to make better decisions, right? So earlier we talked about risk. You know, in the crypto industry, I've seen many times that founders are heavily dependent on one asset appreciating. And that is a lot of risk, a lot of contingencies. And you have, you know, 30, 40 people possibly on payroll.

[00:25:23] You can't have so much of your capital tied into something like Bitcoin. That thing could dip 40% in the next six months. And suddenly you can't pay all these people that are making the product that you're putting out there into the community. Or maybe, you know, salespeople, they're closing deals and so forth. And what we've done is, you know, we made the model for clients.

[00:25:48] We would also have these weekly meetings or monthly meetings with them and say, hey, look, you need to stop hiring. Or you need to start liquidating some Bitcoin, put in a cash reserve. Or you can even possibly buy some derivatives to hedge that risk. You know, these are things that are open to them. One of the craziest things is, you know, now they're better.

[00:26:13] But years ago, I remember Bitcoin miners would never hedge their Bitcoin price. They would just mine as they go. And then they would sell the Bitcoin, you know, at the end of the month or whenever their electricity bill is due. They will sell the Bitcoin live. And whether that price is high or not, they take the hit and they pay the electricity bill. And we went to some of our mining clients and say, hey, look, you're getting killed on opportunity cost.

[00:26:43] You could have hedged your bet, you know, and it doesn't cost you much to buy that kind of level of insurance out there. There's wonderful derivatives right now in the crypto space as well. So a lot of people don't know how many to buy because they also don't even have accounting done, you know, and what their exposure is. And so that's more on the CFO, you know, package. You know, we sell our services on two parts, right?

[00:27:10] We have the accounting bookkeeper package, which we call the controllership. And then we have then the CFO package. And we encourage, you know, big companies or even medium, small size companies that's doing anything from 2 million and up to buy both packages. But it's up to them at the end of the day. So I got to ask this now because you mentioned risk. You mentioned Bitcoin.

[00:27:38] Back in my corporate days, I used to build, you know, technology with the platforms and stuff. And one of the software that I use was MicroStrategy. Yeah. Right. So now MicroStrategy has become this giant risk on hedge fund, you know, or fund where they are. Or, you know, how do you, how do you, you know, and the market crashes, like it's possible.

[00:28:04] Then you have a giant, you know, the next FTX or what, you know, what, how do you see from a CFO perspective? How do you see, you know, guiding your clients to be able to say, okay, this is what they're doing. And maybe we want to do things differently or the same. Or how do you, what's the effect of MicroStrategy on this market, man?

[00:28:28] Well, MicroStrategy, you know, even though they invest heavily in Bitcoin, it is managed by a very mature board. And they've been in business for a very long time. They are a large enterprise with a lot of accounting, financial controls, legal controls, risk controls. They got policies up the roof. So I wouldn't worry about that. There's guys there that, you know, come from similar background as I do. They're running stress tests every day.

[00:28:57] By running scenarios, if Bitcoin goes up and down 15, 20%, what's the, you know, implications to the MicroStrategy, you know, corporation and shareholder value and so forth. So they're all good. But the FTX thing, I can actually speak to that because I met one of the top executives that reported to Sam Bankman-Fried on a flight back to Toronto.

[00:29:20] And he fortunately was not tied to the whole issue that happened over at FTX. He was left out of that circle, but he was very close to the inner circle. And I remember meeting him on the plane and he said to me that he doesn't know about the accounting processes over there, but he believes that Sam is very smart and that the accounting is automated.

[00:29:51] Those were his words. And obviously we found out later that there was no accounting. There was nothing in their QuickBooks online. The fact that they were even using QuickBooks online for that scale of a company is just, you know, shocking. And what we found out is in the end, you know, they basically just had a very simple napkin math Excel sheet. You know, so they weren't doing accounting. That's the end of it.

[00:30:18] If you're doing accounting, if you're at least filing and you have good systems in place, you're not going to be an FTX. And FTX happened not just because of lack of accounting. It happened because few people in the company had a very high administration rights to move funds without approval from board and so forth.

[00:30:45] And at the end of the day, you know, anyone within the inner circle can transfer themselves, you know, billions of dollars. Right. And that's what, you know, led to their downfall as well. Got it. So micro strategies is very different. They have controls. They have everything you need from a financial perspective. Yeah.

[00:31:08] I don't think, you know, you know, the founder, Michael Saylor can, you know, transfer, you know, a hundred million dollars worth of Bitcoin in the next hour, you know, by himself on the phone. And I think there's a whole process. I think multiple people or maybe lawyers have his crypto keys, the company crypto keys.

[00:31:30] So in case if, you know, something were to happen to him, you know, the company can still access those crypto funds. And that's what you get from an established company, because those guys actually think about these scenarios versus a lot of these startups. You know, founders, most founders, I'll tell you, not only do they not have an accounting background, most founders have never worked at a major institution before.

[00:31:57] And so they never learned about policies and never learned about controls. They never learned about, you know, having multiple sign offs on things. They never really appreciate it or respect it. So when they start a company, they're still running that company in the same way, you know, they did probably like four or five years ago in the garage. Yep. Yep. I worked at AIG and I did stress testing for CCAR.

[00:32:24] So, you know, I know all of that, like the different accounting scenarios, the bureaucracy. So, you know. Well, you learn to appreciate it as you see a lot of the drama unfold, right? Like when I was working corporate, I thought it was overkill. Then I came into the startup world and I said to myself, you know, these guys will benefit a lot with some of these policy thinkings and controls over this.

[00:32:54] It's just it takes time and patience to set it up. And I think a lot of founders don't have the stomach for it. You know, they want to go out and do exciting things, close deals, go to fancy dinners, go to conferences and speak. You know, get a creative and beautiful office space. Accounting and policymaking, sitting in a room with accountants and lawyers is not top on their list on enjoyable things to do.

[00:33:23] And out of my clients, the ones that have been successful are the clients that could stomach the boring stuff. You know, and they do it because they know they have to, not because they like it. Got it. They have to. They have to. Well, this has been an enjoyable conversation for me. I'm one of those boring guys from the background. What I, you know, so I appreciate, I love talking to you. I have one last question.

[00:33:51] Um, it's how can people find out more information about you, about Aquifer CFO, become customers, clients? How can they do that? Yeah, no, that'd be amazing. You know, uh, you can find us on LinkedIn, Aquifer CFO. Our website is aquifercfo.com. You know, I'm happy to also chat with anyone that has, you know, questions about their current situation and what can, what they can do today.

[00:34:18] To really prevent the mess six months, one year ago. It's worth having that conversation today. You know, don't sit on that issue. It's not going to get better. It's not going to go away. And, um, you know, you're either going to need investor money or you're going to need money to operate your business. You know what's coming. Yeah. Awesome. Thank you very much for your time today. Thank you, Jamal. I appreciate it.