Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk is the risk associated with the effect of changes in market factors on the value of the assets and liabilities held on our balance sheet, including interest rates, foreign exchange rates, prices of crypto assets, or volatilities such as market volatility or product liquidity.

Interest rate risk

We had cash and cash equivalents, including restricted cash and customer custodial cash, of $11.6 billion and $17.7 billion as of September 30, 2022 and December 31, 2021, respectively. Our investment policy and strategy related to our cash and cash equivalents and customer custodial cash is to preserve capital and meet liquidity requirements without increasing risk. Our cash and cash equivalents primarily consist of money market funds denominated in U.S. dollars and cash deposits. We also earn interest income from a revenue agreement we hold with the issuer of USDC. Changes in interest rates would primarily impact interest income due to the relatively short-term nature of our investments. A hypothetical 100 basis points increase or decrease in interest rates would have resulted in a $51.8 million and $139.3 million increase or decrease in total revenue for the three and nine months ended September 30, 2022, respectively.

Foreign currency risk

Foreign currency transaction risk

Revenues, expenses, and financial results of our foreign subsidiaries are recorded in the functional currency of these subsidiaries. Our foreign currency exposure is primarily related to transactions denominated in Euros and British Pounds attributable to cash and cash equivalents, customer custodial cash and customer custodial cash liabilities and other intercompany transactions where the transaction currency is different from a subsidiary’s functional currency. Changes in foreign exchange rates, and in particular a weakening of foreign currencies relative to the U.S. dollar may negatively affect our results of operations as expressed in U.S. dollars. We have experienced and will continue to experience fluctuations in our results of operations as a result of gains or losses on the settlement and the remeasurement of monetary assets and liabilities denominated in foreign currencies that are not the functional currency. We recognized net realized and unrealized foreign currency losses of $87.4 million and $221.8 million for the three and nine months ended September 30, 2022, respectively, compared to net realized and unrealized foreign currency losses of $18.8 million and $25.3 million for the three and nine months September 30, 2021, respectively, in other expense, net in the condensed consolidated statements of operations.

In the third quarter of 2022, we entered into foreign exchange forward contracts to hedge our exposure to foreign currency exchange rate risk on assets and liabilities denominated in currencies other than the functional currency. The forward contracts reduce, but do not entirely offset, the effect of foreign currency exchange rate fluctuations on our assets and liabilities. The gains and losses on the forward contracts are recognized in other expense, net in the condensed consolidated statements of operations.

Foreign currency translation risk

Fluctuations in functional currencies from our net investment in international subsidiaries expose us to foreign currency translation risk, where changes in foreign currency exchange rates may adversely affect our results of operations upon translation into U.S. dollars. We recognized losses on translation adjustments, net of tax, of $18.3 million and $33.1 million for the three and nine months ended September 30, 2022, respectively, compared to losses on translation adjustments, net of tax, of $3.2 million and $6.7 million for the three and nine months ended September 30, 2021, respectively, in the condensed consolidated statements of comprehensive (loss) income.

Market volatility and other risks associated with derivatives

We have exposure to derivatives and related hedges measured at fair value. Market risk on derivatives is the exposure created by potential fluctuations in market prices and other factors and is a function of the type of derivative product, the volume of transactions, the tenor and terms of the agreement and the underlying volatility.

As of September 30, 2022, we had embedded derivative assets of $3.6 million, as well as embedded derivative liabilities of $3.2 million as a result of entering into transactions to borrow crypto assets, which are recorded on the condensed consolidated balance sheets. We also had an embedded derivative asset of $4.3 million, as well as an embedded derivative liability of $3.7 million for other payables denominated in crypto assets, and an embedded derivative liability of $5.8 million for accounts receivables that are denominated in crypto assets. These embedded derivative assets and liabilities are recorded on the condensed consolidated balance sheets in accrued expenses and other current liabilities and accounts and loans receivable, net of allowance, respectively. In addition, we had a derivative asset of $22.9 million as a result of entering into foreign exchange forward derivative contracts that are recorded on the condensed consolidated balance sheets in prepaid expenses and other current assets. As of September 30, 2022, a 10% increase or decrease in the fair value of the derivative positions would not have a material impact on our financial results. For more information, see Notes 2. Summary of Significant Accounting Policies, 9. Prepaid Expenses and Other Assets, and 12. Derivatives, of the Notes to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

Equity investment risk

We hold strategic investments in privately held companies in the form of equity securities without readily determinable fair values in which we do not have a controlling interest or significant influence. These investments are subject to a wide variety of market and price-related risks due to the lack of readily available market data, which requires us to make significant estimates and assumptions that could substantially impact the carrying value of the investments. We perform a qualitative assessment of our portfolio of strategic equity investments on a quarterly basis for indicators of impairment. Our analysis includes a review of operating results, credit rating, asset quality and business prospects of the investees, changes in the regulatory and macroeconomic environment, and general market conditions of the geographical area or industry in which our investees operate in. If indicators of impairment exist and the estimated fair value of an investment is below the carrying amount, we will write down the investment to fair value. As of September 30, 2022 and December 31, 2021, our strategic equity investments in privately held companies was $357.0 million and $364.0 million, respectively. We are required to record all adjustments to the fair value of our investments through our condensed consolidated statements of operations under other expense, net. During the three and nine months ended September 30, 2022, we recognized impairment expense of $1.6 million and $70.9 million, respectively, related to our strategic investments in privately held companies. We anticipate volatility to our net income (loss) in future periods due to changes in fair value associated with these investments and changes in observable prices and similar transactions that could impact our fair value assessments. Based on future market conditions, these changes could be material to our financial results. For more information, see Note 9. Prepaid Expenses and Other Assets of the Notes to the condensed consolidated financial statements in Part 1, Item 1 of this Quarterly Report on Form 10-Q.

Market price risk of crypto assets

We generate substantially all of our total revenue from transaction fees on our platform in connection with the purchase, sale, and trading of crypto assets by our customers. Transaction revenue is based on transaction fees that are either a flat fee or a percentage of the value of each transaction and may vary depending on payment type and the value of the transaction. We also generate total revenue from our subscription products and services and, while revenue from these products and services have not been significant to date, most of this revenue will also fluctuate based on the price of crypto assets. Accordingly, crypto asset price risk could adversely affect our operating results. In particular, our future profitability may depend upon the market price of Bitcoin and Ethereum, as well as other crypto assets. Crypto asset prices, along with our operating results, have fluctuated significantly from quarter to quarter. There is no assurance that crypto asset prices will reflect historical trends. A decline in the market price of Bitcoin, Ethereum and other crypto assets has had and could in the future have an adverse effect on our earnings, the carrying value of our crypto assets, and our future cash flows. This may also affect our liquidity and our ability to meet its ongoing obligations.

We record impairment charges on our crypto assets held when crypto asset prices decrease below the carrying value of these crypto assets. As of September 30, 2022, a 10% decrease in crypto asset prices would not have a material impact on our impairment charges. For more information, see Note 7. Goodwill, Intangible Assets, net, and Crypto Assets Held of the Notes to our condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q.