It looked like a reckless bet at the time, and in these days of crypto-madness, it's looking more outrageous by the day. Early this year, Elon Musk famously wagered $1.5 billion in Tesla's corporate cash on Bitcoin. As the signature crypto soared, the value of the EV-maker's holdings swelled by over $1.3 billion more than it paid, and despite the recent slide, Tesla's still sitting on a nice––though shrunken––paper profit.

But here's the downside that's gone mainly unnoticed by the financial media and Wall Street analysts. The special accounting treatment Tesla applies to its Bitcoin holdings will require the manufacturer Tesla to book losses called "impairments" in its second quarter, even though its overall investment is still above water. If Tesla's price holds at its current level of around $38,000, the hit won't be enormous. But to offset the write-downs, Tesla would need to sell a big chunk of the coins left in its coffers, a move that could send Bitcoin swooning. And if Bitcoin falls well below $30,000, a level it recently approached, Tesla will suffer losses big enough to erase several quarters of the profits it garners making and marketing EVs.

Most of all, the impairments in the June quarter will remind investors that Musk made an already risky stock a whole look riskier by taking a flyer on an ultra-volatile asset that's swung by 10% or more from highs to lows on eight days in mid-to-late May alone. The view that, "Hey, this might seem crazy, but the guy's a genius––just look at the billion-plus Tesla's making on Bitcoin!" is giving way to, "Nobody knows where this thing is headed, and if it collapses, Tesla's got a hand grenade buried in its warchest."

The treat posed by Bitcoin is causing consternation on Wall Street. "Many investors never wanted Musk to go down the Bitcoin path," says Daniel Ives, an analyst at Wedbush Securities. "The focus should be on its progress in making deliveries, the global EV tidal wave, and getting through the chip shortage. Instead, too much attention's going to the Bitcoin piece." It's especially frustrating, he adds, that Musk's recently soured on the crypto that months before, he was lavishly praising, hammering the value of Tesla's holdings. "It was like burning down your own house," he says. "The Bitcoin piece has created a dark cloud over the whole story. And the damage is all self-inflicted."

Let's examine how the accounting rules governing Bitcoin will create losses for Tesla in Q2, and how deep those losses will go if the king of cryptos suffers a steep slide from here.

Early on, Tesla made huge paper gains on its Bitcoin wager

Tesla first unveiled its $1.5 billion Bitcoin investment in its 10K, published on February 8. But it wasn't until details emerged in its 10Q for the first quarter that investors could estimate how many coins it bought, the average price paid, and the gains on its holdings. The 10Q stated that as of March 31, Tesla owned $2.48 billion in Bitcoin. Since the price at the NYSE close that day was $58,919, we can estimate that its treasury held around 42,100 coins. Between early February and the end of March, Tesla sold 10% of its coins for $268 million. It had bought those batches for $140 million; hence, it pocketed a $128 million gain. (The math implies that at the peak, Tesla held some 46,800 coins.)

It appeared that the value of the Bitcoin still on Tesla's books, plus what it reaped on the sale, totaled $2.748 ($2.48 billion plus $258 million). Since its cost of acquiring all those coins was the celebrated $1.50 billion, Tesla on March 31 was triumphantly sitting on total realized and unrealized gains exceeding $1.2 billion, or more than 80% on its investment, all captured in eleven weeks. The coins it had purchased at an average price of $32,000 were by the the end of Q1 worth almost $59,000.

Tesla headache: the special accounting treatment for cryptocurrencies

At that point, the Bitcoin gambit looked like a big winner in a quarter where Tesla booked a pre-tax profit of just $15 million, excluding sales of regulatory credits to rivals. By that measure, it was only the Bitcoin sale that turned its results positive. But the 10Q contained a little-noticed item that foreshadows what's to come in Q2, and potentially bigger problems in subsequent quarters. Even though Tesla sold 10% of its coins for a huge profit, it was still obliged to book an "impairment" charge to pre-tax earnings of $27 million. (That write-down reduced its net gain from $128 million to $101 million.)

Here's a summary of the accounting rules that created the impairment, and will trigger more in reported losses in future quarters. The Financial Accounting Standards Board (FASB) classifies cryptocurrencies as "indefinite-lived intangible assets." But accounting experts tell Fortune that the standards allow companies wide latitude in how they choose to treat crypto assets on their balance sheets. One option is to compare the original purchase price, or "carrying value" of Bitcoin, say, to where it's trading, or its "fair market value" at the end of each quarter. Then, if Bitcoin's price on June 30 is below what Tesla paid for any of the tranches on its books, it would take an "impairment," or write-down equaling the difference between the "carrying value" and "fair market value–-the price it paid minus the lower price where it trades at the close of the quarter.

But Tesla apparently didn't adopt that "end of quarter" approach. Instead, it immediately takes an impairment anytime during the quarter that Bitcoin's market price falls below what it paid for any tranche of Bitcoin in its treasury. It collects and reports the total of those impairments in the "restructuring" category at the close of the quarter.

In other words, if Tesla bought a bunch of Bitcoin in early February at $35,000 and after a big jump, the price falls to $31,000 on May 19 (as actually occurred) it's obliged to take a $4,000 impairment on every one of those coins. But if Bitcoin vaults back above $31,000, Tesla doesn't get to mark the coins back up and eliminate the write-down. Those impairments are forever. In fact, even if market prices across the whole portfolio rise far above what Tesla paid, and that happened for awhile, it can't book a gain. Instead, it has to keep valuing the coins at their original cost so long as they're in the black, and at their new, reduced "carrying value" if they're impaired.

It's only when Tesla sells that it can register a profit. That gain amounts to the difference between the carrying value of coins and the hopefully higher numbers they fetch. Put simply, when prices on the crypto exchanges fall below what Tesla paid for a coin or bunch of coins, it posts a loss (or impairment) on that coin or batch. But when prices rise above those carrying values, it can only notch a gain by trading the coins for cash. In Q1, a small portion of what Tesla bought subsequently dropped below the coins' original cost, triggering the $27 million impairment. But since most of its portfolio soared in price, Tesla was able to garner a big gain by unloading 10% of its holdings at much more than it paid.

Tesla's approach is sound and ultra-conservative

It appears that Tesla could follow two different paths, and still satisfy FASB's guidelines for intangibles. As stated, one choice would be booking losses only when the average cost of its Bitcoin purchases fall below the market price at the end of the quarter; the second would consist of taking impairments on any individual batch on its books bought for more than the close-of-quarter prices on the exchanges. "The reason Tesla has all these options is that FASB has issued no guidance for Bitcoin," says Ed Ketz, an accounting professor at Penn State University.

Tesla is taking a cautious stance by following two FASB tenets, says Albert Meyer, a leading accounting expert at Bastiat Capital, "timeliness" and "specific identification." It achieves "timeliness" by booking the impairments as soon as they occur, based on current quotes, rather than based on prices at the end of the quarter. It practices "specific identification" by basing each write-down on the individual batches whose purchase prices fall below market prices. "The specific identification approach and immediacy of recognizing an impairment are prudent," says Meyer. "I have no problem with it."

It's noteworthy that if Tesla were testing for impairments at the end of each quarter, it wouldn't have shouldered that $27 million loss in Q1, and might avoid write-down altogether in Q2. Instead, its judicious bookkeeping will train a spotlight on the dangers of its Bitcoin adventure.

This time, the impairments are likely to be bigger

In mid-May, Musk shocked the markets by tweeting that due to Bitcoin's troubling carbon footprint, Tesla would no longer accept coins as payment for its EVs. But amid rising fears he'd bail on Bitcoin entirely, Musk later declared the Tesla didn't plan to sell any of the coins still in its treasury. So we can assume that as of today, it still holds 90% of its original purchases, or 42,100 Bitcoin.

Those coins, however, are worth far less than just a few weeks ago. In mid-April, Bitcoin hit an all-time high of $64,863. At that point, Tesla's trove boasted a market value of $2.73 billion, putting its total unrealized and realized gains around $1.36 billion, $150 million more than at the end of Q1. Since then, Bitcoin has sunk by 41% to $38,000 as of mid-afternoon on May 25. Tesla one-time $1.36 billion windfall has shrunk to around $378 million.  

For Q1, Tesla revealed that its "carrying value" for those remaining 42,100 Bitcoin is $1.330 billion. That means the average "basis" for the coins still on its books is $31,600. But for calculating impairments, the average doesn't matter, nor does it count that Tesla's "made money" overall. Once again, the key number is the lowest quote posted on the exchanges during the current quarter. Any coins that Tesla bought above that level must be marked down to that bottom price. The difference between the low point and the higher prices Tesla paid for any coin or bucket of coins constitutes the impairment.

Thus far in Q2, Bitcoin's basement price came on May 19 when the crypto slumped to $30,682. That's the day the Chinese government barred banks and payments providers from accepting cryptocurrencies. Here's where it gets tricky. We don't know how much Tesla originally paid for different tranches of Bitcoin, all acquired between January 1 and February 8. But to arrive at an average of $31,600 across all purchases, it must have acquired bushels at over $30,682. During the span when it was buying, prices fell below that level on only a dozen days.

To gauge the possible size of the looming charge, I'll make the simple assumption that Tesla bought half the coins still on its books at more than its average acquisition price of $31,600, and half at less than that number. Let's posit that it paid $29,500 for the "bargain" 21,500 coins, and $33,700 for the other 21,500 (that's an average price of $31,600).

In that case, Tesla faces in impairment of approximately $3,018 per coin (the $33,700 it paid per coin minus the quarter's low point of $30,682). The Q2 charge would come to $65 million.

Doesn't sound too bad. But just the idea that for accounting purposes, Tesla lost money on its vaunted Bitcoin wager would be highly embarrassing. Musk might feel obligated to break his pledge and offset the charge by selling Bitcoin that's harboring gains. The rub is that prices have fallen so far that he'd have to dump a lot of it to fill the $65 million hole. By my estimate, if prices remain at today's $38,000 level, Tesla would need to offload 10,000 coins, a quarter of its holdings, to get square.

Since Musk is Bitcoin's chief influencer, a sale that size could spook its fans and send their cherished token diving once again. Or imagine that prices return to their early December level of $25,000. Tesla would then suffer $278 million in impairments. Or how about $20,000? At that level, Tesla would be taking a $484 million loss on a portfolio that was once $1.3 billion "in the money."

Keep in mind that in the past four quarters, Tesla posted a pre-tax deficit of $127 million after subtracting its revenues from the sale of regulatory credits, a fount that Musk acknowledges will rapidly decline. A big loss on Bitcoin could wipe out, or seriously dent, its profits from selling cars and batteries, if any, for the rest of 2021 or even longer.

The real problem is that Bitcoin's lurching, totally unforeseeable trajectory makes Tesla's already hard-to-predict future earnings even foggier. The last thing Tesla needs is uncertainty, and by embracing what may be the most mercurial major asset class of modern times, Musk's doubled down on risk. Musk got stupendously lucky playing in the Bitcoin casino with $1.5 billion staked by Tesla's shareholders. Now, his luck is fading. Who knows if next month he'll still have more chips than when he started? That's just the kind of question his shareholders, who've seen one-third of their holdings vanish since Tesla's shares peaked January, don't want to be asking.