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NAV & AccountingReviewed 2026-07-21

Fair Value Hierarchy

A three-level classification ranking how reliable the inputs behind an asset's fair value are, from quoted market prices to manager models.

Definition

The fair value hierarchy is a three-level framework — commonly known by its US GAAP reference, ASC 820, with a near-identical structure under IFRS 13 — that classifies an asset's fair value measurement by how reliable and observable the inputs behind it are, not by the asset's type or size. Level 1 covers quoted prices in an active market for an identical asset; Level 2 covers observable inputs other than a direct quoted price, such as a price for a comparable asset or a quote in a market that isn't very active; Level 3 covers unobservable inputs — largely manager assumptions and models — used when there is no reliable market data at all.

Classification is about input quality, not asset quality — a perfectly legitimate, valuable asset can still sit in Level 3 simply because there is no active, observable market for it yet, while a low-quality but actively-traded asset can sit in Level 1. Funds are typically expected to disclose the split of NAV across the three levels and the methodology behind any Level 3 valuations.

Why it matters

The hierarchy exists to stop a fund from implying more pricing certainty than it actually has. A NAV that's mostly Level 3 carries meaningfully more valuation risk than one that's mostly Level 1, even if the two headline NAV figures look identical — and LPs and auditors specifically want that distinction visible rather than buried in a single blended number.

For a crypto fund, the level split is often one of the more informative single disclosures a manager can give an LP: it shows, at a glance, how much of the fund's NAV rests on genuinely observable market prices versus the manager's own models and judgment.

The three levels, with crypto examples

Level	Input type	Typical crypto example
Level 1	Quoted price, active market, identical asset	BTC or ETH spot price on a deep, liquid exchange
Level 2	Observable inputs other than a direct quote	A mid-cap token priced via a comparable liquid pair or a thin single-venue quote
Level 3	Unobservable inputs, manager models or assumptions	Vesting or locked tokens, pre-launch allocations, illiquid OTC or DeFi positions

Common mistakes

Assuming any token that technically 'trades on an exchange' automatically qualifies as Level 1 — a thinly-traded or single-venue market is genuinely closer to Level 2, and a manipulable one may not deserve Level 1 treatment even with a visible quoted price.
Defaulting to Level 3 for convenience or speed rather than doing the work to source a genuinely available Level 1 or Level 2 input.
Not disclosing the actual methodology behind a Level 3 valuation to LPs and auditors, leaving 'manager judgment' as the entire explanation.
Treating hierarchy classification as a proxy for materiality — a small Level 3 position still needs the same rigor and disclosure as a large one; the level says nothing about size.

In practice

A single crypto fund's book can span all three levels simultaneously in a way many traditional funds never see in one portfolio — Level 1 BTC and ETH, Level 2 mid-cap altcoins thinly traded on a handful of venues, and Level 3 vesting allocations or illiquid OTC and DeFi positions, all held at once. Each level needs treatment consistent with the fund's own valuation policy, since the hierarchy classifies input quality but the policy is what actually specifies the methodology used.

Because Level 3 assets carry the most valuation risk and the least external check, funds with meaningful Level 3 exposure commonly face closer scrutiny during LP due diligence on exactly how those positions are marked.

Questions, answered

What is the fair value hierarchy?

The fair value hierarchy is a three-level classification — Level 1, 2, and 3 — ranking how reliable and observable the inputs behind an asset's valuation are. Level 1 is a quoted price in an active market; Level 3 is an unobservable input based on manager models or assumptions.

What crypto assets are typically Level 3?

Vesting or locked tokens, pre-launch allocations, and illiquid OTC or DeFi positions with no active market are typically Level 3, since their valuation depends on a manager model or assumption rather than an observable market price.

Does a higher fair value level mean a better asset?

No. The hierarchy classifies input quality and reliability, not asset quality — a legitimately valuable but not-yet-liquid asset can sit in Level 3, while a low-quality but actively-traded one can sit in Level 1.

Why does the fair value hierarchy matter to LPs?

It shows how much of a fund's NAV rests on genuinely observable market prices versus manager judgment. A NAV that's mostly Level 3 carries more valuation uncertainty than one that's mostly Level 1, even if the headline figures look the same.