Cryptocurrency Essential knowledge for business · Cryptocurrency – Essential knowledge for...

Cryptocurrency – Essential knowledge for business 1

With you in business, with you in life. blasermills.co.uk

CryptocurrencyEssential knowledge for business


Cryptocurrency has dominated the financial pages over the last six months; innovative Blockchain technology has allowed an increasing number of new, decentralised digital currencies to make exponential gains, in both value and user adoption. Blockchain has the potential to revolutionise several industries, particularly those with innate transactional inefficiencies, but it is international, peer-to-peer payment systems that have seen early success. However, talk of a bubble has continued whilst the FCA have warned of the risks of investing in newly launched currencies. UK/EU regulators have now set their sights on cryptocurrency trading to combat its use in laundering criminal assets.

Here we look at the brave new world of cryptocurrency, which in 2017 saw:

• Bitcoin hit record high of £15,375.64 ($19,843.10) per coin;

• Total market cap of all cryptocurrency hit $813 billion (roughly the size of Turkey’s GDP);

• Bitcoin futures trading launch on Chicago’s largest derivatives exchanges;

• Record number of digital transactions and new wallet openings;

• IBM launch enterprise-ready Blockchain platform (the technology that underpins Bitcoin and other cryptocurrencies);

• Criminal usage of cryptocurrency switch from Bitcoin to encrypted types such as Monero.

ContentsWhat is cryptocurrency and how is it used?

Why is it relevant and what are the risks?

Cryptocurrency around the world The main players in the market

What does it all mean? (The jargon explained...)

How does a cryptocurrency transaction work?

Buying and selling cryptocurrency

UK taxation and accounting issues

The Newsroom

Contact us


What is cryptocurrency?

Cryptocurrency, otherwise known as virtual or digital currency, is the online alternative to traditional money. Cryptocurrencies are peer-to-peer monetary systems that use cryptography to generate and manage the exchange, rather than relying on a central authority. Transactions are made over a shared online ledger, using digital wallets that hold your currency. Most can be re-sold for traditional currencies at the prevailing exchange rates over an ever-increasing number of cryptocurrency exchanges, used to conduct mainstream purchases or traded for other tokens.

What started as a ‘cypherpunk’ pipedream is now being piloted by a host of major international corporations, including IBM, Walmart and Nestle to name a few. The best known and most widely adopted variant, Bitcoin, recently attracted international headlines when the exchange rate hit $10,000 for the first time. By early December 2017, Bitcoin was trading at or above $17,000. This incredible run means that had you invested the equivalent of £100 in Bitcoin in 2010 it would be worth around £1.25 million today.

These sorts of headlines, and the almost unparalleled earning potential of cryptocurrency, have attracted major interest from the investment world. Towards the end of 2017 there was a huge surge in Bitcoin trading, particularly in new accounts being opened, in the build-up to the launch of “futures” contracts by two major American exchanges, meaning that institutional investors will now find it easier to buy and bet against Bitcoin. Shortly afterwards there was a price ‘correction’, which was widely predicted, and Bitcoin again showed its volatility, shedding roughly 35% of its value in the last 10 days of 2017.

It’s risky, and some respected commentators have compared virtual currencies to Ponzi schemes. So why the buzz? Comparatively, cryptocurrency is quicker, cheaper and more secure than any other traditional currency in use. The total market cap of all currencies in circulation has exploded, growing to roughly the equivalent of Turkey’s entire GDP in size in the space of less than 10 years, making it a highly significant and increasingly influential part of the modern global economy.

Uses of cryptocurrency

Cryptocurrency has both commercial and criminal applications. Commercially, it is increasingly functioning like any traditional foreign exchange currencies, but remains to many primarily an investment opportunity rather than a serious platform for conducting business. The wildly fluctuating but steadily increasing value of virtual currencies make for potentially large gains for the initiated investor, but this has also fuelled fears of a bubble similar to the dot com crash of the early 2000s.

Cryptocurrency, like gold, offers a form of portfolio insurance due to its de-centralised nature. Individual coins have different key features and technological fixes meaning an investment portfolio can be spread across a number of established and emerging currencies.

Blockchain In the UK, we have seen some world firsts in user-adoption of blockchain Distributed Ledger Technology (DLT), which threatens to revolutionise or ‘disrupt’ certain industries, such as property conveyancing. October 2017 saw the first ever UK conveyancing transaction conducted using blockchain technology, without the need for lawyers. A dentist in Wales acquired a £700,000 commercial property in an online deal executed in four seconds using blockchain technology, within days of the offer for sale being listed. The platform claims to use hash and encryption technology to ‘record the bidder verification process, offers made, offers accepted and the formation of online electronic contracts’, which could potentially remove the need for the UK Land Registry and other third party intermediaries who's functions currently involve checking and verifying the various stages of the transaction. Organised crime and money launderingUntil fairly recently governments and mainstream industry have been slow to get to grips with cryptocurrency, due in part to its historical association with the dark web, meaning it remains in many ways a regulatory 'grey area'. Criminals favour cryptocurrency for its anonymity, which grants them financial independence free from government oversight. Transactions in Bitcoin are rife on the dark web, where illegal goods such as narcotics and weapons can be bought and sold with minimal scrutiny. There is growing concern amongst UK law enforcement regarding the 100+ Bitcoin ATMs across the country, and the ease with which criminals can utilise these to launder large amounts of criminal proceeds. However, since the authorities are getting better at tracking the use of Bitcoin, emerging ‘encrypted’ currencies such as Monero have begun to attract increasing traffic amongst the criminal community.

Bitcoin reached parity with an ounce of gold on 2 March 2017.

4Cryptocurrency – Essential knowledge for business

Why is it relevant?

Blockchain technology, the digitised, de-centralised public ledger that supports all cryptocurrencies, holds enormous potential for both companies and private individuals. Advances in the application of the technology have seen pilots in the food industry, global logistics, healthcare, real estate, international finance and many more. The potential for instant, secure, transparent and low-fee or free transactions anywhere in the world at any time mean that the technology could transform certain industries overnight, as well as render others almost obsolete. Investment opportunity The global cryptocurrency market has been appreciating in value for the last 8 years, and has recently gone through a period of enormous and sustained growth. The total value of all the world’s cryptocurrency is literally increasing by the millisecond and at the time of writing is worth well over $800 billion. Whilst many speculate that the price of Bitcoin has reached or is close to reaching its zenith, these sentiments have been consistently proven wrong and other established coins, as well as newly launched currencies, present a huge investment opportunity.

Transactions Cryptocurrency transactions have the potential to be much quicker and more secure than conventional transfers because of the lack of a third party intermediary and central authority (banks, lawyers etc.) This system also minimises, or even eradicates, transfer fees, depending on the method and exchange used. However, this all relies on the strength of the network as many exchanges rely on a set number of confirmations before a transaction is approved on the ledger. Bitcoin, for example, is currently experiencing record high traffic, resulting in higher miner’s fees and longer confirmation times for transactions. Busy networks also require huge amounts of processing power and electricity, which can lead to technical issues and shorting out under pressure.

Security Cryptocurrency is designed to be completely anonymous, thereby removing the risk of card or identity theft. Blockchain relies on DLT in order to create an indelible record

of all dealings, insuring against faked transactions. New transactions (blocks) must be approved by multiple users before they are added to the shared ledger (chain), which means that it would be very difficult (or even impossible) to coordinate a false record of a transaction.

What are the risks?

As an exclusively online technology, cryptocurrencies are vulnerable to the same cyber-attacks as any other business with an online presence. Furthermore, fraudsters will seek to exploit the public’s lack of awareness of cryptocurrency by tricking people into fraudulent transactions or business opportunities. This is especially damaging given that cryptocurrency transactions are neither refundable nor cancellable, as the identity of the parties in a transaction cannot be identified once it has taken place. Furthermore, the anonymity provided by cryptocurrency networks means it is very difficult for offenders to be identified and any stolen property or currency retrieved.

The most recent high profile cryptocurrency ‘heist’ hit the digital mining marketplace NiceHash, who’s CEO Marko Kobal admitted had seen 4,700 Bitcoins stolen when hackers managed to infiltrate the company’s system through a compromised computer. At the time the hack was reported (7 December 2017) the stolen Bitcoin were valued at roughly $75 million. However, the largest single theft of this type occurred in August 2016, when leading Hong Kong exchange Bitfinex was targeted and 119,756 Bitcoins were stolen. The price of Bitcoin has nose-dived whenever a serious hacking incident has been reported, although it has always recovered in time.

These types of incident demonstrate the vulnerability of online currency to determined and highly sophisticated hackers, such as those working for the North Korean regime, who some have suggested are stepping up their activities in this area. Cyber-security is therefore an integral ingredient of the future sustainability and acceptability of virtual currency, as perceived weaknesses in the manner in which wealth is held (i.e. digital wallets) affect not only the end consumer but all also all major exchanges and investors.

Governance One of the major issues to consider is the internal governance of the individual currencies, which can result in ‘forking’. Forks can pose a threat to the viability and stability of the blockchain, and consequently, they can have a significant impact upon the value of the asset. A ‘soft-fork’ refers to a change in the protocol enforced by the majority of miners, leading to a change in the code that is ‘backwards-compatible’, i.e. the previous transaction remain valid despite following the old rules. A hard-fork involves splitting the path of blockchain and invalidating the previous transactions to allow a radical upgrade to the protocol, which requires universal user adoption. Eventually, old nodes (points in the network) who continue to try and use the old protocol will recognise the need to upgrade and re-join the blockchain.

Many developers of cryptocurrency promote consensus-driven improvement of the model. However, to quote the Economist on the subject: “different humans have different interests.” Taking Bitcoin as the prime example, in August 2017 there was a hard-fork driven by the differences in motivation between the different stakeholders; miners want higher transaction fees, whereas users want fast transaction speeds and lower fees. In this case a group of developers felt that a proposed Bitcoin Improvement Proposal (BIP) benefited investors over transactional users, which led to a split and the creation of Bitcoin Cash. This effectively created new money as everyone who previously held Bitcoin now also held a corresponding amount of Bitcoin Cash. The effective creation of new money poses significant governance issues due to the potential for inflation-driven panic and the eventual collapse of the system.

Warning: as things stand, cryptocurrency losses due to wallet hacking are generally irrecoverable.


Cryptocurrency around the world

The legal regulation and treatment of cryptocurrency varies depending on the domestic jurisdiction of the end user. An individual currency’s exchange value is independent of domestic banks and governments, and is based instead on a number of other factors such as market confidence, market cap and demand. As public awareness and confidence in the use of cryptocurrency has spread, the overall value of the main currencies has rapidly increased.

United KingdomThe UK government does not regulate cryptocurrency and it is treated as foreign currency. Capital gains tax must be paid on any taxable gain as a result of cryptocurrency investment. (See pages 12-13 for in-depth analysis of UK treatment of cryptocurrency from an accounting and tax perspective.)

United StatesThe US classifies cryptocurrency as a commodity, and it is taxed as property. The Chicago-based Cboe and CME derivatives exchanges recently began trading in Bitcoin futures contracts, which has been widely viewed as an important step toward acceptability among institutional investors. US regulators have classified certain ICOs as securities, which has led to the exclusion of US investors from some new currency launches.

NetherlandsThe Dutch government does not regulate cryptocurrency, but encourages its development in the country and is developing a national cryptocurrency, the Guldencoin.

RussiaRussia has condemned cryptocurrency as high-risk and will not allow it to be traded on official exchanges.

ChinaWhile private individuals can hold and trade cryptocurrencies, banks and financial firms are prohibited from doing so in China. It has also recently banned all cryptocurrency exchanges and ICOs.

AustraliaCryptocurrency is treated as a foreign currency in Australia and is no longer subject to double taxation. Cryptocurrency exchanges have come under tighter government control recently in an effort to prevent terrorists and criminals from using the currency for financing.

EstoniaCryptocurrency has been strongly encouraged in Estonia, with it being treated as a foreign currency. A recent governmental move to create a national cryptocurrency, the Estcoin, was discouraged by the EU however.

KenyaKenya’s M-PESA system, a mobile phone-based money transfer and micro-financing service, recently announced a Bitcoin device, with one in three Kenyans now owning a Bitcoin wallet.

South KoreaAn early adopter of Bitcoin, South-Korea’s appetite for trading in cryptocurrencies has fuelled the worldwide price increases that have caught international attention. The Seoul government met recently to discuss regulatory measures to curb the explosion in the trading of cryptocurrencies, amidst widespread fear of potential contagion of any crash into the wider financial system, as well as security concerns for cryptocurrency users. A South Korean exchange called Youbit recently shut down its operation following a second major hack, after having nearly 4,000 bitcoins stolen in a cyber-attack in April 2017 that the country’s spy agency linked to North Korea.

There are plans for UK/EU-wide regulation to combat the rise of crypto-facilitated crime, focusing on identifying traders.


The main players in the market

There are over 1000 different cryptocurrencies, with new coins launching all the time. The core driver behind real wealth generation is, of course, user adoption. The best-known and most widely traded currencies currently include:

Bitcoin (BTC) Market cap - $277,256,413,391 USD Created in 2009, Bitcoin is the original cryptocurrency, which was created by the online presence Satoshi Nakamoto. It dominates the market, with 48% of total market capitalisation. Nakamoto specified that only 21 million will ever be released. This means that Bitcoin will therefore be immune from supply-related inflation once this happens. The first ever cryptocurrency transaction took place in 2010, when a programmer bought a pizza for 10,000 Bitcoin, which would be worth about £123,000,000 today.

Bitcoin Cash (BCH) Market Cap - $42,906,008,211 USDThis variant of Bitcoin was created on the 1st August as a result of a hard fork, which split the Bitcoin blockchain and increased the block size limit to eight megabytes. Today, Bitcoin Cash has been broadly adopted by the major digital currency exchanges such as Coinbase and Bitfinex. The project has been successful and BCH’s value went above £3,000 per coin in late December 2017.

Ethereum (ETH) Market cap - $109,854,146,184 USD Created in 2015, there are far more in circulation but individual ether coins are less valuable than Bitcoin. Ethereum suffered from a damaging hack in 2016 (when more than $64 million worth were stolen), which led to the currency ‘forking’. This in turn led its value to fluctuate between $400 and $0.10 per coin. However, it has since recovered and shown strong potential, reaching up to $1,000 per coin in early 2018.

Ripple (XRP) Market cap - $131,540,703,285 USD Created in 2012, Ripple varies from most other cryptocurrencies in that it cannot be mined. Ripple digital wallets can be used for conventional as well as cryptocurrency, so the technology has been adopted by some banks such as Santander and UBS.

Dash (DASH) Market cap - $9,988,199,992 USDCreated in 2014, Dash is a cryptocurrency which pioneered the use of ‘masternodes’ – more senior parts of the network which allow Dash to provide services that Bitcoin’s ubiquitous system cannot, such as instant transactions, private transactions (which don’t appear on the blockchain) and completely decentralised governance.

Litecoin (LTC) Market cap - $15,882,093,303 USD Led by former Google employee Charlie Lee, Litecoin aims to subtly improve on the Bitcoin platform, upon which it is almost entirely based. The primary differences are the reduced block creation times (2.5 minutes) and the openness with which the currency’s leadership communicate their vision for the platform. Litecoin was the first of the major currencies to adopt ‘Segregated Witness’, a soft-fork designed to address the scalability issue that limits Bitcoin’s transaction speeds.

Iota (MIOTA) Market cap - $11,601,648,220 USD Created in 2016, this newcomer to the market has seen exponential growth to become an established player. The platform, which relies on Directed Acyclic Graph (DAG) technology instead of ‘traditional’ blockchain means that the system remains free regardless of the size of the transaction and can easily scale. It has been developed with collaboration from Microsoft and Fujitsu.

NEO (NEO) Market Cap - $10,338,120,000 USDNEO was founded in 2014 and was launched on GitHub in June 2015. Its developers describe NEO as “a non-profit community-based blockchain project”, which is aimed at driving the development of smart contracts to realise a smart economy. To achieve this the advanced NeoContract smart contract system has been developed. The currency has seen impressive recent growth, entering the top 10 currencies by market cap and putting on approx. $160 per coin since mid-2017.


The main players in the market

The graph above shows the present market share for the top 10 cryptocurrencies in circulation, against the others. Bitcoin dominates over all, for now, but data suggests that its market share will drop over time. This graph, right, outlines the total market cap (total value of all cryptocurrencies in circulation) from from January 2016 to present.

$750 Billion

$500 Billion

$250 Billion

$0

01/16 04/16 07/16 10/16 01/17 04/17 07/17 10/17 01/18

Market Capitalisation

Bitcoin

Ethereum

Ripple

Bitcoin Cash

Cardano

Litecoin

NEM

Stellar

IOTA

NEO

Other

Source: www.coinmarketcap.com

500 150 250100 200

144

10

10

11

12

13

13

42

70

129

Billion USD

228


What does it all mean? (The jargon explained…)

Confused? That’s not surprising. Like all revolutionary technologies, the terminology takes some getting used to. So, we’ve put together a handy glossary of all the key terms you’ll need to know in order to get to grips with cryptocurrency.

Blockchain The defining aspect of a cryptocurrency – the way in which they are organised makes each cryptocurrency unique. A ‘blockchain’ is an electronic history tracking each and every transaction in a particular cryptocurrency. One block represents a group of transactions. The wide dispersal of the blockchain (every cryptocurrency user has access to them) means that no one individual or central authority can ever control that currency. The public transaction log ensures that the same coin cannot be re-used for the same payment, as each payment must be individually verified by the mining community. Once it has been verified, the blockchain is updated, and would therefore invalidate any further attempt at payment using the same element of the currency.

Distributed Ledger Technology (DLT)A distributed ledger, or shared ledger, referred to as distributed ledger technology, is an asset database that can be shared across a network of users, groups or institutions, anywhere in the world. The technology underpins the blockchain technology that cryptocurrencies use. All participants within the network can have their own identical copy of the ledger, which can then be scrutinised and compared with other copies of the ledger. Changes to the ledger are only made once there is consensus in respect of the transaction, or once a set of terms are met under a ‘smart contract’, which is activated automatically on receipt of trigger information. The extent to which the ledger can be updated, and the method by which this is achieved or approved, is dictated by the rules set by the network. It is the distributed nature of the ledger that makes it extremely difficult (or even impossible) to tamper with, because in order to successfully fake an entry on the ledger, the cybercriminal would have to attack all the existing copies of the ledger simultaneously.

Cryptography Loosely translates as ‘hidden writing’ and is the basis of all cryptocurrency. Modern cryptography in computer science uses complex algorithms to encrypt and decrypt data and communications. The process involved converting legible information into a digital form, which can then be authenticated, anonymised and encrypted to ensure integrity.

Cryptographic hash The alphanumeric code, which is the digital form of the legible information – created using a cryptographic cipher.

Cryptocurrency Exchange Marketplace where cryptocurrencies are exchanged for traditional currency. The largest of these is Bitfinex, followed by Kraken and OkCoin.

Digital Wallet An account for storing cryptocurrency (can often contain more than one type of cryptocurrency). Each wallet generates two types of code: one public code for receiving currency (a 34-character alphanumeric code, equivalent to a sort code or account number), and one private code for sending currency (equivalent to your banking password). The codes are different for each transaction, ensuring anonymity. Examples include Coinbase, TREZOR and Exodus.

Bitcoin Client The end user of software that sends and receive Bitcoins (more generally, client).

Altcoin Any cryptocurrency that is not Bitcoin.

Network The network of computers through which Bitcoin transactions are broadcasted. The distributed ledger is thus maintained by the network through which it is shared.

Cryptographic nonce A cryptographic nonce is a set of numbers which can be anything between 0 and 231. It is this number which “unlocks” a blockchain for a miner. These numbers are considered impossible to guess, and occupy the computing power of the miner.

Initial Coin Offering (ICO) The launching of a new cryptocurrency. Similar in theory to a traditional IPO, this applies to the pre-sale of coins of the new currency (or tokens of the new project) as an instrument to raise funds for the development of the platform. ICO’s have proven incredibly successful, generating millions of dollars in pre-sales, with Ripple being one of the most successful forerunners. Since then, Ethereum have developed smart contracts, whereby you can exchange ether for tokens in the new project, allowing the development of an unlimited number of potential applications, all from the one platform.

The legal state of the ICO remains mostly undefined. Generally speaking tokens are sold not as a financial asset but rather as a digital asset. This is why ICO is often referred to as ‘crowd sale’. In 2017 ICOs raised over $1.5bn, which led the UK’s FCA to issue a consumer warning to potential investors, which describes ICO’s as “very high-risk speculative investments”. The promotion and uptake of ICOs is a regulatory grey area, with no investor protection and often limited and inadequate documentation to support the initial offering. The failure of DAO, a controversial ICO that collapsed following a massive hack, led to US regulators to deem certain ICOs akin to securities, and therefore subject to the same legal framework that governs the sale of traditional securities.

Market Cap The sum total value of all units of a cryptocurrency. Thus, the market cap of an individual cryptocurrency is the number of units in existence multiplied by the exchange value of the unit. The total cryptocurrency market cap is the sum total of all the individual currencies. At present these are ever increasing values as no one currency has achieved its total output (remember: Bitcoin is limited to 21 million units).


Protocol The natural definition of a set of rules applies here – each cryptocurrency operates on its own individual protocol, a complex set of rules based around a consensus algorithm. The original Bitcoin protocol operates around a ‘proof of work’ algorithm, where miners work to solve extremely difficult cryptographic puzzles. The first to do so wins the prize (12.5 new Bitcoin) and a small transaction fee, and a new block is added to the chain. This ensures the integrity of the chain. However, this system has limitations, such as the massive amount of computational energy required in order to maintain the ever increasing chain of transactions. This has led to alternative protocols being developed to try and achieve faster and more energy efficient systems, such a proof of stake, proof of activity, proof of burn, proof of capacity and proof of elapsed time.

Mining Cryptocurrency is controlled and regulated by the community of miners. Mining is the process of mathematically verifying blocks of transactions. The cryptocurrency network randomly assigns the job of verification to a miner. Once the verification has been completed (at least six verifications are recommended for any transaction), the miner receives a transaction fee (minimal) and a reward of cryptocurrency.

Given the enormous mathematical difficulty of the verification, which uses the entire blockchain and both keys provided by the parties, modern miners use highly advanced computing technology to speed up their calculations and improve the odds of another verification being assigned to them.

Most Bitcoin transactions still take 10 minutes to verify. The verifications have become more complicated over time, as the blockchain becomes larger and more complex. It is now therefore significantly more difficult to be a miner than it was when cryptocurrency was first invented – originally the blockchains were basic enough to solve manually, without the aid of a computer.


How does a cryptocurrency transaction work?

Cryptocurrency transactions are sent and received using electronic wallets, and are digitally verified to ensure security. The distributed ledger means that everyone connected to the network can see the transaction and can trace the units back to the point of production.

Taking Bitcoin as our example, we look at how a transaction actually occurs. In this case, party A wants to receive Bitcoin from party B:-

A sends B the code for its Bitcoin address (digital wallet). This code is unique to this transaction, and is publicly published.

B instructs its Bitcoin client to send X amount of Bitcoin to A’s address. The transaction is created and signed using the private key for the sending address.

The transaction is sent to the network with 3 key pieces of information; input (A’s original source of Bitcoin = C), amount (to be transferred) and output (B’s Bitcoin address).

The transaction must now be verified using the recently publicised code to A’s digital wallet.

A bundle of transactions is bundled together into a block, including the A-B transaction.

Miners’ computers are set up to create hash values. These are created using the blockchain, and cryptographic nonces, which the miner’s computer tries to guess.

Eventually the miner will compute the correct hash value, and will verify the transaction. Other miners’ computers also work to verify it. This is called a ‘proof-of-work’ protocol.

The newly verified transaction block is added to the blockchain, permanently changing it to reflect the transactions in the block, including A’s transfer to B.

The miner receives their transaction fee (taken from the transaction amount) and a prize of newly created Bitcoin (currently 12.5 Bitcoin).

The transaction is verified, and the Bitcoin is transferred from A’s wallet to B’s, in exchange for another currency. This process takes about 10 minutes.

1

2

3

5

6

7

8

9

10

4


Buying and selling cryptocurrency

You cannot simply go to the nearest Post Office and buy some cryptocurrency as you would with traditional foreign currency. Bitcoin has no physical presence, meaning you cannot take it out at an ATM. In order to buy or sell cryptocurrency you either need to mine it (which requires enormous energy and computational power), or, more realistically, you need a digital wallet.

Digital wallets act a digital safety deposit boxes, with a glass frontage. The most popular sites are Coinbase and Blockchain.info. In order to open a wallet you need to set up an account, which is much like you would with any other website, except that they often require two-factor authorisation. This would normally be your mobile phone number (i.e. sms pin) but experts have warned against this as it is easier to hack than security keys such as Google Authenticator.

Once you have a digital wallet set up you can buy and sell Bitcoin (and other currencies depending on the site chosen) by using online banking transfers or simply paying securely with a debit/credit card.

Most services offer more than one currency, with the most popular alternatives being Bitcoin Cash, Ethereum and Litecoin. Coinbase, for example, uses a handy dashboard with real-time values of the main currencies against the pound or the euro. You can also hold traditional currency in your digital wallet and exchange directly between your accounts.

In order to purchase less common coins such as Ripple or IOTA, you will require a separate account on a cryptocurrency exchange such as Bitfinex. These currencies cannot generally be purchased for traditional currency, but can instead be traded for Bitcoin or Ethereum and held in an exchange wallet. Thus, you cannot convert these directly into pounds or euros. Instead, you would need to achieve this through a series of exchanges and/or transfers back to your digital wallet before selling your stock at the prevailing rate. Whilst transactions are generally conducted quickly (up to 10 minutes with Bitcoin), the rapidly fluctuating value of the various currencies means that a good deal of application is required for the average consumer in order to achieve the best exchange rates when transferring funds.


UK taxation and accounting issues – with Carl Lundberg (partner), Gerald Edelman Chartered Accountants

The future of Cryptocurrencies is far from clear and we can only speculate as to how the UK government will decide to treat cryptocurrencies for the purposes of taxation down the line.

The current UK tax regimeThe only available guidance from HM Revenue and Customs’ ("HMRC") is from 2014, back when there were far fewer bitcoin millionaires. Whilst rather non-committal, it sets out the following:-

VATFirstly, HMRC states that the UK VAT rules would need to follow the VAT guidance that may eventually be implemented across the EU, although this has since been superseded by Brexit and now appears rather unlikely as we prepare to leave the EU. Generally, transactions involving the transfer, mining and exchange of cryptocurrencies for other cryptocurrencies or for fiat money are exempt from VAT. The exempt status of the spreads earned on the exchange of cryptocurrencies was confirmed by the European Court of Justice in 2015.

However, transactions where cryptocurrencies are used to pay for the supply of goods or services, instead of fiat money, are still subject to VAT in the same way as if fiat money were being used. Whether VAT is payable on a supply of goods or a service is connected with the goods or service being supplied and not the method of payment. For example, a person buys £120 worth of taxable goods from his or her local supermarket (priced inclusive of £20 VAT), but instead of paying the supermarket £120 he pays using a cryptocurrency; this doesn’t exempt the supply of goods from VAT and therefore the supermarket will still be liable to account for the £20 of VAT to HMRC, despite not having received any pound sterling.

Corporation tax on a company’s trading profits or chargeable gainsHMRC stated in 2014 “Whether any profit or gain is chargeable or any loss is allowable will be looked at on a case-by-case basis taking into account the specific facts.”

Continuing with the example above, imagine the supermarket, which at the time of sale received £120 worth of cryptocurrency, held on to it until its financial year-end, at which time it was worth £200. The £80 ‘foreign exchange’ gain would be chargeable to corporation tax, as of course would the profit derived from the original sale of goods. Had the value of the cryptocurrency held by the supermarket fallen to, say £100, then the loss of £20 would be allowable against corporation tax for the year. This treatment is the same as if the payment had been made in another fiat currency, such as USD or EUR.

Any companies that derive profits from trading in cryptocurrencies, rather than holding them for long-term investment, will pay corporation tax on those profits. Similarly, companies investing in cryptocurrencies and holding them for long-term gains would be taxed on the gains and allowed loss relief on any capital losses in accordance with the normal rules for companies.

It should be noted that in 2014 HMRC went on to say “…a transaction may be so highly speculative that it is not taxable or any losses relievable. For example gambling or betting wins are not taxable and gambling losses cannot be offset against other taxable profits.”, so there may be instances where profits, gains or losses from speculative positions are not considered to be taxable, although it is not clear exactly what the parameters are in order for a transaction to qualify for this treatment.

Income tax and capital gains tax on an individualLike the corporation tax rules for companies, all profits and losses derived by unincorporated businesses from trading cryptocurrencies, or from cryptocurrency transactions, are taxable under the normal income tax rules. However, it is very unlikely that buying and selling cryptocurrencies on one’s own behalf would be considered a trade and therefore amounts accrued from the same are far more likely to be treated as gains rather than profits.

Gains and losses accruing to individuals on cryptocurrencies are taxable under the capital gains tax (“CGT”) rules. Gains are crystallised and become taxable when the assets are converted back to any fiat currency.

The annual CGT exemption for individuals for 2017/2018 is £11,300, so those generating gains in excess of this from trading cryptocurrencies beware – they are reportable and CGT will be payable at the rate applicable to your level of earnings.


Stamp dutyIn the recent climate of record-low interest rates, investors have been incentivised to invest in riskier assets. In seeking to avoid low returns on cash and bonds, investors have looked higher up the risk curve and invested in cryptocurrencies, instead of limiting portfolios to funds, equities and traditional commodities, such as gold. This in turn has contributed to the generally increasing price of the main cryptocurrencies as transaction levels have rapidly increased.

One key difference in investing in cryptocurrencies over equities is that there is no stamp duty payable on purchase, whereas, whilst not particularly significant, stamp duty is payable on the purchase of shares at a rate of 0.5%.

Other digital tokensAs ICOs are becoming ever more popular and businesses are issuing tokens with certain rights attached in exchange for crypto or fiat currency, consideration should be given to the taxation of non-currency digital tokens. Given how slow the authorities have been to react to cryptocurrency trends it is perhaps unsurprising that there is no specific legislation or guidance covering this area. For now, the existing income tax and CGT legislation should be applied logically in order to determine the tax payable on income and gains from such assets.

Taxation: The futureAs the popularity and use of cryptocurrencies spreads and an ever-increasing number of people are generating profits and gains from these assets, the UK Treasury is already planning a crackdown to prevent money laundering and tax evasion, meaning that soon certain cryptocurrency transactions may no longer be anonymous. How the Treasury intend on achieving this remains to be seen, but given the levels of profit now involved in Bitcoin trading alone, we can certainly expect HMRC to be forceful in this area.

As alluded to above, it is now highly likely that if the current guidance on VAT on cryptocurrency transactions is to change, this will be implemented directly by the UK government (rather than by EU consensus), subject of course to the agreements arrived at in respect of VAT within the Brexit negotiations. As regards income tax, CGT and corporation tax, legislation may be updated to include specific references to cryptocurrencies and other tokens, but they should be expected to apply in the same way as they do currently.

How should companies and LLPs account for investments in cryptocurrencies?Current accounting standards are not modern enough to provide bespoke accounting rules for cryptocurrencies, so at present cryptocurrencies must be accounted for as intangible assets. Intangible assets may be held at fair value if there is an active market for the asset, although the revaluation gains and losses do not get taken to the income statement, but instead the statement of other comprehensive income.

It seems to be an industry consensus that this isn’t the most useful way of presenting the financial information connected with such assets to investors, but until the International Accounting Standards Board and the Financial Reporting Council devise something bespoke for these types of assets, it will remain.

What effect will Blockchain have on accounting in business?It is expected that distributed ledger technology will have far-reaching application, with the aim of improving security and increasing efficiency by reducing the need for human involvement in transactional processes.

Whilst it is not yet clear when the technology will be adopted into the world of accounting and quite how transformative it will be, it seems a natural step for a technology built to record and verify transactions to be used for recording accounting entries.

Example: application of blockchain technology in sales and purchase ledgers; whereby transactions between organisations are recorded on a ledger shared between those two organisations and verified by each party. When it comes to reporting, an agreed indisputable record of the sales and purchase transactions would exist, which of course would assist greatly in terms of auditability of the organisations’ results.


The Newsroom

CommercialEU: The European Central Bank has criticized the Estonian government’s plan to create a national cryptocurrency, suggesting that EU states will not be permitted to launch any form of currency that competes with the Euro. Estonia had planned to make its cryptocurrency, the Estcoin, available through ICO and investment to members of its e-residency program. However, the project may be possible in the future through a public-private partnership. – Bitcoin.com News

Estcoin can be used to reward e-residents (people who set up a business online in the country), verify someone's identity online or be used for payment attached to the euro. - Reuters.

China: In September 2017 China decided to shut down the operations of all cryptocurrency exchanges as part of a crack-down on all forms of cryptocurrency. In November 2017, the Chinese cryoptocurrency exchange was shut down. September’s announcement prompted a 16% slide in the value of the Bitcoin against the Dollar, though the Bitcoin has recovered since. ICOs were also banned, though the trading of Bitcoins against other forms of cryptocurrency is still permitted. – The Verge & Forbes

Russia: The governor of Russia’s central bank, Elvira Nabiullina, has endorsed China’s view on cryptocurrencies, refusing to classify them as a foreign currency, payment method or monetary asset, but stopping short of giving them an official classification. She described them as “a financial pyramid that may collapse at any moment”. – Coindesk

US regulation and market fluctuation: Many financial publications are predicting a drop in the price of bitcoin, making 2018 a year of huge investment potential. The number of cryptofunds is also expected to triple this year. Meanwhile, the U.S Securities and Exchange Commission is warning of the risks of cryptocurrency and has stepped in to suspend trading through some companies amid concerns about the accuracy of information about the company. This has led to speculation that the US will regulate cryptocurrency and the investment thereof much more robustly going forwards. - CNBC

Lesser known cryptocurrencies on the rise: Dogecoin suffered a long period of stagnation since its launch in 2013. However, as the interest in cryptocurrencies has exploded, dodgecoin increased more than five-hold in value in December 2017. – Independent

Investment trends: In November 2017, a survey by venture capital firm Blockchain Capital found that 30% of those in the 18-34 age range would rather own Bitcoin than government bonds or stocks. The study of more than 2,000 people found that 42% of millennials are familiar with Bitcoin, compared with only 15% among those aged 65 and over. - Bloomberg

CriminalWannaCry: The NHS and over 230,000 other companies were hit in May 2017 by the WannaCry ransomware, which locked up computer data and demanded a ransom (to be paid in Bitcoin) to unlock the files. Up to $130,000 was paid by some victims, with no evidence that payment would unlock computer data. The anonymity of cryptocurrency has prevented the identity of the attacker being identified.

Cybercrime: Monero in particular is popular because of its stringent privacy provisions, and has appreciated by over 1,000% this year. - CNBC

Terrorism funding: The Australian government has announced a reform to the Anti-Money Laundering and Counter Terrorism Financing Act, which will make cryptocurrency exchangers the responsibility of the Australian Transactions and Reporting Analysis Centre (AUSTRAC), which seeks to prevent criminals and terrorists from using the anonymity of cryptocurrencies to commit crimes or terrorist acts. – CNBC

EU crackdown on Bitcoin crime: The UK and other EU governments are planning to further regulate bitcoin and other cryptocurrencies to bring them in line with anti-money laundering and counter-terrorism financial legislation. Traders will be forced to disclose their identities, which will end the anonymity that has made cryptocurrency attractive for drug importation and other illegal activities. – The Guardian

Regulators warn of fraud: The US markets regulator issued a warning in December to investors buying cryptocurrencies, cautioning that there are higher risks of “fraud and manipulation” in the market. Jay Clayton, chairman of the Securities and Exchange Commission, warned that some trading of fundraising schemes ICOs that use cryptocurrencies may be breaking the law. – The Telegraph

Criminals are turning away from Bitcoin and more towards Ethereum and Monero, as authorities get better at extracting user data from the blockchain. Illegal transactions in Bitcoin now only make up 20% of total transaction volume, which is down from 50% in 2016.


Opinions are divided on the integrity and legitimacy of cryptocurrency and the appropriate way in which to regulate and treat it in the world of commerce. However, what cannot be denied is the astronomic growth in value and the impressive impact that virtual currency is having around the world. More importantly, the potential of the technology that underpins these new currencies means that in some form or another, they are here to stay.

We predict that ever-increasing user adoption, the development of Fintech and the involvement of big business, means that cryptocurrency has an important future. Consequently, we expect that there will be a raft of new regulation to deal with the governance and accountability issues in the near future to allow business to properly engage with and adapt to the use of cryptocurrency and other DLT-based applications.

Disclaimer – legal information The information contained within this briefing document is for informational purposes only. The above is intended as a commentary, not legal advice and should therefore not be considered exhaustive, timely or accurate.

No content published in this briefing document constitutes a recommendation that any particular security, portfolio of securities, digital asset, transaction or investment strategy is suitable for any specific person. Nothing stated herein is intended as an inducement to invest in, or a recommendation of, any of the securities or digital assets highlighted or any particular investment strategy; nor should it be considered a solicitation to buy or sell any security or digital asset discussed.

Before acting on any information contained in this document, readers should consider whether such an investment is suitable for their particular circumstances, perform their own due-diligence, and if necessary, seek professional legal and/or financial advice.

The reader is reminded that virtual currencies are highly speculative assets and that investors do so at their own risk.


At Blaser Mills Law we have a multi-disciplinary team of corporate and commercial, IP, data protection, disputes, financial crime and regulatory lawyers who can advise on a range of issues, including analysing and mitigating the legal and regulatory risks associated with these transformational technologies.

If you or your business have any questions regarding the use of cryptocurrencies then please contact our head of Financial & Business Crime:

Daniel Martin, LL.MLead Cryptocurrency and Blockchain lawyer e: [email protected]: 0203 8142020 d: 01494 411184

Contributing author Carl Lundberg is a partner at Gerald Edelman Chartered Accountants. Should you wish to discuss any of the taxation or accounting matters above, please do not hesitate to get in touch with Carl on 020 7299 1415, by email to [email protected] or connect with him on LinkedIn.

High Wycombe | Amersham Rickmansworth | London

020 3814 2020blasermills.co.uk

Cryptocurrency Essential knowledge for business · Cryptocurrency – Essential knowledge for...

Documents

Transcript of Cryptocurrency Essential knowledge for business · Cryptocurrency – Essential knowledge for...