UHY GLOBAL JUNE 2018 FEATURE


BITCOIN – PITFALLS OR POTENTIAL


THE BITCOIN BUBBLE MAY BURST, BUT THAT DOES NOT MEAN THE VIRTUAL CURRENCY – AND THE TECHNOLOGY THAT SUPPORTS IT – WILL DISAPPEAR Nobel prize-winning economist Joseph Stiglitz wants it outlawed. Billionaire investor Warren Buffett says it will “come to a bad end”. During the first half of 2018, the hitherto wildly fluctuating value of bitcoin appeared set on an inexorable downward trend – with the most famous cryptocurrency is losing support as quickly as it sheds value. But advocates remain. Japanese businesswoman Mai Fujimoto, who goes by the nickname “Miss Bitcoin”, told newswire AFP in January: "I convert all my disposable income into cryptocurrency. I have been doing this for nearly a year now. I convert all my savings into cryptocurrency instead of putting them in a bank." It is a conundrum. Experts around the world warn of the imminent burst of the bitcoin bubble, and many governments are openly hostile to its very existence. But enough Miss Bitcoins have bought and traded the currency to take its value on a wild and unpredictable ride. Short-term speculation certainly plays a large part – although Mai Fujimoto started using bitcoin to cut out bank fees when sending money abroad. For all the anxieties around its reputation as the payment method of choice for criminals and terrorists, there are legitimate reasons for ordinary people to use a decentralised currency, free from the control of banks and governments. JAPAN LEADS THE WAY Japan is one of the countries that recognises ordinary people’s desire to use bitcoin in their everyday lives. In April 2017, the Japanese government passed a law recognising bitcoin and other virtual currencies as legal tender. Morito Saito, senior vice president of UHY FAS Ltd in Tokyo, believes that several factors have helped to give bitcoin legitimacy in Japan. “Firstly, Japan's Financial Services Agency (FSA) started regulating bitcoin, and that led to its credit rising,” he says. “The FSA issued a licence to cryptocurrency exchanges, also requiring them to have minimum capital reserves and anti-money laundering checks in place.” With official sanction and oversight, bitcoin’s credibility rose. Morito Saito says that another decisive factor was the decision of several leading financial institutions – including major Japanese banking groups SBCC Venture Capital, Mizuho and Mitsubishi UFJ Capital – to invest in Bitflyer, the country’s leading bitcoin exchange. “Major retailers, such as Bic Camera and Marui, started partnerships with Bitflyer, which also raised the credibility of bitcoin,” he adds. In fact, this raised bitcoin’s credibility to the point where, today, a number of major Japanese retailers accept bitcoin payments, and at least one company has offered to pay part of its employees’ salaries in virtual currency. ADVISE OR IGNORE? Few countries regard the trading of cryptocurrencies as favourably as Japan. China was the world leader in bitcoin trading until 2017, when the government clamped down on trading platforms. In 2014, Bangladesh passed a law threatening to jail anyone caught using the virtual currency. Other governments have not seen fit to legislate for or against bitcoin, but much of the current mood is negative. Both US secretary of the treasury Steven Mnuchin and British prime minister Theresa May have recently raised familiar concerns about criminals exploiting the anonymity of cryptocurrency for illicit ends. The G20 have also confirmed plans to implement the Financial Action Task Force (FATF) anti-money laundering and anti-terrorist financing standards to cryptocurrencies. All of which leaves financial services companies with a dilemma. What view to take on bitcoin (or the virtual currencies that replace it)? How to advise inquisitive clients? Governments and experts may have turned on bitcoin, but many investors are following its fluctuating fortunes closely. Bitcoin may (or may not) end badly, but the conditions that led to the creation of virtual currencies in the first place will not go away easily. The Australian government has remained neutral over the issue, leaving citizens free to trade bitcoins as they choose. But Selwyn Cohen, managing partner at UHY member firm Cohen Fasciani in Melbourne, echoes the sentiments of many. “A large number of our investor clients are trading in bitcoin, but as a profession we still know relatively little about it,” he says. “I have seen some clients make significant gains. I must say, however, that I am not aware of any of these clients banking realised gains.” Even in Japan, where bitcoin trading is especially popular among young people, accountants remain cautious when issuing advice, at least for the moment. “We would like to find out [first] if cryptocurrencies like bitcoin will be used with confidence in the wider world as well,” says Morito Saito at UHY FAS Ltd in Tokyo. “If we can trust it, we would like to advise on it in future, if requested to by our clients. “We still do not know whether bitcoin is a bubble. However, as the volatility is high, and because it is generally believed that a small number of holders possess most bitcoins, we believe that the price is very unstable.” REAL-WORLD NEEDS With instability being the defining feature of bitcoin at the moment, should financial services companies take cryptocurrencies seriously at all? Paul Mencke, partner at UHY member firm Govers Accountants/Consultants in Eindhoven, the Netherlands, thinks that while the currencies may be virtual, their popularity has been fuelled by real-world concerns. “In my opinion, the bitcoin bubble has a number of causes,” he says. “The antipathy towards banks and financial institutions was initiated by the credit crisis. In a world with large environmental problems, there is scepticism about traditional industries, and ‘new kids on the block’ are welcomed. Coupled with which, there is a very strong belief in the power of innovation, technology and, these days, the disruptive combination of digitisation and the internet.” Warren Zafrin, partner at UHY Advisors, Inc. in New York, United States, believes that cryptocurrencies evolved to fill a real need. “There is no denying that bitcoin has real applications,” he says. “For example, if you are transferring a tangible asset, like a car or a mortgage, tokenising that asset – making it digital – cuts out paperwork and reduces costs. The same applies to transferring cash abroad.” Warren says the key to understanding bitcoin is to see it as an asset rather than a currency. “Like most new assets, there are fluctuations,” he adds. “We are seeing the first of many fluctuations for this asset. But the price will eventually stabilise, in a way no different to the eventual stabilisation of any volatile commodity. The only real advice for people wanting to invest right now is to find an exchange that you trust, and to use a digital wallet to secure the currency.” Bitcoin may weather the current storm and find real worth as a digital asset. It may become a useful financial tool, a free and effective way to transfer assets or move money abroad. Or it may fade into insignificance, another online novelty that ultimately delivered less than it promised. BLOCKCHAIN - AN ACCOUNTING TECHNOLOGY But even if bitcoin crashes, the technology upon which it is built – blockchain – is unlikely to follow it down. Put simply, blockchains are dispersed digital ledgers with no central control. Transactions are recorded in a network of identical ledgers, making them permanent and immutable, and creating the transparency and confidence that allow cryptocurrencies to work. But cryptocurrencies are only one of the potential applications of blockchain – many of the others directly affect the role and work of financial services companies. The Institute of Chartered Accountants in England and Wales (ICAEW) describes blockchain as “fundamentally an accounting technology”. Blockchain creates trust without central oversight, removes the need to reconcile disparate ledgers, and creates absolute transparency around transactions. As the ICAEW states: “Assuming that all the technological barriers could be overcome, blockchain has huge potential.” At UHY FAS Ltd in Japan, Morito Saito also takes a positive view. “It seems that blockchain technology can be utilised in many ways,” he says. “We think that it will be of great help to the transparency of corporate accounting and financial transactions.” There are worries over security and the potential for the wide propagation of fraudulent transactions, as well as legitimate ones. For that reason, Morito Saito believes that the sector needs to guide the evolution of blockchain applications, helping to create services and solutions that utilise blockchain while ensuring proper supervision and regulation. Those services need to be standardised and optimised to work across sectors and borders. Warren Zafrin at UHY Advisors in New York, United States, also sees risks in blockchain, alongside real opportunity: “Blockchain can free up the time and resource to allow firms to invest in the advisory side of their businesses. Companies need to know about blockchain; they will also need blockchain-based solutions and services. Firms could spend more time solving the financial challenges of clients, as opposed to just reporting on them.” Indeed, they may need to do this, because automated efficiency comes at a price. Blockchain has the potential to significantly reduce the need for some of the more mechanical accountancy tasks, and jobs in bookkeeping and reconciliation work may be put at risk. We are not there yet. Blockchain may fail to surmount its technical obstacles. As Warren says, it is not yet clear how individual chains link together, and how to make the technology scalable for widespread application. But the potential for blockchain to increase efficiency, reduce costs and open up new avenues of operation for forward-thinking accountancy firms is real – in theory, at least. For now, bitcoin will continue to make the most headlines. Unusually, the rather unflashy and arcane back-office technology that supports it may be the innovation that ends up changing the world. Click here for our infographic on how blockchain works THE VIEW FROM UKRAINE As a country known for its growing and innovative technology sector, it is perhaps no surprise that Alexander Koinov, managing partner at UHY Prostor Ltd in Kiev, has noted the growing popularity of bitcoin in Ukraine. “Cryptocurrency was an extremely popular topic in Ukraine in 2017,” he explains. “National media outlets reported on bitcoin, and we saw a number of cryptocurrency-themed meet-ups and conferences where people could learn about the history of bitcoin and the principles of the technology behind it. I would say that most Ukrainians know the word ‘bitcoin’ and understand it as an investment instrument with the potential to bring a good profit. “If our clients were to ask about investing in cryptocurrency, our advice would be that they must accept the risk of losing money before investing in bitcoin due to the price fluctuations we have seen.” However, in the Ukraine, the focus on bitcoin is as much on mining (the process of creating bitcoins by using special computer equipment to solve complex mathematical problems) as investing. “The mining of cryptocurrency is very profitable in Ukraine,” says Alexander. “This is because the price of electricity for businesses is very low, and there are many suitable and cheap premises and technically well-educated staff.” Beyond the cryptocurrency itself, Alexander believes that the technology that underpins bitcoin is likely to have the most impact going forwards. “I am sure that blockchain technology will change the face of accountancy in the next 10-15 years,” he says. “By then, this revolutionary technology could have solved the very important task of providing an absolute 100% guarantee of credible information. Information that has been approved once by blockchain can never be changed or deleted – that could be a hugely significant development for accountants.” This, of course, raises the question of how accountancy firms should prepare for blockchain and the disruption it may bring. “At present, if we look at the services offered by accountancy firms, they are largely focused on audit and accounting,” says Alexander. “Many elements of these services will become automated as technology develops, and so we have to be prepared to transform and take advantage of possibilities to create new value in our service offerings. Using blockchain technology at an enterprise level, for example, is one area where we are likely to see development – and now is the right time to talk about it.” Our UHY expert contributors to this article are listed in alphabetical order below, including contact details. For more information about UHY's capabilities, email the UHY executive office: info@uhy.com CRYPTOCURRENCY GLOSSARY The advent of cryptocurrency has brought with it a whole new language. Our glossary covers the basics. BITCOIN The world’s first and best known decentralised digital currency or CRYPTOCURRENCY, released in 2009. BLOCKCHAIN A DISTRIBUTED LEDGER that underpins the use of bitcoin and other cryptocurrencies. CRYPTOCURRENCY Digital currency that uses encryption to secure and verify transactions, and to regulate the generation of currency. Cryptocurrencies operate independently of a central bank, with transactions performed through NODES and recorded in a DISTRIBUTED LEDGER. DIGITAL WALLET Software held on an electronic device that enables electronic transactions and can be used to store CRYPTOCURRENCY. DISTRIBUTED LEDGER A shared and synchronised database that operates on a peer-to-peer network. MINING The validation of cryptocurrency transactions. Mined BITCOINS are added to the BLOCKCHAIN by a miner. Miners are incentivised by receiving new bitcoins when transactions are validated. NODE A point in a network that enables the transmission of data. In the case of cryptocurrencies, nodes are the means through which transactions are verified.


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