Blockchain, Bitcoin and ICOS
Current Issues | Financial services | 23rd November 2017
There has been much talk in the press about blockchain, Bitcoin and ICOs. Here we attempt to break the jargon down and explain it all, and also consider some of the accounting and tax implications.
Blockchain is a good place to start, as it is the concept upon which this new industry is built. A blockchain is essentially a ledger of transactions which gets larger over time as more transactions are added to it. When a bunch of new transactions are ready to be added, they are called a block. A blockchain is simply a chain of blocks added together to form a ledger. The ledger itself is not in one place. Full and partial copies of it are spread out across computers across the world. You may have heard the term Distributed Ledger Technology, and this is what this means, as the ledgers are distributed across many locations.
The appeal of blockchain technology is that when you want to add some more transactions to the ledger, all the existing transactions are verified using a complex algorithm. The theory goes that you can’t cheat the system, as the list is being continuously verified. If one copy of the ledger is altered, then it is disregarded by the system as there are many other correct copies.
As blockchains are essentially a list of transactions in a theoretically immutable list, there are many applications which they can be used for. Bitcoin is an example of using this list to track financial transactions, but a blockchain could be used to record property titles, share transactions, airport baggage movements, to name just a few. Anywhere that you need a list of things, blockchain can be used, which is why it is considered to be the next game changing piece of technology.
We may see in a few years, accounting transactions linked to the blockchain which would theoretically mean that audits are not required, as a transaction within a blockchain definitely took place, and therefore doesn’t need checking.
This is one of the first ‘crypto’ currencies and has to date been the most successful. Many people wonder why it is worth anything at all, but across history, we have assigned value to things (gold is only valuable because it’s rare and looks nice, and we’ve decided that it has a value).
Bitcoin does in fact have two key features making it valuable. The first is that it is built on blockchain technology, which means every transaction is recorded and theoretically immutable. If you wanted to pay someone £1 for example, you could buy £1 of Bitcoin, send the Bitcoin to them (thereby recording the transaction) and they could then swap this Bitcoin back for £1.
The second feature making it valuable is that it is a decentralised currency, not linked to any bank or country. This makes it an appealing way of putting your money somewhere else if you are worried about your own currency (at time of writing, South Korea is the biggest buyer of Bitcoin as they are worried about a war with the North). If widely adopted it also gives the potential to travel the world and pay for goods with a single currency, rather than changing up currency each time you go abroad.
Of course it has some downsides, and the main one is that Bitcoins are stored in a ‘wallet’ which is only really linked to an email address, making ownership largely anonymous. A wallet can be in the form of an app on your smart phone and consists of lots of letters and numbers. If you lose this ‘key’ then you can’t access your money.
The other disadvantage is that (in the UK at least) it is not regulated, so if you want to buy or sell Bitcoin you have to use a company or website based solely on trust, rather than some solid registration process or underlying authority. It’s likely that this will be brought into regulation at some point.
Bitcoin transactions are verified in the blockchain as described above, and this takes lots of computing power and electricity. The people and companies who are doing this verification are called ‘miners’ and they are rewarded in Bitcoin by the network for the computing power they contribute.
Could it be hacked? Yes, theoretically if you had enough computing power. However, currently it would take half the electricity consumption of Denmark, and you’d need a few billion to spend on computing equipment.
How do you account for it? If you are a company and you hold Bitcoin, it’s probably going to be classified as either stock, or a cash equivalent, depending on what your company does. As with any asset, if it goes up in value you have a taxable gain subject to corporation tax. If you are an individual, an increase is treated as a capital gain and is again taxable.
Initial Coin Offerings
These are another hot topic and have raised more money in the last year than private equity funds (over $3bn in 2017 alone). An Initial Coin Offering (ICO) is a bit like crowd funding. It is a way for a company (usually in the fintech/blockchain space) to raise finance quickly and this is raised in crypto currencies, usually Bitcoin or Ether.
The way it works is that a number of ‘tokens’ are created (using blockchain technology of course) and these are given some value by the company wanting to raise finance. They may entitle the holder to first dibs on the new bit of technology the company is creating, or it may promise some profit share in the future. Unlike an IPO, in an ICO the tokens aren’t linked to equity so the holder has no share of the company.
Once issued, the tokens may be put on an exchange and can be traded like shares. They go up and down in value in the same way. There are even investment funds which invest in a range of tokens. Essentially the whole financial industry has been mirrored in the cryptocurrency and blockchain space and this has happened over the course of just a few years.
ICOs are not regulated and investors decide what to invest in based on a ‘whitepaper’. This is a document issued by the company, and is a bit like a business plan. They are therefore highly speculative and risky. They have proved themselves however to be a very efficient way of raising finance in this market which has helped it develop so quickly.
From an accounting and regulation stand point, a company undertaking an ICO needs to be careful that it is not seen to be issuing transferable securities and which would therefore bring it within the scope of FCA regulation. So legal and accounting advice is highly recommended.
Shipleys has early experience in this sector and has a number of clients within the space. Please get in touch if you would like more information.
Specific advice should be obtained before taking action, or refraining from taking action, on any of the subjects covered above. If you would like advice or further information, please speak to your usual Shipleys contact.