What you need to know about accounting for bitcoins?

The first time I heard the phrase blockchain technology was over the holidays when my husband was talking to his cousin. I was not about to show my hand that I wasn’t too clear on what blockchain is until I fully understood the conversation, then I heard the word Bitcoin. Afterwards I thought I knew what the conversation was about.

There are key things that emerged from that conversation namely, blockchain technology as the future, more cryptocurrencies emerging and the fundamentals of investments i.e. risk, perception and value. These have led to many people debating over investing through cryptocurrencies (which is not yet fully understood) or traditional investments (which everyone understands). The similarities and differences between the traditional investments and these digital assets brings about many issues of financial recognition and disclosure for us accountants. In this article I want to first deal with the basics of bitcoin, and the blockchain technology behind it before we can discuss the financial reporting side of things in the part two of the article.

Bitcoin is considered part of blockchain technology and to understand blockchain technology you need to have an idea of what Bitcoin is.

The Bitcoin narrative appeared in a 2008 paper authored by a person, or persons using the pseudonym Satoshi Nakamoto. It detailed an electronic cash system that enabled online payments to be transferred directly, without the traditional intermediaries like banks, credit card companies and governments to ensure trust and certainty. The technology that lay behind the digital currency (bitcoin) is what is known as blockchain technology. Bitcoin is only one of about seven hundred applications that use the blockchain operating system.

Blockchain technology underpins digital currencies and ensures that all transactions are properly conducted and recorded. But what is stored on the blockchain need not be just a monetary unit – it has other interesting uses. For example

  • Financial Services: Smart Bond and Smart Contracts (used to describe computer code that can facilitate the exchange of money, content, property, shares, or anything of value)
  • Smart Property (The decentralized ledger also becomes a system for recording and managing property rights as well as enabling the smart contractsto be duplicated if records or the smart key is lost)
  • Digital Identity
  • Digital Voting
  • Distributed Cloud Storage etc.

Explained in layman terms “Blockchain is to Bitcoin, what the internet is to email. A big electronic system, on top of which you can build applications. Currency is just one.” — Sally Davies, FT Technology Reporter.

Collin Thomspon Blockchain Product Designer and Growth Marketer describes blockchain as, “a type of distributed ledger or decentralized database that keeps continuously updated digital records of who owns what. Rather than having a central administrator like a traditional database, (banks, governments & accountants), a distributed ledger has a network of replicated databases, synchronized via the internet and visible to anyone within the network.”

Now the intermediary relationship or the central administrators would perform a range of important tasks that help build trust into the transactional process like authentication & record keeping. The need for intermediaries is important when making a digital transaction as digital asset like money, stocks & intellectual property, are essentially files, they are incredibly easy to reproduce. This creates what’s known as the double spending problem (the act of spending the same unit of value more than once) which until now has prevented the peer to peer transfer of digital assets for example Bank A holds $1 and would like to transfer that $1 to Bank B, this would need to go through Regulator X, the double spending problem of Bank A making a digital transfer of the same $1 to Bank B and Bank C at the same time is reduced as the transaction goes through Regulator X for validation. Hitting closer to home, some may wonder how there is a mismatch between the RTGS balance and the physical cash notes???

The aim for Bitcoin was to remove the middlemen when the digital transaction is made, now you are wondering how the validation, authentication and record keeping process is done. When a digital transaction is carried out, it is grouped together in a secret code or cipher of protected block with other transactions that have occurred in the last 10 minutes and sent out to the entire network. Miners (members in the network with high levels of computing power) then compete to validate the transactions by solving complex coded problems. The first miner to solve the problems and validate the block receives a reward e.g.in bitcoin network a miner receives bitcoins.

The validated block of transactions is then timestamped and added to a chain in a linear, chronological order. New blocks of validated transactions are linked to older blocks, making a chain of blocks that show every transaction made in the history of that blockchain. The entire chain is continually updated so that every ledger in the network is the same, giving each member the ability to prove who owns what at any given time.

It seems more bitcoins are being created or “mined” just like how countries print money essentially yes but there are limits. The bitcoin protocol specifies that the reward for adding a block will be halved every 210,000 blocks (approximately every four years). Eventually, the reward will decrease to zero, and the limit of 21 million bitcoins will be reached and the record keeping will then be rewarded by transaction fees solely. This raises the question on whether bitcoin can be compared to e.g. gold because it has a limit in terms of supply and also use unlike other traded “currencies or commodities”.

There are over 30 digital currencies that are indexed on the Cryptocurrencies Index (CCI30.com) with a total market capitalisation of over US $766 billion to date (Coinmarketcap.com). Some describe Bitcoin as “digital gold” which to date has reached over $ 251 billion US in total value to date.

Now it seems cryptocurrency is a form of exchange/currency (because many retailers are beginning to accept as a form of exchange) that does not exist in physical form but only digitally. Kodak announced on 9 January 2018 that they will be launching their own cryptocurrency called KodakCoin and this has led to its share price doubling after the announcement. The cryptocurrency is not linked to any physical currency, nor is it backed by any government, central bank, legal entity, underlying asset or commodity. Now this creates a nightmare for accounting I believe but that’s Part 2 of the Bitcoin and Blockchain Analysis.

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About the Author : Cleopatra

Cleopatra is a Technical Manager at Training and Advisory Services. She is an expert in both IPSAS,Audit and IFRS. You can contact her at cleo@tas.co.zw

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