Accounting for Crypto

The period leading up to June 30 saw the usual raft of end of financial year updates, special offers and reminders from equipment suppliers, business service providers, accountants, tax specialists and even the ATO itself.

Crypto is certainly getting a lot of attention in Australia at the moment.

First, there is a Senate Select Committee on Australia as a Technology and Financial Centre, including “opportunities and risks in the digital asset and cryptocurrency sector”. The Select Committee is also looking at ways to define and/or potentially regulate crypto assets.

Second, ASIC has launched a public consultation process on crypto ETFs. This follows a desire from the regulator for more policy guidance from the Federal Government on the “regulatory perimeter” for crypto assets.

Third, the CPA published an op ed on the need for more clarity in crypto asset accounting. Not just in Australia, but across the world of International Financial Reporting Standards.

None of this should be surprising, as governments, regulators, tax authorities, professional bodies and institutional investors are still struggling to comprehend this new asset class, and the technology that underpins it.

Do crypto and digital assets represent currency, commodity, real estate, software license, network membership, utility access, payment mechanism, store of value, financial security, or unique property rights? Depending on the design, use case and origination of a token and its economic properties, the answer could be “yes” in each case – albeit not all at the same time.

In my consulting work with Brave New Coin, I get to speak to clients on a daily basis about their own crypto activities – be they exchanges, asset managers, accountants, tax authorities, regulators or investors. A lot of the discussion involves education – helping them to make sense of the technology and its potential. Some of the time they are simply asking our advice about how to address a particular issue, or they need a recommendation for a custodian or broker. A few share the regulatory challenges they face, and seek our perspective in how to navigate them. Others need more technical help, in building software solutions, or with on-chain analysis and wallet tracking (even though “free” block explorers already do a pretty good job in that regard). While many simply need a source of market data and indices for price discovery and NAV calculations, or a process to capture and track the crypto equivalents of corporate actions.

If anyone wonders how we are doing to make the reporting of crypto holdings as simple as equities or fixed income assets, my own experiences suggest we have a way to go. Legacy accounting and portfolio tools struggle with crypto: for example, can they calculate to 8 decimal places? how do they deal with an air drop? and how do they distinguish between Ether and Ethan Minerals (both use ETH as their ticker symbols), or Cardano and Adacel Technologies (both use ADA). And if I am an accountant, auditor, financial planner or adviser, how can I make sure I understand my clients’ portfolio of crypto investments, if I don’t have the appropriate tools?

Next week: Goya – allegories and reportage for the modern age

Notes from New York Blockchain Week

Courtesy of Techemy and Brave New Coin, I was fortunate to attend this month’s New York Blockchain Week. Here are some high-level observations from my personal notes (all views are my own):

First, depending on who you asked, attendance numbers for the headline event, Consensus (organised by Coindesk), were well down on last year. Certainly, compared to last year’s human zoo (based on feedback from people who were there), there was more breathing room in the conference venue, and less frantic activity in the crush to get to and from plenary sessions.

Second, the last time I attended a Consensus event, Consensus Invest in December 2017, Bitcoin hit a then record peak of US$10,000. And while we did not see new all-time highs this month, Bitcoin again obliged with a substantial rally – such that many delegates felt that the crypto winter had thawed. Certainly, it helped to buoy the mood of the whole week, and the organisers of the Magical Crypto Conference were confident enough to bring a live bull to their event. (And where my colleague, Josh Olszewicz moderated an excellent panel on Exchanges.)

Third, there were more corporate exhibitors at Consensus – a sign that the Blockchain and Digital Asset sector continues to mature. Some of the enterprise solutions on offer are still early stage (for example, one institutional custody provider I spoke to are only servicing their clients’ Bitcoin holdings), and we are yet to see some high-profile projects get beyond proof of concept stage. Meanwhile an important component in Smart Contract management, ChainLink, is about to launch on their main net, and there was a lot of discussion around scaling (such as the Lightning Network) and interoperability (such as Submarine Swaps).

Fourth, another recurring theme was Custody solutions. Pension funds and other institutional asset managers are demanding robust, industrial strength infrastructure before they will allocate any of their funds under management to the new crypto asset class, as they will not entrust assets to be stored on exchanges or in vulnerable wallets. Moreover, institutional players require segregated client accounts, full transaction records and holding reports, independent and fair-value pricing data for NAV calculations, in addition to clearing, settlement and custody services.

Fifth, and linked to the above, there were a number of projects talking about dark liquidity pools. Not for any nefarious reasons (and not to be confused with the dark net), but to replicate what happens in other asset classes. Parties may wish to trade with trusted counterparts, but they don’t necessarily want to know each other’s specific identity. When it comes to placing a particular buy or sell order they might not want to reveal a position.

Finally, while there were some frivolous and lunatic fringe elements to the week, in general it felt more “grown up”. There were fewer ICO’s being shilled, and a number of projects that I spoke to (exchanges, protocols, tokens) are going through a period of transition and restructure – across their management, organisation, finances, legal entity or business model. Another sign of growing up in public.

Next week: Postscript on the Federal Election

 

 

Blockchain and Crypto Updates

Courtesy of Techemy and Brave New Coin, I’ve just been on another whistle-stop global tour: 5 cities, 4 countries, 3 continents in two and a half weeks….. Along the way, I caught up on some of the latest market and regulatory developments in Blockchain and cryptocurrency.

Giant billboard in Tokyo’s Ginza district

First, there was no hiding the fact that the past six-month “correction” in crypto markets has had an impact on trading volumes, investor appetite and institutional enthusiasm – as well as generating some regulatory noises. More on the latter below. At the same time, many of the first wave of Blockchain projects that attracted funding over the past 4 years are still at the development or test net stage, or only just launching their MVPs. Hence some investor caution on new token issuance.

Second, there are probably far too many Blockchain and crypto conferences – or rather, volume is diluting the quality of content, meaning too many sub-par events. There is no shortage of interesting topics and informed speakers, but the format and delivery of so many panel discussions and plenary sessions end up sounding tired and lacklustre.

Third, expect a crypto-backed ETF to be listed on a major exchange very soon. I even think it will come out of Europe, rather than the US, but that’s just a personal view. Such a product is going to help with investor diversification and will eventually enable retail investors to get exposure to this new asset class, even within their personal pension plans, without the same level of risk and volatility than direct holdings or spot trading.

Fourth, institutional investors are still looking for institutional products and services: proper custody solutions, robust benchmarks, hedging instruments, portfolio tools and risk analytics. One challenge is that the market is still trying to define crypto fundamentals – the sorts of analysis we take for granted in other asset classes (earnings per share, p/e ratio, yields, Sharp ratio, credit risk, etc.).

Fifth, Japan feels like a case of “two steps forward, one step back”. Just over a year ago, cryptocurrencies were formally recognised as a legal form of payment. Then in late 2017, the FSA issued the first batch of crypto licenses to qualifying exchanges. Japan continues to represent a significant portion of crypto trading (partly a legacy of retail FX trading, partly a result of regulatory restriction in other markets). But yet another exchange hack earlier this year prompted the regulator to put the industry on notice to smarten up, or face the consequences. Exchanges are subject to monthly monitoring, and the self-regulating industry body is undergoing a few changes. Plus, exchanges are no longer able to list privacy coins.

Finally, with the lack of legal clarity or regulatory detail around initial coin offerings (aside from blanket statements that “all ICOs are securities until proven otherwise”), there is still a lot of regulatory arbitrage. Certain jurisdictions are actively attracting new issuance projects to their shores, and positioning themselves as being “ICO friendly”. Ironically, even though the SEC in the USA has been particularly vocal about ICOs that may actually be deemed securities, it has not defined what constitutes a utility token (or made any announcement on the new category of security tokens). However, there have been some recent announcements out of the SEC suggesting that neither Ethereum nor Bitcoin are in fact securities. More interestingly, the State of Wyoming is looking to make Blockchain and associated crypto assets a major pillar of its economy.

NOTE: The comments above are made in a purely personal capacity, and do not purport to represent the views of Techemy or Brave New Coin, their clients or any other organisation I work with. These comments are intended as opinion only and should not be construed as financial advice.

Next week: Bad sports

Token Investment Summit, Vienna

To demonstrate how far Blockchain, cryptocurrencies and digital assets have permeated the traditional world of asset management, the Token Investment Summit in Vienna (organised by Crypto42 and hosted by the Vienna University of Economics and Business) covered a number of topics of particular interest to institutional investors.

Brave New Coin Head of Research, Rafael Delfin introduces the General Taxonomy for Cryptographic Assets

William Mougayer kicked the day off, discussing the need to define “Blockchain fundamentals”. In particular, some of the token jargon needs to be better explained (air dropping, locking, burning), and some industry practices (token definition, protocol design, staking, and on-chain governance) require more formal and consistent standards. Projects need to address their “Token-Market Fit”; chains need to think about their scaling and interoperability; and tokens need to deal with decentralized exchanges, post trade clearing, and asset classification.

Next, Rafael Delfin from Brave New Coin presented the General Taxonomy for Cryptographic Assets (covered here before), followed by pitches on behalf of Rigoblock (decentralized fund infrastructure), HydroMiner (green mining), Conda (equity tokens via a crowdfunding platform), Artis (time-based value or asset transfer on chain), Streem (“start & end” events only) and Ocean Protocol (the data exchange network from BigChainDB).

There was an overview of ICO regulation, comparing some of the developments in Germany (Bundes Block’s Token Regulation Paper), Austria (University of Graz’s KryptoStaat project), Switzerland (FINMA paper on ICOs) and Gibraltar (GBX token listing using a risk-based model).

Much of the day was given over to discussing compliance, taxation, accounting, token economics and investment research (such as token valuation models, correlation analysis and crypto returns). There was also a local case study on the Optioment scam, and the potential criminal and civil breaches.

Finally, a panel of VCs provided their perspective how to navigate this asset class, as the industry weighs up the recent wave of more speculative tokens, and moves to more structured capital gains, especially from so-called security tokens.

Next week: CoinAlts Fund Symposium, New York