It’s Not Really about Bitcoin, It’s about Change

Fayez Choudhury | June 10, 2014 | 1

The accountancy profession plays an important role in promoting the growth of economies and the efficient operation of markets. In these times of rapid technological change, we should also be key players in the financial innovation taking place across society. There is perhaps no better example right now than the development of virtual currencies, such as “bitcoin.” What are the major challenges and opportunities that bitcoin presents for the profession? What role should we play in its evolution?

What is Bitcoin?

Bitcoin is a virtual form of money—a “crypto-currency” that utilizes secure communication, data integrity, and authentication technologies. Bitcoin has the qualities of a commodity in finite supply. The total count of bitcoin is currently more than 12 million. However, there is a planned cap on the number of bitcoin available—20,999,999.9769 in the year 2140.

No one owns the bitcoin network. It is controlled by bitcoin users around the world via peer-to-peer technology with no central authority or banks. Managing transactions and the issuance of bitcoin is done collectively by the network. Bitcoin payments are currently processed with little or no transaction fees, although users may include fees with transactions.

Anyone can use bitcoin. You can buy them from a bitcoin exchange or from other users. They are stored in secure digital “wallets,” can be used as payment for products or services with any business that accepts them, and can be exchanged back into hard currency (additional information is available online from bitcoin).

Challenges to the Financial Reporting Supply Chain

Bitcoin poses challenges that impact the financial reporting supply chain—including accountants, auditors, and those in financial leadership positions.

Cybersecurity

Even with today’s advanced encryption and security technologies, experts say that bitcoin is vulnerable to sabotage. Bitcoin payment processors run the risk of distributed denial-of-service attacks, whereby networks become unavailable to their intended users. There are also risks posed by hackers who compromise the integrity of data and commit theft.

Fraud

Bitcoin transactions are irreversible and there are no protections. Recently, a bug was detected in the bitcoin software that allowed the creation of false transactions and transaction details. There have also been reports of Ponzi schemes and other types of investment fraud. In 2013, the Securities and Exchange Commission issued an investor alert cautioning investors about the risks of buying and using digital currency such as bitcoin.

Risk management and internal controls

Bitcoin’s transparency poses risks. Transactions are recorded instantly in a public ledger—a “block chain” that contains permanent transaction information. Anyone can monitor this information, and the email addresses of those conducting transactions. Thus, new addresses should be generated for each transaction as competitors could conceivably reconstruct a cash-flow statement from such information. In addition, because bitcoins are stored in digital wallets, corporate treasurers should be careful to allocate funds into wallets stored in separate systems.

Volatility and value measurement

Bitcoin values have been volatile and difficult to classify. In 2013, the price soared from less than $15 to more than $1,000 over the course of the year. Volatility can be traced to a number of factors, including negative publicity (e.g., media coverage of fraud or theft) and government reactions regarding its legitimacy. Most jurisdictions that do regulate bitcoin have rejected its classification as a currency since it is a peer-to-peer unit. In addition, several nations have characterized bitcoin as “assets” and others as “intangible assets.”

Taxation

Is bitcoin a capital asset, like a stock or commodity that is subject to capital gains taxes, or a fiat currency, for which gains are taxed like income? Or is it an asset rather than a currency, forcing users to deal with complicated tax rules associated with bartering? This would likely discourage some businesses from accepting bitcoin in order to avoid record keeping difficulties associated with bartering.

Regulatory uncertainty

Many regulators are still undecided about how to treat bitcoin, and countries are reacting to bitcoin, and its classification, differently. The US has not taken an official position on classification. Russia has said it will regulate virtual currencies because they can be used for money laundering and financing terrorism. The European Union has warned citizens that they are unprotected when using it. China has recently banned the use of bitcoin as a regular currency.

Opportunities

Bitcoin poses opportunities to strengthen and expand the scope of what accountants do and how we do it.

Closing the gap between accounting and IT

The complex technologies required for bitcoin demonstrate that form and content are increasingly becoming inextricably linked. The data encryption processes involved are a function of the accounting information and vice versa. The gap between accounting and IT will continue to narrow as more dynamic cross-functional teams emerge. This offers the potential for accountants to develop new specializations and accounting firms to expand business advisory services.

Improved corporate governance and audit procedures

The public ledger, block chain, and other encryption proprieties can evolve into transparent, systemic safeguards. The traceability of transactions and nearly all forms of record keeping tied to them could actually reduce fraud and force those in key financial roles to ensure responsible behavior in ways that ethical codes cannot. Everything from managing business operations, accountability to investors, and consumer protections can be improved. As the bitcoin system relies more upon cryptographic proof than on human trust, its transparent processes may eventually require different audit procedures, given the complexity of the technological environment.

New business models

Accountants are in an ideal position to consider the advantages and disadvantages of bitcoin. Clearly, many industries and markets have yet to adopt the currency or even consider how it would work in their business models. Accountants may be among the first to consider the practical, logistical, hands-on implementation issues in their clients’ industries.

It’s Not Really about Bitcoin, It’s about Change

Digital currencies could be here to stay. Whether bitcoin succeeds or fails isn’t really the point. There already are other virtual currencies on the rise and competing for market share. Given the challenges and opportunities—and the accountancy profession’s linkages with these issues—shouldn’t we be involved in the debates that shape the innovation, use, and regulation of cyber-currencies?

We invite your views.