Paul Golden 8 Jan 2018 04:07pm

The future of cryptocurrencies

Proponents of cryptocurrency describe it as the future of payments. But, says Paul Golden, a number of important issues remain to be addressed before digital virtual currencies are fully embrace

Caption: Illustrations: James Olstein

The European Central Bank defines a virtual currency as “a digital representation of value, not issued by a central bank, credit institution or emoney institution, which in some circumstances can be used as an alternative to money”.

A cryptocurrency is a digital virtual currency that uses encryption technology or cryptography in its creation and to ensure the security of transactions involving its use. As of 7 November 2017 there were 1,265 cryptocurrencies, although bitcoin is by far the most widely used and accounts for the majority of the total market capitalisation.

Payment mechanism

Dr Micheál Ó Floinn is a lecturer in cybersecurity law at the University of Southampton who spoke at a recent Fraud Advisory Panel event on cryptocurrencies at Chartered Accountants’ Hall and is the co-author of the paper A Brief Introduction to Cryptocurrencies. He says very few businesses in the UK are using cryptocurrency as “money” or as a payment mechanism for a number of reasons.

“Firstly, there isn’t much consumer interest in spending cryptocurrency,” he explains. “What we are seeing is greater use of bitcoin and other so-called ‘altcoins’ for trading and investing, rather than as a payment transaction method. Coupled with issues such as the investment in infrastructure required to accept cryptocurrencies as payment, the incentives are simply not there at the moment.”

According to Ó Floinn, it is also a rapidly evolving field, both technically and from a regulatory perspective, and this is an inhibiting factor for most businesses. “There are many different cryptocurrencies emerging – each with different features – and there is currently even some uncertainty about the real bitcoin, due to various software forks,” he says. “For all of these reasons, it is understandable that businesses are nervous about embedding cryptocurrencies in their business activities.”

While there is a lot of interest in the UK in the potential of the distributed ledger technology that underpins these currencies, Ó Floinn suggests that many businesses overestimate the efficiency gains they can make from it.

David Lyford-Smith, technical manager at ICAEW’s IT Faculty, acknowledges that interest in bitcoin has risen, but agrees that it is still perceived by many as an investment rather than a means of payment – a view fuelled by the sharp increase in its value against the dollar this year.

“This volatility limits its value as a unit ofaccount,” he explains. “Companies may accept bitcoin payments, but they would not price goods or services in bitcoin and would immediately exchange it for their domestic currency.” He also suggests that relatively few businesses fully appreciate the difference between using bitcoin and the established payment networks.

There are also some technical limitations that need to be addressed in terms of throughput – how many transactions can be accommodated on the underlying infrastructure – and latency, which is the length of time it takes for transactions to be confirmed.

“If bitcoin wants to become a widely used currency, consumers need to be able to use it like they currently use their debit card and the bitcoin blockchain is not yet in a position to enable that in terms of either transaction volumes or speed of confirmation,” says Lyford-Smith. There is also the issue of refunds. Once a party transfers bitcoin to another party, they can only get it back with the agreement of the receiver.

Initial coin offering

Some businesses looking to raise funding are exploring the potential of an initial coin offering or ICO, where issuers accept a cryptocurrency in exchange for a proprietary “coin” or token that is related to a specific firm or project.

“This is a quick and easy source of funding from individuals around the world keen to flip the coins for a quick profit when they are launched on exchanges,” explains Ó Floinn. “Billions of dollars have been raised through this mechanism in 2017 alone and we will soon see much more regulatory intervention in relation to ICOs on both sides of the Atlantic. There are huge risks for businesses that seek to use ICOs without an understanding of the legal ramifications in the countries within which they operate.”

In September the FCA published a consumer warning about the risks of ICOs, noting that the digital token issued may offer no discernible value at all and that projects are often in a very early stage of development.

According to the FCA, ICOs are very high-risk, speculative investments and should only be participated in by experienced investors who are confident in the quality of the project and prepared to lose their entire stake.

Most ICOs are not regulated by the FCA and many are based overseas, which means investors are extremely unlikely to have access to UK regulatory protections such as the Financial Services Compensation Scheme or the Financial Ombudsman Service.

Some issuers might not have the intention to use the funds raised in the way set out when the project was marketed and, instead of a regulated prospectus, often only provide a white paper that might be unbalanced, incomplete or misleading.

Businesses involved in an ICO should carefully consider if their activities could mean they are arranging, dealing or advising on regulated financial investments. Each promoter needs to consider whether their activities amount to regulated activities under the relevant law.

Know the customer

Richard Howlett, founding partner of law firm Selachii, says there is limited potential for fraud if a business accepts bitcoin as a payment method. “As long as the business knows who its customer is and ensures it takes precautions in relation to money laundering, the risk is no higher than accepting normal fiat currency [currency that a government has declared to be legal tender],” he says.

The business would need someone who understands wallets and how payments are sent and received so it is aware when payment has been made, but this is a simple process to comprehend. Obvious precautions include protecting the security of the wallet and bitcoins and ensuring the businesses do not fall prey tofraudsters seeking to gain access to the wallet – but again, this is the same as for fiat currencies.

From a tax perspective, HMRC advises that VAT will be due in the normal way from suppliers of any goods or services sold in exchange for bitcoin or other similar cryptocurrency. The value of the supply of goods or services on which VAT is due will be the GBP value of the cryptocurrency at the point the transaction takes place.

For businesses that accept payment for goods or services in bitcoin there is no change to when revenue is recognised or how taxable profits are calculated.

The general rules on foreign exchange and loan relationships apply to the tax treatment of virtual currencies. Exchange movements are determined between the company’s functional currency (usually the currency in which the accounts are prepared) and the other currency in question. The profits and losses of a company entering into transactions involving bitcoin would be reflected in accounts and taxable under normal corporation tax rules.

The profits and losses of a non-incorporated business on bitcoin transactions must be reflected in their accounts and will be taxable on normal income tax rules.

Payroll option

This summer, payroll company Bitwage introduced a service that allows UK employees to receive part or all of their wages in either bitcoin or competing cryptocurrencies ether and litecoin. According to company president Jonathan Chester, UK workers for companies abroad can use the platform to receive their wages faster and more cheaply. “By leveraging bitcoin as an intermediary instead of correspondent bank accounts, funds can move much faster and cheaper across borders – same or next day instead of up to two weeks,” he says.

According to a survey published by MarketInvoice in September, 21% of businesses expected cryptocurrencies to feature in their payment transactions over the next 12 months. However, relatively few UK companies currently accept cryptocurrency as payment for goods or services.

In July, cosmetics retailer Lush started accepting bitcoin for online purchases through BitPay (which converts the cost of the items purchased in pounds into the bitcoin equivalent at the time of purchase) while in September Frank announced that it would become the first UK PR agency to accept payment for its services in bitcoin.

At the time of publication Lush had not put forward a spokesperson for interview, while Frank declined to comment.